Ordinary Income. Extraordinary taxes.

November 28, 2012

 

Manna wasn’t legal tender, but that doesn’t mean the IRS wouldn’t have tallied it.

 

A couple of days ago we pointed out how money doesn’t care where it came from. Some people think that their regular salaries should go towards daily expenses, while windfalls (inheritances, stock appreciation, house appreciation, etc.) can go towards less vital stuff like vacations and ATVs.

That’s an idiotic perception. If you have an asset to buy, defining “asset” as we do here at CYC (something that’ll build wealth), buy it. With your paycheck, or with a handout from Grandma. Or even a loan from Grandma, depending on what interest she charges. Otherwise, it shouldn’t matter. Regardless of its origins, money goes where it goes.

Well, that’s not entirely true. The only entity that cares how you came by your money is the Internal Revenue Service. Receive money one way, it’s taxed at a certain rate. Receive it another way, it’s taxed at a higher rate. Seeing as the IRS has the power of deadly force*, soon for the crime of not doing your duty for the Motherland and buying health insurance, it makes sense for us peons to accede to the agency’s capricious demands.

As far as the IRS is concerned, there are 2 ways you can receive income:

  1. ordinary income and short-term capital gains
  2. long-term capital gains.

This is simplified, obviously. A full accounting of every exception would take us years to write about.

Ordinary income? That’s:

  • Wages, salaries, tips, commissions, bonuses
  • Interest, dividends, and net income from a business that you own a piece of
  • Gambling winnings
  • Royalties
  • Rents
  • Pensions, assuming you’re one of the few people who collects one.

Meanwhile, capital gains are:

  • Money from the sale of a “capital asset”, like shares of a publicly traded company, or a house that you sold. Unless you’re a land developer and the house is your stock in trade, that kind of thing. The difference between short- and long-term capital gains is arbitrary but defined: hold on to an asset for a year before selling, that’s long-term.

We’ll spare you the numbers, but regardless of what tax bracket you’re in, long-term capital gains are always taxed at a lower rate than short-term capital gains and ordinary income are. There’s a good reason for this, too. Ordinary income (and to a lesser extent, short-term capital gains) carries little risk. If you punch a clock, you’re legally entitled to wages and can sue if you don’t receive them. If you wait tables, society expects that customers will tip you as part of (if not the bulk of) your income.

Long-term capital gains involve tons of risk. There’s no guarantee that that stock you bought years ago might ever result in a payoff. Contrast that with the biweekly checks you get after entering into a standard work agreement. By taxing long-term capital gains at a lower rate than ordinary income (and short-term capital gains), the IRS encourages people to hold onto their investments. If all income was taxed at the same rate, there’d be no incentive for anyone to defer spending (synonyms for which are “save”, “invest”, and “build wealth”.) We’d only chop trees down, never planting any.

So is this just an accounting curiosity, something for you to pass the time reading about on a boring Wednesday? Heck and no. Control Your Cash don’t play that game. If it didn’t apply to your life, we wouldn’t be spending time on it.

The more of your income you can derive via long-term capital gains, the less you’ll have to fork over to the IRS. We devote an entire chapter of the book to this. Chapter IX, the longest and most detailed one. (By far. Although it’s still easy to read, certainly no more difficult than our posts.)

Unless you want to move to Antigua – and before you do, remember that it’s easy to go stir-crazy on a 109-square mile island – you’re going to have to play the IRS’s arbitrary game. Both Wonderland croquet and Calvinball have more consistent rules. This wasn’t always the way, but America’s descent from beacon of freedom to patchwork of statism is a topic for another day.

Maximizing your long-term capital gains is the inevitable result of buying assets and selling liabilities, our 2-pronged guaranteed way to wealth. It means purchasing vehicles for passive, non-sweat income, no matter how modest or expensive: a $25 mutual fund contribution here, a real estate investment trust there. Anything that creates an income stream for you, or that should appreciate (such as a house). Hold onto it for at least a year, and you’ll pay less in taxes that you would if you’d earned similar income via more direct means. Hold onto it indefinitely, and…

You can defer capital gains, too. Sometimes indefinitely. Methods for doing this include structured sales, charitable trusts and 1031 exchanges, which we touch on in the book and will expand upon in future posts. Really we will.

The point is, don’t go to H&R Block with your W-2s and say, “Fix this for me.” And really don’t get a refund anticipation loan. You’ve got a few months to make this work for 2012, and to figure out how to not get burned in future years. Do it now. (By “do” we mean “buy”, and by “it” we mean click the link above. Which is also this link.)

 

*This is not an exaggeration. To quote P.J. O’Rourke, “If you don’t pay your taxes, you get fined. If you don’t pay the fine, you get thrown in prison. If you try to escape from prison, they shoot you.”

Filed Under: Capitalism, Economics, Making Smart Choices, Taxes Tagged With: , , ,

Women, Take Your 72¢ And Be Happy With It

November 14, 2012

Ma’am, if you don’t think you’re getting paid enough, maybe you shouldn’t have chosen modeling for a career

Our favorite talking points of election season:

  1. “Binders of women”
    A candidate could refer, somewhat obviously, to binders of women’s résumés. But if he used the shorthand “binders of women”, that means he’s a misogynist who wants to take the distaff half of the species back to the Stone Age, including his long-suffering wife. (Hmm…they also have 5 kids, who all happen to be male. The chances of that happening are 32 to 1. Can we state unequivocally that there wasn’t some sex-selective infanticide along the way?)
  2. “Women make x¢ for every dollar men make”, x being a number somewhere around 68 to 77.

This one just refuses to die. The consensus interpretation of it seems to be that for your average man who makes $50,000 in his generic job, the average woman beside him makes $36,000 or so. Since some women make as much as their male counterparts, for every one who does there must be another woman who makes even less compared to men.

This is 99% false, and even if it were 0% false, so what? Let’s examine it a little more closely:

Yes, if you add up the total amount of money earned by women in the workplace, divide that by the number of working women, multiply that by the total money earned by men, and divide that by the number of working men, you’ll get something like .72.

But that includes every job in existence, and doesn’t correct for the indisputable fact that women gravitate toward flexible jobs. Ones that allow for plenty of time away from the office, and thus that permit some form of turnover. To cite an example, the combatant commander of CENTCOM can’t take time off to drop his kids off at the pediatrician’s office or petition his boss (that’d be the Chairman of the Joint Chiefs of Staff) for additional maternity leave. Meanwhile, the daycare center supervisor at the Franklin County Public Library can afford to be a little more accommodating.

Of course, “women gravitate toward flexible jobs” is a general statement. More women do so than men, but most gainfully employed people of either sex aren’t as interested in flexibility as they are in earning money.

Lines of work in which women make several dollars for each dollar men make:

  • Stripping
  • Prostitution
  • Tending bar, and sorry if you happen to be a bartender and think we’ve drawn some equivalence between your job and the others on this brief list.

Gals, if you want to make more money, here’s a handy 2-part strategy that never fails:

  1. Pick a career that increases the likelihood that you’ll get paid more. Sure, you’d make a great receptionist. But is that really what you want to do for a living? Maybe it is, in which case, great. But think about what draws people to that job. Heck, ask a receptionist if you want to. They’re easy enough to find. Most of the women who answer phones for a living do so because the demands are small, and it’s easy to find someone to cover for them.
  2. Negotiate better. Look. No one seriously disputes that there are certain activities in which one sex has consistently shown more proficiency than the other. Here are just a few:
  • Child-rearing
  • Lifting 50-pound sacks of cement
  • Being “intuitive”, whatever the hell that means
  • Calculating cube roots and partial derivatives
  • Reading palms and consulting the stars
  • Isolating chemical elements (Yes, Marie Curie existed and was awesome. So were Albert Ghiorso, Glenn Seaborg, Enrico Fermi, Ernest Lawrence, Dmitri Mendelev, Henry Cavendish, Ernest Rutherford, Otto Hahn, Antoine Lavoisier, Joseph Priestley, Linus Pauling and about 1000 more. You want us to keep going?)
  • Interior design
  • Civil engineering
  • Human resources
  • Playing football at a professional level
  • Elementary education

Don’t pretend that men and women, cumulatively speaking, are equally adept at each of the activities listed above. But for the vast majority of jobs, it doesn’t matter whether the person performing them is male or female. Attorney. Veterinarian. United States Senator. Journalist, and if that’s what you do for a living God help you regardless of what sex you are. And yes, tire plant supervisor.

If you’re a woman, and you’re making less than your male coworkers in any of the jobs we just mentioned, why? Did you insist when you were hired that you make as much as the men do? If not, why not? And what if the men don’t each make the same amount anyway?

Alf is a shift supervisor who makes $45,000. Barry is a shift supervisor at the same plant, with responsibilities identical to Alf’s. In Barry’s interview, he insisted on $50,000 and not one penny less. The hiring manager was authorized to pay Barry as much as $54,000. There were no other qualified candidates at the time, and the plant needed to fill the position ASAP. So Barry got his $50,000.

A third shift supervisor position opens up. Cindy applies for it, and gets hired. How much should they pay her?

  • More than Alf? That’s hardly “pay equity” in the traditional sense.
  • As much as Alf? Not if Cindy a) ever glances at Barry’s paycheck and b) knows how to find a lawyer.
  • Less than Alf? No, that’s the very inequality we’re trying to avoid.

Here’s how much they should pay Cindy: whatever she can get.

Why should an employer pay you more than you ask for? More to the point, why shouldn’t you ask for as much as you can get?

The unfortunate truth is that women are almost as bad at negotiating as they are at throwing baseballs. (You ladies know you can move your elbow back, right? Try it sometime.) Heck, one of the brightest and most financially savvy women we know admits that she sucks at negotiating.

It isn’t Congress’s job to do what you can’t, or refuse to. Stand up for yourself, and demand more. Examine your alternatives – you can’t negotiate without leverage. Learn to say no. Reject the first offer. Find competitors and play them off against each other. Unlearn everything you’ve ever been taught about playing nice, being agreeable, not hurting the other person’s pride, going along to get along, etc. Money doesn’t care what sex you are. If Cindy’s years of feminine programming prohibit her from asking for as much as Barry does, that’s not the hiring manager’s problem.

This is so obvious it hardly counts as an observation, but every financial negotiation is inherently adversarial. The employer (client, etc.) wants to pay as little as possible. The employee (or vendor) wants to get paid as much as possible. The company in the above example is profiting off Barry, and profiting even more off Alf. It’s up to Cindy to decide how much she wants the company to profit off her.

It’s not that people of different sexes receive differing pay. It’s that everyone receives differing pay, depending on what they can negotiate. And that’s how it should be, unless you’ve ceded your bargaining rights to a union.

This has nothing to do with morality, or fairness. What Would Jesus Do? He’d tell you that if you agreed to work for a certain wage, even if other people are getting more than you and rubbing your face in it, suck it up until your contract expires. Or find something else.

Filed Under: Capitalism, Making Smart Choices, Newsflash, Role Model Tagged With: , , ,

Price Gouging Doesn’t Exist, And You’re An Idiot

November 2, 2012

 

The view from CYC World Headquarters, shortly before disaster struck

 

“Free” market means exactly that: buyers and sellers agreeing on a price. It’s impractical, however, for buyers and sellers to negotiate every single transaction. Imagine if the supermarket clerk haggled with you on every gallon of milk, every red bell pepper. You’d never make it out of the store, and we’d all end up losing valuable time in the process. So retailers set their prices accordingly. Buy the milk for $2.50, or don’t.

Some people like milk so much that they’d pay more than that, say $3.60. Others would buy only if the price lowered to $2.25. You could argue that the grocer is losing money on the former group of customers, and could be enjoying another $1.10 profit per gallon. You could also argue that concurrently, the grocer is failing to win the business of the latter group: by lowering the price by 25¢, the grocer could sell more milk.

Again, you can’t do this as a practical matter. You set the price somewhere in the middle, in our example $2.50, and that way you can enjoy as reasonable a profit as possible – without having to worry about scaring off bargain shoppers nor giving diehard milk enthusiasts too good of a deal. At $2.50, everyone’s as close to happy as possible.

Office Depot sells a case of 24 half-pint bottles of Nestle Pure Life water for $5, and you have several choices:

  • Shop around for something cheaper, and good luck
  • Buy a Brita filtration system
  • Go without, and just drink out of the tap
  • Fill up your tub before disaster strikes.

Sellers aren’t stupid, mostly. Office Depot knows that if they raised the price to $6, they’d lose too many customers. Office Depot wouldn’t sell enough water to justify stocking it. But if Office Depot lowered the price to $4, they’d sell too much of it. How is it possible to sell “too much” of a product? That’s easy, when you’re not getting a big enough margin over cost. If Office Depot buys the water from a wholesaler for, say, $2.50 for a 24-pack, that obviously means $2.50 profit at current prices. Lower the profit to $1.50, and Office Depot would be leaving money on the table. Maybe they’re leaving money on the table as it is, and the $5 price is just to get people in the store. Either way, $5 isn’t so high that no one buys, and isn’t so low that the store runs out.

Add a natural disaster, and it’s interesting to see how government functionaries panic. Several states have “anti-gouging” laws that prevent merchants from setting prices in response to market demand. This is no different, in principle or in effect, from setting a maximum on the price of Apple stock or on an ounce of gold. The idea is to “protect” the consumer, and it doesn’t work. It never works.

Here’s the problem. A customer who’s worrying about Hurricane Sandy goes into Office Depot, happens to be the first one in the door, sees the $5 price, and immediately buys the entire display of 100 packs. Can’t be too careful, right? It’s an emergency! $500 might be a bargain if there’s no water available for weeks.

And now, no one else can buy water. It’s all gone.

So the retailer sets a limit. 5 packs per customer, whatever. So instead of all but 1 person going without bottled water, now, all but 20 do.

But knowing that there’s going to be increased demand for bottled water, what if Office Depot were to quadruple its price?

When a case costs $20, people start thinking.

  • Do I really need all this water?
  • Could I economize, maybe get along with as few bottles as possible?

Raising the price to $20 means that only the most motivated buyers are going to buy. Artificially maintaining the $5 price, in light of increased demand, decimates supply. Office Depot knows it might be a while before it can get more water from the wholesaler, who’s probably not going to be able to deliver any more in the near future. Either way, fixing the $5 price causes shortages – the very opposite of what you want to have happen (and what market forces dictate) in a natural disaster.

The North Carolina Attorney General speaks of “unfair profit”, as if an Act of God leading to the certainty of a dwindling supply is somehow the retailer’s fault.

This isn’t just anti-American, it’s inefficient. Again, prices should be agreed upon by buyer and seller without a 3rd party poking its nose in and claiming to be on the side of liberty and justice. If a seller sells bottled water that turns out to be tainted with E. coli, or if the buyer tries to pay with counterfeit bills, that’s when government should get involved. But when two parties agree to exchange a fixed amount of money for a fixed amount of a good, government intervention only causes problems far greater than the alleged one it’s trying to correct.

(Thanks to Darwin’s Money for the inspiration.)

Filed Under: Bad Examples, Capitalism Tagged With: ,
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