What’s Wrong with the Healthcare Market?


I was thinking the other day about the American healthcare system and why it doesn’t seem to function like the other markets.  I mean, there is really no issue with getting food – it is cheap and plentiful.  Sure, people who make a lot of money are able to buy better quality food, or at least food that costs a lot of money in fancy restaurants, but anyone who is willing to work a little can get enough to feed their families, even if it is very little steak and a lot of ground beef and chicken.  Clothing is also not an issue – you can pay $5,000 for a dress, but anyone who works can get can cloth themselves and their family.

The healthcare markets, however, are different.  The cost of things can be very high, such that even someone who makes a good, middle class income can be bankrupted by a hospital stay.  There are some ways to save money, but in general the premium price is almost always charged, particularly when things are urgent.  Why is it the free enterprise works great for food and clothing – necessities of life – but not healthcare?

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Then I started thinking about it a bit and realized that healthcare is not operating under the free enterprise system like food, clothing, shelter, and virtually everything else.  Healthcare is different for these reasons:

  1.  Most people pay for buffet plans, then use as much as they want without concern for costs.
  2. Most services are provided without the consumer or the provider knowing what the price will be.
  3. The final price is decided after the product is consumed, and often the consumer and the person/entity that pays is different.
  4. Many people receive services and pay nothing.

Think about what it would be like if you went into a restaurant that had the same policies.  You can already see what happens when you pay a fixed amount for unlimited food since there are buffet restaurants.  People eat a lot more than they would if they were paying per item, and also tend to concentrate on the more expensive items.  Very quickly the buffet restaurants learn how much they need to charge and earn a profit, and that tends to be a reasonable amount since there is only so much people can eat.  But in the medical system prescriptions, devices, and services can be really pricey, so if people just keep consuming a little bit more it drives up costs, which is why premiums seem to rise every year.

 

                 

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Think now what the effects of the second and third items – having services provided without knowing the cost and not even deciding on the final price until the product was consumed  – would be in the restaurant industry.  What if you walked into a restaurant and sat down and there were no prices on the menu.  You ask the waiter about the price of a steak and he says that he’s not sure since it would depend on your insurance.  You tell him you don’t have restaurant insurance and ask him what you would pay.  He says he’s not sure since everyone pays with insurance.  He might be able to tell you the list price was $500, but says you’d probably pay a lot less.  You then go ahead and order meals for you and your family, sweating the whole time because you’re not sure what the meal was going to cost you.

At the end of the meal, the waiter comes out with the check – $3,455.  You look through the bill and see that rolls were $30 each!  You know you could have bought a whole pack of rolls across the street for $5.  You say that there must be some sort of mistake.  The waiter refers you to a manager who says that they could work out a payment plan.  He also says that he’d be willing to cut $1,500  off of the bill.  You’ve already consumed the food, so you can’t just say “No thanks!” and walk out the door.

Would you go to a restaurant like this?  Maybe you would if you had a meal plan where you paid a fixed amount for food at the restaurant, but what if the price of that meal plan just went up every year until you were paying $5,000 per year for the plan?  Would you be tempted to go to the restaurant more often?  Would you get more food than you really needed, and insist on only the best food while you were there?


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And what if while you were at the restaurant, you saw the family next to you just walk out without paying a bill?  They got the same food and the same service, but paid nothing.   You ask the manager why they didn’t pay and he explains that they didn’t have any money to pay, so they just eat for free as part of the restaurant’s benevolence.  Of course, you realize that the restaurant doesn’t have any source of money except for people like you who eat there and pay their bills, so you’re really paying for the bill of the family that eats free.  Going to the lot you notice that they are stepping into a brand new Cadillac.  You are getting into an old Honda because you want to save up some of your money to pay for things like food and can’t do that with a big car payment.

Obviously this is not the way that restaurants work.  The prices are clearly printed on the menu in almost every restaurant and there is no negotiation.  While you do not pay until after you’ve eaten, you have a good idea of what your bill will be and you choose restaurants based on what is in your wallet since you know that you’ll need to pay the bill after the meal or they’ll call the police.  No one eats without paying, so the price fo your food is only based on what you eat.  You’re not paying for other people.  As a result, prices are reasonable and there is a wide variety in choices of restaurants.  If eating at fancy places is your thing, you can put your money towards that and cut in other areas.  If it is not, you don’t need to pay the same price as others who like fancy places when you do go out since you can pick a cheaper place.  With medical care, especially when it is an emergency, there is little choice.  Plus if you’re on insurance because you’re worried about a big bill, you end up paying premium prices whether you use your medical care often or not.

 


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So how do we fix the healthcare system in the US?  Well, we start having people save up money for medical costs so people can pay for their own care for one.  We make prices transparent for another and have consumers pay the bill and get reimbursed by insurance rather than having fifty different deals cut with insurance companies and having the consumer have no idea what things costs.  We also get medical costs out there where people can see them rather than have everything so hidden.  Maybe there is a tech entrepreneur out there who can take that last idea and run with it.  Think about an app that tells you what the price of procedures are across your city and what that would do to medical care prices.

So what do you think?   Please join the conversation and leave a comment.  Contact me at VTSIoriginal@yahoo.com.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why Are Republicans Afraid of Free Market Healthcare?


The United States has fantastic healthcare.  We have all of the latest machines and gadgets.  You can get in and see a doctor often the same day, but certainly within a couple of days if needed.  There are also starting to be walk-in clinics at drug stores and other places where you can go without an appointment for simple things like ear infections and poison ivy rashes.  There are readily available hospitals and emergency rooms for more serious events.  Finally, there are all sorts of new drugs coming out all of the time that treat virtually everything that makes ailments that were once considered just part of growing older a thing of the past.  Certainly the care available is among the best in the world.

The issue is not healthcare, but the way in which payment has been made for healthcare for the last 40 years or so that has made the sticker price very high and the amount that people are paying increase faster than inflation.  The issue is that prepaid healthcare, in the form of cover-all health insurance plans, has become a standard benefit at work. It has also become a common benefit provided by the government for those who don’t work or who have jobs that don’t provide health insurance.

Insurance is a good thing to buy and part of a free-enterprise market.  Most people don’t have an extra $50,000 in the bank to pay for their and someone else’s car and injuries should they get into a car accident, so they buy car insurance that covers the costs should it happen.  People also don’t have an extra $200,000 to replace their home should a tornado wipe it out, so they have home insurance.  In both cases people don’t pay the full price of a car accident or a home each year when they buy the insurance – they pay a small fraction of the price based on the amount that the insurance would pay should an event occur and the likelihood that it would occur in any given year.  Insurance works well for events that are unlikely to happen, but that would be financially devastating should they occur.  This keeps the cost affordable but makes sure the money is available for the few people who use it each year.

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What is called health insurance in the US includes an element of insurance that covers things like liver transplants and hospital stays that are unusual, but it also covers doctor’s visits, prescriptions, and labs that will happen for most people each year.  This means you are paying the full cost of these procedures, plus a bit extra to cover administrative fees and profit for the insurance company.  Plus, since people are paying for everything regardless, and it will cost the same whether you go to the doctor fifty times or three times, and whether you get the name brand drugs that see for $500 per month or the generics that sell for $15 per month, people tend to use healthcare more and not take cost into consideration in their choices.  This then causes the cost of insurance to rise.

Another factor is that health insurance makes pricing very opaque.  The sticker price for a doctor’s visit might be $150, but the doctor might have an arrangement with the insurance company that they’ll take $40.  An x-ray might have a sticker price of $500, but the insurance pays $75.  If you ask the doctor, you might get similar prices, or pay just a little more or a little less, if you’re paying cash.   If you’re dealing with a hospital it is more difficult to negotiate since they’re trying to get as much as they can to of each patient, so their willingness to cut a deal will be based in part on their expectations of whether you’d be able to pay the full amount.     Because a lot of people pay nothing at the hospital, or the hospital gets less than the cost of care from the government Medicaid or Medicare programs, they charge others more to make up the difference.  They then claim that the ones who don’t pay are getting “charity care” from the hospital, when really the patients who pay out-of-pocket or use insurance are paying the their bills, and they don’t even get to deduct the gifts from their taxes.

                 

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Free-markets, where there are many consumers and many providers trading with each other, would work with health care just as it works with everything else.  If everyone just paid out-of-pocket and didn’t use insurance except for major events, the costs would immediately drop to be in line with what the insurance companies pay or even less since the doctor’s would no longer need to spend time and money sending in insurance claims.  If everyone were paying for themselves, costs would decline since you wouldn’t be paying the costs that others didn’t pay, just as it would be a lot more expensive to go out to eat if you were paying for the tables around you rather than just the cost of your food.  Prices would also start to be more transparent,  as medical centers started to advertise their prices and specials to attract customers.  Those that didn’t provide their real pricing would lose customers since people wouldn’t put up with not knowing the price before they bought things and being surprised at the end just as they wouldn’t shop in stores that had no prices until they got to the register.  Prices would drop as providers looked for ways to be more efficient and cut their costs to avoid being undercut by other providers.  Manufacturers of medical devices and drugs would also look for ways to cut costs if they were competing for consumer dollars rather being able to bill insurance companies since they would not be able to sell drugs that cost $100 per pill.


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Despite the vast evidence that free-enterprise makes markets more efficient, lowers prices, and improves customer satisfaction, Republicans are scared to go to a free-market system.  Rather than simply repealing Obamacare and shifting to a market system over a reasonable transition period as they’ve said they wanted to do for the last six years, they want to go to some sort of Obamacare 2.0 that still has all of the collective payment for care but without the things that sort of make Obamacare work like the requirement that everyone get insurance.  We could be on the road to a great system where anyone who works a regular job would worry about getting healthcare no more than they worry about getting food.  Why the fear?

The answer is simple:

  1. Eliminate the tax break for providing insurance through work to encourage employers to simply pay their employees money and separate healthcare from work.
  2. Require everyone to put away money into a health savings account so that they have the money needed for healthcare so that others don’t get stuck with their bill.
  3. Make the health insurance market free, allowing insurers to sell anywhere they wish rather than being confined to certain states.

Do these things and watch healthcare costs drop as the free-enterprise system does its magic.  There is no reason to fear.

So what do you think?   Please join the conversation and leave a comment.  Contact me at VTSIoriginal@yahoo.com.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

A Failure of Government and the United Airlines Passenger Debacle


There is probably few people who haven’t seen the absurd video of the passenger being forcibly dragged off of a United Airlines flight.  Obviously this was a grave public relations error by United Airlines, and I hope the man in the video gets a lot of money from them.  In business, you put the customer first.  Bumping passengers from the plane so that four employees could take the flight was, in a word, stupid.  United could have:

  1.  Not overbooked the flight.
  2. Offered more money for people to volunteer to wait for the next one. (Someone would have volunteered if enough money were offered.)
  3. In the worst case, rent a car and have your employees drive the four hours to Louisville for the flight the next day.  As it was, they probably took longer to get there than they would have driving.

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The truth is, however, that scene could have been any of the major airlines.  They all overbook, and they all force people to miss their flight if they cannot get volunteers.  United was just the lucky ones who had the right combination of a clueless flight crew, a frustrated passenger, and an over-the-top group of security guards.

         

The real issue isn’t the airlines (or it isn’t just the airlines).  The issue is that the airlines have an effective monopoly on air travel, or at least there is little enough competition that an airline can say, “Gee, I should charge $50 to check a bag,” and there aren’t isn’t enough choice for passengers to tell them where they can stick their baggage fees.  This is one instance where government regulation is needed since there is not enough room for enough competitors to make free enterprise work.  There are only so many spots at the airports, and the air traffic control systems can only handle so many planes, and it is so expensive to start an airline that few people can do so.  This means there is not enough competition, so the airlines can basically abuse customers all they want, because “Where you gonna go?”

Here is where government should be stepping in to protect the consumers.   You would think that the government would be making sure the paying customers, many of whom have very little choice but to fly occasionally, were protected from price gouging and abuse.  They are falling down on their duty, and in many cases making things worse.   Why are airlines able to charge big fees for bags, or food on the plane, or even the ability to have enough leg room to avoid dying of a blood clot?  And why are they allowed to put so many seats on the planes and make it so uncomfortable?  Why are airport food prices so high, and why are they able to charge so much for things like water when every passenger is forced to buy water and drinks since they cannot bring them through security?  Given the monopoly airlines and vendors at the airports have, where is the government regulation protecting the citizens – the ones who elected them?  Instead, governments are conspiring with the airlines and vendors to get more money from the passengers in the form of taxes and fees.

Think of what had happened to that man before the video you saw, as happens to everyone foolish enough to take a flight:

  1.  He left home early, worried that he might hit traffic and be late to check in.  If he was late, he would miss his flight and lose his money.
  2. Once he got to the parking lot, he needed to wind all around to get into the lot, then drag his bags to a shuttle.  Hopefully the shuttle wasn’t full when it got to his stop.  No one helped him drag his bags up the stairs onto the bus, and everyone was impatient with him.
  3. When he got to the terminal, he had to drag his bags down, walk who knows how far into the building, and then drag his bags all along the concourse to the line for his airline.
  4. He had to wait, perhaps a half hour, for a kiosk to open up.  He then had to drag out his itinerary, figure out where the confirmation number was, pull out a credit card to verify his identity, and check himself in.  If he forgot something of had to wait in line too long, he might miss his flight.

                            

5.  After checking in, he had to wait for the airline attendant to print his luggage tags and give them to him.  He probably received no greeting.  He had to worry that his bags weighed too much, or he’d pay a $100 fee, plus he had to pay $50 per bag regardless.  When the airline rep was done, if he was lucky, she dropped the bags, face down so that things in the pouches got smashed, on a conveyor behind her.  If not, he had to drag his bags to another line and wait for them to be inspected by TSA.  He had to wonder as he left them if they would actually make it on the plane.

6.  After checking in the bags, he had to find the security lines for his gate.  He probably got no directions to the gate from the check-in counter and had to look all over his boarding pass to figure out which gate was his.  If he messed up, he would miss his flight.

7.  Once in the security lines, he probably had to wait 20 minutes to reach the first TSA agent, who probably gruffly asked for his ID and looked at him like he was a serial killer.  He may have gotten a nice greeting (the first ones are usually the most professional), but he would be made to feel that if he was lucky and did everything right, he would be allowed to proceed.  Otherwise, he would miss his flight.

8.  After getting his ID checked, he would then wait in an even longer line, wondering if he was going to make it to the gate on time or miss his flight.  Finally he would be told by an agent yelling to the crown that he needed to take off his shoes, belt, hats, coats, and empty his pockets entirely.  He would then need to put his wallet, passport, and everything else of value into the x-ray machine , wondering if someone would steal it on the other side before he got a chance to get to it since his stuff might get through before he cleared the scanners.  He probably hoped that he had not lost his ID in the rush and confusion.

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9.  After waiting for the people in front of him, and having to walk where lots of people who didn’t think to wear socks had trod just before him, an agent would then motion for him to enter the scanner where he would be forced to assume the surrender position – hands up, palms out — while his naked body was revealed to a total stranger in the other room.

10.  If anything was detected in his pockets, or if he was just lucky number 22, he would be made to go to a little cubicle, where he would be patted down all over his body, including his private parts.  Through the whole, humiliating experience, he would be wondering if he would miss his flight.

11.  After finally getting through security and struggling to get dressed again, he would need to stop by a shop to get some water since he couldn’t carry any through.  Rather than paying the $1 or so as he would have seen outside of the airport, the price would be $4 per bottle.  The government has done nothing to protect him from this price gouging.  Instead, the city and state government have probably set the rents really high, basically making the vendor charge a huge price for water.  He is captive in the airport, so he has no choice but to pay the price or go thirsty.

12.  At the gate, he would be required to wait for the flight to board, probably not told that there was a delay until the time at which he was to board had long passed.  If he were late, he’d miss the flight and lose his money.  If the plane was late, too bad.

13.  During boarding, he would need to wait while all of the more important people boarded the plane.  He would finally have his section called, need to wait in a long line to get through the doors, then wait in an even longer line as people slowly pushed their way past the folks in 1st class who were getting their first drinks, and make his way slowly back into the cattle section as people fought to get their bags stowed.  He probably didn’t have any room over his seat for his bag by the time he got there since someone sitting behind him took the space for one of her large bags.

14.  Finally, after all of this, he made his way into his tiny seat with no leg room that was just big enough to wedge himself into.

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Then, he is told he would need to leave so that the airline could have some of their employees fly.  Where is the government to:

  1.   Make parking rates reasonable.
  2.  Prevent baggage fees and other price-gouging fees.
  3.  Provide a smooth, friendly, courteous screening process.
  4. Ensure prices for concessions are reasonable, given the monopoly they have created (or maybe require the airlines give you a $0.25 bottle of water after you’ve paid $400 for a flight).
  5.  Prevent airlines from kicking you off of the plane after you have paid for your ticket and shown up on time.

Where government regulation is needed, they have failed miserably.

What do you think?  Please leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The ACA was Terrible; the AHCP Even Worse


Those who are regular readers to this blog will know that I am not a fan of the Affordable Care Act (ACA), a.k.a.Obamacare.  Amazingly, the Republicans have created a replacement plan that is even worse called the American Health Care Act (AHCA).  In what appears to be an effort to avoid making anyone mad, they have basically taken out the parts of Obamacare that sort of made it work, but that people didn’t like because it cost them money, and left the things in that made it financially unstable, but which everyone loved because they were “free.”  Having a lot of people getting free stuff, with no way to pay for that free stuff, is a sure-fired way to bankrupt an industry.  The ACA nearly destroyed the heath insurance industry – the AHCA will surely finish it off if it passes as it is.

The things people loved in Obamacare:

Subsidies (paid for by taxpayers and people paying full freight on the unaffordable, Affordable Care Act insurance)

Keeping young adults on parents’ health insurance until 26 (really, this provision has no effect since young adults rarely get sick, so their health insurance would be really cheap if they ever left their childhood bedroom)

Coverage of preexisting conditions (the most unaffordable provision, since this allows people to buy insurance on the way to the hospital)

No lifetime or yearly maximums (should be included, but raises rates)

Things people didn’t like:

Penalties for not buying health insurance (the only way to make premiums affordable)

Collection of healthcare data by the Feds (creepy)

Forcing religious businesses and entities to buy insurance that included abortant drugs (so much for the 1st Amendment)

So the AHCA tries to keep the things people liked, but get rid of the biggest thing that people didn’t like:  being forced to buy insurance, particularly really expensive insurance for those who are young because they are covering all of the high costs of those who are old.  With the ACA, many young people wisely decided that they were better off paying the penalty, so they didn’t buy the insurance, which pushed the price higher for everyone else, until the ACA entered the death spiral.  The AHCA does nothing to fix this issue, and even makes things worse, since now those who don’t buy insurance until they are sick don’t even pay a penalty.

         

The secret to reducing the price of healthcare, and making getting it a non-issue for virtually everyone just as buying food is a non-issue for anyone with a job, is to get most people to actually pay for their healthcare.  This can only be accomplished if you make sure that they put enough money aside so that they have the money when needed, rather than spending every dime and then not being able to pay their medical bills.  Not even requiring people to buy health insurance is a sure recipe for having lots of people with no money to pay the bills when they have an emergency.  This means the costs for those who actually do pay will get even higher.

A good health care plan has people saving up money when they are well to pay the inevitable times where they will need healthcare.  It also means having them mainly pay for the services they receive, as opposed to having insurance that covers everything regardless of cost, to give them an incentive to use less health care or choose lower cost options when it really isn’t important.  Basic, routine care like physicals and ear infections should be paid for by individuals with money they have saved for medical expenses.  The large, unexpected expenses that rarely happen to an individual like the long hospital stay due to needing to replace a kidney should be covered by major medical insurance.  Insurance only works if most people never use it, since then it is cheap for everyone and since you want to make sure that the few people who incur the big expenses are covered.  The solution is therefore the following:

                            

1.  Require that everyone sets up a Health Savings Account (HSA) and contributes a required portion of their income to the account, up to a certain dollar value of income.  The contribution percentage would decline after a certain amount is saved in the HSA, meaning that those who used little healthcare would have a higher take-home pay, providing an incentive to maintain high account balances and not spend money unless needed.  Those who cannot contribute enough to cover reasonable costs would have their contributions subsidized.  Any money left at death would be passed to heirs.

2.  Require that everyone also buy major medical insurance – insurance that pays for costs above a certain, large threshold, like $20,000.  Ensure that there are enough insurance companies competing that the price of this coverage is as low as possible and the service is as good as possible.   These policies must be clear on what is covered and government should fine any company that does not immediately pay for a covered service (no denying payments for sick people, hoping they won’t dispute the mistake and just pay the cost themselves).  The threshold could also be raised as an individual increased the amount in his HSA, thereby lowering the premiums.  For example, an individual with $40,000 in an HSA could have a major medical plan with a $40,000 deductible, which would cost less than one with a $20,000 deductible.

3.  Develop a high risk pool, subsidized by taxes, that covers those with really bad medical luck (like a major disease at 18 years old before starting a job and getting major medical insurance).  These individuals are rare so most people would be able to cover themselves with everyone saving up a portion of their income in an HSA, so spreading the risk out over the whole population won’t cost much.

4.  Require that all medical providers post costs and stick to those costs (no preference for one patient over another).  This would allow individuals to shop around for the best deal and eliminate price disparities as currently exist.

What would things be like after this plan is implemented?   Most people would just pay for their medical treatments out of their HSA when needed because they would have the cash saved up.  There would be no need for the doctor’s office to file insurance, reducing costs.  In addition, because most people were paying their bills and you wouldn’t need to pay for other people, costs would drop dramatically.  Imagine $20 office visits, $15 X-Rays, etc….  Hospital stays would be maybe $150 a day instead of the thousands they now cost per day.

There would also be incentive to save money, and therefore people would pick the cheaper option when it really didn’t matter and not use healthcare when not really needed.  This would cause less demand, and therefore lower prices.  Doctors could also provide a discount for procedures that really reduce costs like certain exams.  Prices would decline to the point where getting healthcare is no big deal for most people.  With most everyone paying for their own healthcare, the cost to cover those who could not would be easily obtained through charity or taxes.  Now that’s health insurance reform.

Contact me at vtsioriginal@yahoo.com, or leave a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

A Tax You Should Support – The Fair Tax


There is a tax system that everyone should support except for tax preparers and accountants, and that is the Fair Tax.  The Fair Tax is a consumption tax that would replace all of the other taxes that are currently levied by the Federal Government, including the Income Tax, Payroll Taxes (Social Security and Medicare), and corporate income taxes.  By a “consumption tax,” it is meant that the tax is paid when money is spent, like a sales tax, rather than when it is earned.  Some of the basics of the tax are as follows:

  • The tax would be levied on all goods and services and paid by the consumer.  It is expected that the tax rate would be about 23% if current revenue levels are to be maintained.  While this may seem like a lot, consider that income taxes for the middle class are currently about 15%, Social Security Taxes are 12.5%, and Medicare taxes are a few percent.  Add these together and the Fair Tax sounds great.
  • Each citizen would receive a prebate at the beginning of the year to offset the amount of taxes paid.  Because everyone would receive the same prebate, those who make less money would end up paying less in taxes each year.  Some would pay no taxes, as is currently the case for about 50% of Americans.
  • Because all other taxes would be abolished, one would receive ones entire paycheck – no deductions – and would not need to file income taxes at the end of the year or keep track of cost bases and income sources.

There are many advantages to this system over the current system.  A few of them are:

1) There is no need to file income taxes.  This means that there is no reason to keep all of that paperwork (or generate that paperwork), there is no need to spend hours teach year trying to figure out tax forms, and there is no need to pay a tax preparer each year just to comply with the law.  The tax would be figured out automatically when you buy things and collected by the retailer just like sales tax.

2) Those who save would pay less in taxes, motivating people to save.  Conversely, those who spend would pay more in taxes, motivating people not to spend.  Note that the prebate would prevent those with little income from paying a bigger portion of their income in taxes.  For example, if the tax rate is 20% and the prebate is $10,000 per year, no one making less than $50,000 per year would pay anything in taxes even if they spent their entire income.

3)  The expenses borne by businesses for tax preparation and tax avoidance would be eliminated since there would be no need to keep money oversees, depreciate equipment, or play other games to reduce taxes.  Also note that all of those funds that are currently sitting overseas to avoid taxes would come back and be invested in our economy.

4)  All money spent would be subject to taxes, making it more difficult to cheat.  Money earned by drug sales and prostitution would be taxed when it was spent just like money earned from working at a restaurant.  Everyone would be taxed rather than just those who follow the rules.  This means that the tax rates for everyone who is currently paying their fair share would be less.

5)  Because business costs for compliance would be less, prices of things would decrease.  It is expected that this decrease would largely offset the 23% tax.

6)  There would be no need for college savings accounts, medical savings accounts, and the like.  There would be no income taxes, so there would be no reason to shelter money from taxation.  Likewise, there would be no need for IRAs.  Think of all the time that could be saved.

If this sounds good, please check out the Fair Tax Website for more information.  Then tell a friend or three.  Finally write to your members of COngress or call them and tell them that you would like to enact the Fair Tax.  If enough people speak up, we could never need to file taxes again.

 

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.comor leave in a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Trickle Down Economics Debate: Con Argument 1


Posted below is Mark’s response, responding to my last post in the Trickle Down Debate.   Please be sure to visit Mark’s bloghttp://spiritusfinancial.wordpress.com/

You have made a very strong case on how lowering taxes for President Reagan circa 1975 would have resulted in job creation. That’s a solid and strong argument, especially when tax rates for the very wealthy were 70%.

For my side of the debate, I would respectfully suggest we fast forward from 1975 to 2010. Instead of the highest tax rate being 70%, it is now 35%. Letting the current tax cuts expire for the top 2% in our country would increase their tax rate to 39.6%-back to the rate under President Clinton. Yes, it’s an increase of nearly 5% and yes it’s true, the top 2% pay about 50% of the income taxes collected in our country, yet in my opinion, not enough to deter an entrepreneur from starting a new business, making a new movie or hiring additional employees.

If we were in fact having a debate in the country about raising tax rates on the highest income earners back to 70%, then we would be flirting with disaster. But as a financial planner, I work with many business owners that have done very well financially over the past decade. Yes, a nearly 5% tax increase will pinch, but will it deter business owners/job creators from making a new investment in their business which in turn could mean adding new staff? I have yet to see evidence of that stopping anyone from moving forward with a new venture.

There’s no doubt that there’s a fine line between tax rates and job creation. Yet with tax rates on the highest income earners at 39.6% during the Clinton years, not only did the middle class see strong job and real income growth, but as a country we managed to put ourselves in a surplus situation financially.

Finally, since we’re mentioning President Reagan, I was happily surprised to read David Stockman-Regan’s Budget Director, recent op-ed in the NYT call for letting the tax cuts on the wealthy expire as planned.

Respectfully yours,
Mark Zaifman
Spiritus Financial

See Pro Argument 2: https://smallivy.wordpress.com/2010/08/11/the-trickle-down-debat-pro-argument-2/

See the original Pro Argument: https://smallivy.wordpress.com/2010/08/08/the-trickle-down-economics-debate-pro-argument-one/

Saving for Retirement – Pay Yourself First


We all need to start doing a better job saving for retirement.

The investments do not really matter that much. One can do just great putting their savings in several mutual funds, going into one of the targeted retirement funds that do the asset allocation for you, or building up a portfolio of individual stocks and gradyually shifting more into cash and bonds as retirement looms. The key is to invest regularly.

Investing early is also absolutely critical, since the earlier you start, the easier it is.  The reason is that the amount of interest gained in the years at the end, when there is a large sum built up, greatly outweight the amounts received in all of the other years.  The more years you have at the end to let the money continue to accrue interest, the better. 

So what is the best way to actually save that money, despite all of the forces that make it difficult?  Just like with a diet, where there will always be an excuse to eat more than you should there will always be a reason to delay putting money away.  Just like with a diet, one must change one’s lifestyle to get good results.  One cannot go on and opff a diet and expect to keep the pounds off.  One can also not expect to start and stop retirement savings and expect to be successful.

Everyone will basically spend all that he/she makes. If one is bringing home more than the cost of his mortgage, food, and lights, he will buy a new car or add a cell phone, movie subscription, join the wine club, take vacations, or do something until he has spent the surplus.  Someone who is making $40,000 per year will spend about $40,000 per year, plus an additional $3000 or so on the years that the “emergencies” happen, such as an air conditioner breaking down or a new roof being needed.   Likewise, a person making $250,000 per year will spend $250,000, plus an additional $20,000 when emergencies happen.  Some of the individuals that you may think are rich are actually just one lost paycheck away from missing their mortgage payment.  They have large incomes, but spend every dime.  The people who are actually rish probably dress modestly and live in modest homes, with really nice interior features.

To retire comfortably, one must put away about 15% of one’s income (write off Social Security – it won’t be there).  This is the amount required to allow you to continue to live the same lifestyle through the rest of your life without another income.   The trick is to put money away just like another bill before you have the opportunity to increase your lifestyle to suck up the extra cash.  Just write a check each month to a mutual fund company or a brokerage account for 10-15% of your paycheck, just like you’re paying any other bill.  Also, take advantage of 401k’s, since again the money is taken out before you have a chance to spend it.  Typically the plan is to invest in the 401k up to the company match, then max out IRA accounts, then return to the 401K up to the maximum.  If one is still not at 15% of gross income, put more money away in a standard, taxable account. 

And once it is in there, don’t ever take it out unless you are retired or about to be on the streets.  The taxes are onerous, plus for every dollar you take out when you are young, you lose $32, $64, or even $128 dollars when you are ready to retire.  It just is not worth it for that vacation or new car.

Are Interest Rates Finally Working?


There is an old saying in Wall Street, “Don’t fight the Fed.”  The Federal Reserve, with its ability to set interest rates, has a huge effect on the economy.  If they lower interest rates they can turn a sluggish economy into one running at full speed.  Likewise, by raising rates they can pop speculative bubbles and bring about a recession (see 2000 and 2007).  It is therefore unwise to be buying when interest rates are rising or to sell short when rates are being lowered.  The effect is so great that the plans of the Federal Reserve are kept secret to avoid moving the market.

Because bond interest rates and the returns of other investments are effectively indexed off of bank account rates and the prime rates, lowering rates makes stock prices go up.  Lowering interest rates also make the cost of borrowing money, which means it is easier for companies to borrow money to finance new projects and expand, thereby making higher earnings.  Lower interest rates also lower rates on home mortgages and credit cards (a little bit), so people might also be able to spend more.  This tends to make the economy grow.  Because stocks tend to lead the economy (remember that people buy stocks based on what they think a company will earn, not what it is currently earning) the first thing that tends to happen when the Fed lowers interest rates is that stocks tend to go up. 

It is common for the stock market to go up long before the rest of the economy gets into high gear.  On the other side, when the Fed starts to raise rates, the stock market tends to fall before the economy starts to slow.  One can think of it therefore as a control system where there is a 6 month to 1 year delay between the time the Federal Reserve takes an action and the economy starts to respond.  This delay causes some people incorrectly think that higher interest rates cause a better economy and vice versa because the Fed tends to raise rates when the economy is doing well (to quell inflation) and lower them when it is doing poorly (to spark the economy).  If you plot interest rates against the GDP, therefore, you will see that interest rates tend to be high when GDP is growing and vice-versa.

In the recent recession, things were so overblown during the real estate bubble, and there was so much uncertainty caused by the doom and gloom projections and the unprecedented government action that the market did not respond when the Fed lowered rates essentially to zero.  It looked as if we might see the same thing as Japan during the “lost decade” in which interest rates were low but the economy remained in the doldrums.  While I’m not yet convinced we’re ready to head higher, things are looking better with the recent rally.  Uncertainty remains with the possible passage of Cap and Trade and the upcoming expiration of the Bush tax cuts, either of which could cripple the economy.  The reaction of the market to the Financial Reform Bill was also not encouraging.

So, what to do?  As always, it is very difficult to accurately predict the near-term.  We might start to take off due to the low interest rates, or we might remain mired in a bear market as economy-killing legislation is passed.  One must always look at the long-term, however, and continue to buy regularly, taking advantage of the lower prices to build up positions.  Eventually things will turn, or the whole economy will collapse and it won’t matter anyway.

Like what you’re reading? Keep the blog going – Refer a friend – https://smallivy.wordpress.com

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

When will Housing Prices Bottom Out?


There is much speculation on when home prices will finally bottom out and start rising again.  Various government programs have been attempted that offer incentives for home buyers but they only have the effect of causing people who were going to buy a home anyway to move up their buying decision.  When the program ends the increase in sales ends with it and home prices continue to fall.  Because consumers tend to spend less when the price of their home is falling, both because they are unable to borrow from their home to pay off credit cards–freeing them up for more spending–and because they feel less rich and therefore are less willing to make purchases and go on vacations.

Likewise, attempts to halt the slide by having banks “reset” loans that are in default, forgiving missed payments, lowering the principle, and adjusting the terms of the loan have met with similar failure.  In fact, because the loan is reset the buyer starts to feel entitled to not paying if he feels that the loan is somehow unfair.  Even though he felt the price of the home was fair when he bought it, because he has seen his loan reset he fells that he deserves the value to be lowered if home prices continue to fall.  This results in a cycle of default, reset, and default, each time driving the home price further down.

Home prices, like stocks have a fair value.  Unfortunately, during the housing bubble this fair value was forgotten as individuals paid more and more for houses simply because they felt, no matter what they paid, that they could later sell the house for even more money. In the least they thought that the price of the house would continue to increase, so if they did not buy now they might never be able to do so. 

Payments through traditional 30-year fixed rate loans were above the buyers’ ability to pay.  In order to pay for the houses, individuals first began taking out took out 0% down loans since a 20% down-payment was out-of-the-question.  Later, Adjustable Rate Mortgages were used since they started at a lower interest rate.  Then individuals started taking out interest only loans where they only paid the interest, and even then the loans were taken out at teaser rates such that the interest rate was only low for the first year or two.  Finally they started taking out Option ARMS which allowed individuals to pay less than the interest amount, such that the amount owed actually increased over the first several years of the loans. 

Because they were not able to afford the payments once the loan was reset and they needed to start paying off the principle, many went into default.  This caused banks to stop making loans because they could no longer sell them to third parties, and the price of houses could no longer increase.  At this point they began to fall back towards fair value as homes are foreclosed upon and buyers reduce the bids they make for houses.  Even if they were willing to pay a high price for a home the banks are not willing to make the loan.  Until houses reach their fair value they will not stabilize and the various programs simply have the effect of delaying the inevitable.

I would submit that the fair average value of a house for a given area is about equal to the price that would allow the average  person living in that area to purchase that house and pay no more that 30% of his net income (after taxes) for that house.  Currently home mortgage rates are extremely low, owing to the fact that the Fed Funds Rate is also extremely low and all interest rates are tied to the Fed Funds Rate.  The current rates for a 30-year loan are around and unheard of 5%. 

In the table below I present the payment, net income, and total income required to purchase houses of various prices assuming an interest rate of 5%on a 30-year loan.   Note that the net income required is found by dividing the yearly payments by 30%.  The total income required was calculated by assuming various tax rates (income, Social Security, etc…) ranging from 25% to 50% of total income, depending on income level.

 Table 1: Income required assuming a 5% loan rate

Home Price Monthly Payment Net yearly Income Total Yearly Income
$100,000.00 $537.00 $21,480.00 $28,640.00
$200,000.00 $1,074.00 $428,960.00 $57,280.00
$300,000.00 $1,610.00 $64,400.00 $99,077.00
$500,000.00 $2,684.00 $107,360.00 $165,169.00
$1,000,000.00 $5,368.00 $214,720.00 $429,440.00

So, for $100,000 houses to sell, there needs to be enough people in the area who make at least $28,640 per year to meet the supply.  If there are not, the price will need to continue to drop until there are enough people.  Likewise, if there are a lot of $500,000 houses on the market, unless there are a lot of people who make at least $165,000 around looking for a house the prices will continue to fall (or the owners will need to stay in the house and not sell until incomes increase.  Note that an income of about $425,000 is needed to comfortably afford a million dollar house.

Some may say that requiring the payment to be no more that 30% of one’s net income is too restrictive a requirement, but note the effects of the recent bubble in which people were buying houses with much higher payment ratios.  While there may be some who do buy houses at higher levels of leverage, doing so puts them at great risk since any deviation in their income at all or an unexpected expense such as a car breakdown or illness can easily lead to a foreclosure, which again will drive down the prices of houses in that price range.  Such buyers will also probably feel very “tight” financially with little income left over for other expenses.

The rate of taxes has the effect of suppressing home prices.  The total income required to afford a home increases as tax rates increase because paying a greater percentage of income to taxes has the effect of lowering net income.  Because the current government drive is to raise taxes (sun setting the Bush tax cuts and enacting significant new medical entitlements), we should expect the fair value of homes to continue to fall as states and the federal government raise taxes to cover budget deficits and increase social programs.

If rates return to more historic values–either because the Federal Reserve raises them to hold down inflation when the economy starts to pick up or inflation does return and causes rates to rise on their own–the effect on the fair value of homes is even more chilling.  (Note that increases in inflation cause interest rates to increase since lenders need to raise the interest rates they charge just to get back the same effective rate of return–they are being paid back in dollars of lesser value than those that were lent).

Table 2 gives the net incomes and total income levels required if the 30-year mortgage rate rises to 8%.  Note that now the total income required to afford a $300,000 house increases from just under $100,000 to over $135,000.  Unless big raises at work come as well (which don’t look to be in the cards anytime soon), look for housing prices to fall if and when rates are raised unless they stay low long enough for salaries to catch up with housing prices.  Note that the effect is particularly severe because the higher income required means that those able to afford even a $300,000 house will be pushed into the higher tax brackets, so their total income must be even higher than before.

 Table 2: Income required assuming an 8% loan rate

Home Price Monthly Payment Net yearly Income Total Yearly Income
$100,000.00 $734.00 $29,360.00 $39,147.00
$200,000.00 $1,468.00 $58,720.00 $90,339.00
$300,000.00 $2,201.00 $88,040.00 $135,446.00
$500,000.00 $3,669.00 $146,760.00 $266,836.00
$1,000,000.00 $7,338.00 $293,520.00 $587,040.00

So in conclusion, no matter what policy gymnastics the government or banks do, housing prices will continue to fall until they hit the fair value, which is determined by the income level for the area.  If taxes are raised, the value of houses will fall.  If interest rates are raised the value will fall even faster.  The best course would be to stop trying to hold back the bursting of the dam with various gimmicks and allow it to burst so we can clean things up and regain a more sustainable path.  To do so is like trying to bail the Titanic with an ice bucket.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

A Correction vs. a Bear Market



Please allow me to address a pet peeve of mine today.  That is the correct definition of a correction and a bear market.  It wouldn’t bother me so much if just the nightly newscasts got this wrong, but I hear people who should know better such as the Wall Street Journal getting it wrong as well.  Please refer your friends to this post and distribute it far and wide for I’d like to stop hearing people incorrectly using these terms.

First of all, the incorrect definitions.

Often on a newscast during a market downturn someone — either the anchor or the person they are interviewing — will say we’re having a correction, but have not yet entered a bear market.  They then will present the usual, incorrect definition that a correction is when the market has gone down 10%, and a bear market is when it has gone down 20%.  While it is true that the market will tend to decline more during a bear market than during a correction, the correct definition has nothing to do with percentages.  (This is like the old joke that a recession is when people are out of work, but a depression is when you’re out of work!)

To understand the correct definition, one must understand a little about charting, trends and Dow Theory.  For some basic definitions see the past post on charting: https://smallivy.wordpress.com/category/charting/ .  Corrections and bear markets have to do with what kind of trend the market is in. Specifically the long-term trend, which is found using a chart with intervals of a week making up each point in the chart.  Normally a Open-High-Low-Close chart would be used in which the opening price, high price, low price, and closing price for the week would be plotted for each point.  For an example, see the chart for Harley-Davidson during the last year:

http://finance.yahoo.com/q/bc?s=HOG&t=6m&l=on&z=m&q=b&c=

A stock is in an up-trend if the stock is making higher highs and higher lows, such that a straight edge can be laid on the chart and a line drawn from low to low and the stock does not cross this line.  This is known as the trend line.  Harley was in an up-trend from mid-February to mid-May of 2010, and as one can see the lows followed the trend line pretty well, such that each time the stock’s price fell to the trend line it bounced off of it and moved higher.  A down-trend is just the opposite, where the stock sees lower lows and lower highs, such that a straight edge could be used to connect the highs in a descending trend line.  A stock will be in an up-trend, a down-trend, or drawing lines (bouncing between two prices and going nowhere) at any given time.

In order for the trend to change, three things need to happen.  For an up-trend:  1) The stock’s price must break the trend line.  2) The stock must fall below the previous low, and 3) The stock must not reach the previous high.  For Harley the trend line was broken in early May, the low was broken in mid-May, and the stock failed to reach the previous high later in mid-may, so the stock has reversed from an up-trend to a down-trend (like much of the market right now).  One could now form a down-trend by connecting the high reached in early May to the lower high reached in mid-May.

Dow Theory looks at the Industrials (the DJIA) and the transportations (the DJ Transportation Index).  Each time both of these move down in price (one of the regular downward movements as was seen in the Harley chart) while they are in an up-trend — a Bull Market — it is called a correction.  If they both actually change from an up-trend to a down-trend, we are in a bear market.  For Harley, it was in a bull trend from February until May, with corrections about once or twice a month.  In late May it entered a bear trend.   

I’ve heard that the incorrect definition came from someone one of the shows was interviewing who didn’t want to go into Dow theory, so he just gave the 10%, 20% definitions, probably in a statement like, “If it is just a correction, we may see a decline of 10% or so.  If it is a bear market it may go down 20% or more.”  Because a correction only requires one down-leg before the stock climbs to a new high, while a bear market by definition requires at least two down-legs, most bear markets will result in a decline of about twice that seen during most corrections.  Likewise, a correction of less than about 10% probably would be barely noticed, so the trader was probably just trying to get the relative magnitudes across, not knowing that his rules-of-thumb would become gospel.

Corrections can be much larger, however.  An extreme example is the crash of 1987. 

http://finance.yahoo.com/echarts?s=%5EDJI#symbol=%5EDJI;range=my;compare=

In that stunning crash the Dow Jones Industrials went from 2596 to 1938 in one day — a decline of more than 20%!  Looking at the chart, however, you’ll note there was only one leg down, the trend was never broken, and the spectacular bull market that started back in the early ’80’s under Reagan continued clear until the early 2000’s when it was finally ended by the dot-com bust.  Since that time we have been drawing lines.

So, you now know the correct definitions, so please stop spreading the incorrect ones.  Also, forward a link to this post to all of your friends to correct the mis-information.  I’ll know my quest is done when I see USA Today with the correct definition.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security.  Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.