Tax Interest Rates

The common adage says that only two things in life are guaranteed: death and taxes; so today being tax day, it only felt natural to write about taxes. As I have gotten further into my study of finance, it is clear to me that there are many factors, both intentional and unintentional, that are the result of taxes. One interesting, potentially unintentional, result of government taxes and tax refunds is the zero interest rate that you receive on your refund. When the government "borrows" your money and then pays you back, a rational investor would argue that they should be paying you for the use of your funds. The government argues differently. And while many are upset about the government's zero interest rate, it makes sense in the large taxation scheme.

The outline of the argument over the potential losses that tax payers face with zero tax interest rates was outlined in the recent US News article Excited About That Big Tax Refund? Think Again. Abby Hayes discusses why getting a big refund, which for 2014 was $2,847, might not be such a good thing:

In fact, when [the government] writes that fat refund check, the agency is just giving you money back it owes you. In other words, when you get a massive refund, it means you've loaned the government money from your paychecks throughout the year. And the government is not paying it back with interest!

Clearly the interest on tax refunds can be sizable, especially when you consider the return of the S&P 500 as an investment alternative. But the question falls to who foots the bill if you were to offer interest back on tax refunds. Two alternative answers follow: the government provides the refund itself or there is no tax withheld (and thus no refund to follow).

A FiveThirtyEight titled Don't Be So Happy About That Tax Refund provides an analysis of why psychologically the second option would not work:

Getting a government check in the mail (or direct-deposited into your bank account) feels like a windfall. For many people, their annual refund amounts to a savings plan: A third of respondents in the Bankrate survey said they planned to save or invest their refunds.

People seem to be happy with the windfall that they receive from the government, acting as it was an unexpected bonus that they receive, even if it was their own money. In the same sense, there would probably be equal grumblings over the need to pay these taxes every year. If your employer/the government did not withhold some of your income, you might be able to invest these extra savings, but you would have to deal with a significant tax bill every April 15, which could be a painful and potentially credit threatening event (if the taxes were not saved for previously and it results in an inability to pay).

To respond to the first answer (the government pays the interest to you), you have to think of the tax market in current equilibrium. If the government is currently "borrowing" from individuals at a rate that funds enough of their financing throughout the year on an equilibrium basis, making the government pay interest on their borrowing would just cause the government's "cost" basis to increase. The government, with the monopoly power in the tax market, would simply pass these increase costs along to the individuals paying taxes. What follows is that, as the government pays you more for the interest on your tax refund, your tax bill would increase, which should equilibrate out to a zero change for individuals.

The Bad Rap of the Finance Profession

As a business student who is concentrating in finance and someone who will be working in the financial field next year, I take offense to those who call out the financial industry as inefficient uses of talent in the economy. These opponents of the financial industry have taken the opportunity presented by the most recent financial crisis to underscore the problems that investment bankers, hedge fund managers, and other financial intermediaries pose to the "real" economy. However, these opponents like to focus the story on the fringes of financial intermediaries, outlining all of the crooked practices and scandals while generally ignoring the benefits that these financial companies can provide.

A recent example of this fringe story analysis was offered by a Harvard Professor in a recent New York Times article. This professor says that he is disappointed when bright students opt into the financial industry, away from more optimal professions such as doctors, professors, or public servants. The author explains that those in the financial industry are typically "rent seekers" where they take wealth from others and transfer it to themselves. He goes on to explain some of this negative "rent seeking" behavior:

Banks sometimes make money by using hidden fees rather than adding true value. Debt collection agencies may use unscrupulous practices. Lenders to poor people bying used cars can make profits with business models that encourage high rates of default...These kinds of practices may be both lucrative—and socially pernicious.

Using these margin examples to color the financial industry as a crooked business ignores the potentially socially beneficial services that the financial industry can provide. Using the same kind of analysis, you could argue that professors are corrupt because of the illegal actions of one professor or all researchers siphon funds. This type of analysis should not hold for the entire industry as it ignores all of the benefits that the industry gives: namely the role of financial intermediary, giving individuals greater access to debt, financing, and investment options.

Using fringe stories of corruption may not be able to take down the entire financial industry, but breaking down the financial industry into sub-categories show a few "service providers" that might be a net negative to society. One such sub-category is potentially the high frequency trading firms that were touched on in the NYT article and very closely examined in Michael Lewis's book Flash Boys. In the book, former HFT employee Brad Katsuyama discusses the problem of companies investing hundreds of millions of dollars to shave off hundredths of seconds for times of trades and the problem of front-running trades, again something that can be defined as "rent seeking" activities.

But once again, this problem is being focused on at the margin. While it is not clear that reducing trade times by hundredths of seconds is a net social cost (it likely is), Katsuyama ignores the long history of companies investing in faster trading technology that proceeded this current point. Increased speed of electronic trading and compressing spreads on stock trades have both made investing more efficient, allowing capital to move more freely. By only focusing on hundredths of seconds, you ignore the hours that have already been shaved off of placing trades.

Does Title IX Set Women's College Basketball to Fail?

The NCAA Women's College Basketball national championship game was held last night, and to almost no one's surprise, the University of Connecticut Huskies took home the trophy. And, while just the night before myself and my roommates sat engaged in the Men's College Basketball national championship game, we did not tune into the Women's game for even a single moment of the action. And this story is not just unique to my situation: Americans across the country have expressed great interest in the men's tournament while failing to pay attention to the women's game. Clearly the two games are not on the same footing for perceived entertainment value from viewers. However, under Title IX of the Education Amendments of 1972, both the men's and women's basketball teams are required to be treated equally under university funding. Because of this equal treatment, Title IX is setting Women's College Basketball to fail.

The law statute of Title IX is simply defined as "a law passed in 1972 that requires gender equity for boys and girls in every educational program that receives federal funding." While this statute applies to many different areas of educational funding, the one that receives the most public spotlight and debate is the section under sports equality. While not without its fair share of political controversy, Title IX seems to be improving women's participation in sports. The results as found by the Feminist Majority Foundation show:

Fifty-five percent of the "post-Title IX" generation participated in high school sports, compared to 36% of the "pre-Title IX" generation. Because of Title IX, more women have received athletic scholarships and thus the opportunity for higher education than would have been possible otherwise."

Because there are significant benefits to those who play sports, namely health benefits and the possibility for subsidized higher education, it seems fair to argue that the advancement of Title IX has had a positive benefit for women.

I do not deny that Title IX has significant benefits for gender equality in education, but from a business execution standpoint, Title IX is setting Women's college athletics for failure. This idea was recently highlighted by Kate Fagan, former women's college basketball player and current ESPN W contributor, in the FiveThirtyEight Hot TakeDown podcast:

The NCAA Women's Basketball loses the most amount of money of any NCAA championship at $8 million. They don't want that designation and they shouldn't have it considering the amount of money that ESPN pays to broadcast the tournament and other factors. But at the end of the day, as they [people inside women's basketball] say, they have golden handcuffs.

The podcasters point to specific areas such as travel budgets that show that as men's basketball take entire charter jets to different tournament locations. While the men's sports teams budgets may be able to handle this "luxury", Title IX also requires the women's teams to take charter jets, which the podcasters specify is something that is not necessary. Because of this imposed gender equity, the women's game is forced to continue to take losses and continue to be subsidized by the men's game, something that does not make good business sense. From a pure business standpoint, allowing the women's game to cut unnecessary expenses can potentially make them profitable and continue to stand alone as its own sport. This would still allow women athletes to continue to receive the benefits of sports as described above, while making the NCAA more economically efficient.

While it may be difficult, both politically and socially, to garner support to reform, offering solutions that balance the spirit of the Title IX law and economic efficiency can appease both sides of the debate. The intention of Title IX was to promote equal educational opportunities for both genders, something that can still be achieved through an analysis of what is actually "necessary" for sports programs. Returning to the example of travel budgets, analyzing both the men's and women's teams needs for travel arrangements (ie. team size, time between competitions, distance traveled, etc) can create a fair allocation of expense budgets. If it determined that men's teams need such "luxuries" and women's teams do not, then women's teams should not be (golden) handcuffed into such unnecessary, inefficient expenses.

Technology and the Competitive Landscape

When I purchased my first iPod during middle school, I knew my music experience would change forever. No longer was I confined to the case of CDs for my music library, no longer was I constrained to sitting still while listening out of fear of skipping CD playback. Now as I sit down writing this post, I have barely noticeable headphones in and access to a seemingly limitless library of music through my Spotify Premium subscription. From LimeWire and iTunes, the changing technology of music has consistently shaped the music industry and pushed the competitive landscape of music entertainment to places that might not have been imaginable before the advent of the iPod only 14 short years ago.

Within the music industry, there have been some surprising trends in the revenue model of music, constantly adapting to new technologies, and even giving rise to some old technologies. A recent Forbes article titled New Music Industry Revenue Figures Show an Illusion of Stability breaks down the different sources of revenues for recorded music. Their analysis is best summarized by the graph (below) and their conclusion:

The trend is clear: a certain segment of the population still likes owning music, but those people are finding that they like owning a physical object more, particularly one available in packaging that acts as a canvas for art, photos, lyrics, and liner notes...

From an era in 2003 where seemingly none of the recorded music revenue came from downloads or streaming music services to a current era that is dominated by these segments has coincided with the increasing availability of these technologies. The use of flash hard drives in mobile devices has allowed music consumers maximize the size of their music library while minimizing the need for storage/transportation of the physical copies of music. However, the download service has begun to give way to the prevalence of on-demand or streaming music services which once again allow consumers to expand their music libraries while virtually eliminating the need for any individual's need for physical storage space.

However, it is interesting to note that there has been a recent resurgence in vinyl technology, which as the article revealed is the fastest growing segment of revenue for the recorded music industry. The explanation that the article gives for the rise of this once almost extinct technology is one that pervades within the music industry: consumers care about the "art" of music and vinyl allows them to have not only physical album art, lyric tracks, etc., but also gets them closer to the "true" sound of the music.

At the intersection of the rising on-demand music streaming service and the "art" of music is the new streaming service called Tidal. Launched last week, Tidal has the backing of several big named artists such as Jay-Z, Kanye West, Madonna, and Taylor Swift. The service pushes an image of art and the artist:

Alicia Keys, who spoke for the group, described Tidal as "the first ever artist-owned global music and entertainment platform. We want to create a better service and better experience. Our mission goes beyond commerce and technology."

With the artists themselves standing behind the music, potentially making the music experience greater than an individual consumer would be able to achieve on their own, this service could appeal to both the vinyl, art seeking and streaming segments. The ability to capture this market successfully could once again push the music industry to new fronts, competing not only on the volume of music available, but the quality and exclusivity of this music.

On the 'Blue Eagle'

In the intersection of the political and economic spheres, the debate over minimum wage has long been stuck in a cycle of costs and benefits. Opponents of minimum wage laws point out the disruptions in the labor market, imposing a price floor for potentially low skill jobs. Minimum wage supporters argue that it benefits the worker, allowing them to earn a higher wage (and thus spend more) than they would have been able to in the unregulated labor market. However, understanding the history of minimum wage in the United States can give a better sense of why minimum wage laws might suspend a Constitutional right and how political maneuvering ultimately pushed the law into power.

In the early stages of minimum wage, there was a long history of both the state and federal governments attempting to pass laws to specify working conditions and provide a standard of pay. However, each of these movements were struck down by the judicial system, often the Supreme Court of the United States, on the grounds that it violated Article I, section 10 of the Constitution: freedom of contract. Court cases such as Hammer v. Dagenhart (1918), Adkins v. Children's Hospital (1923), and Morehead v. New York (1936) all established a precedent of the legal system to not allow the government to interfere with labor negotiations.

New Deal legislation also attempted to establish voluntary minimum wage based on American Patriotism. The National Industrial Recovery Act allowed employers to take part in the "Blue Eagle" program:

Signers agreed to a workweek between 35 and 40 hours and a minimum wage of $12 o $15 a week and undertook, with some exceptions, not to employ youths under 16 years of age. Employers who signed the agreement displayed a "badge of honor," a blue eagle over the motto "We do our part." Patriotic Americans were expected to buy only from "Blue Eagle" business concerns.

While employers signed more than 2.3 million of these agreements, covering 16.3 million employees, the National Industrial Recovery Act was ultimately gutted because of a 1935 Supreme Court ruling on a "sick chicken" decision: nothing that ultimately had to do with voluntary employment programs.

President Franklin Roosevelt, who was a large backer of the New Deal legislation, did not end his push for minimum wage when the NIRA was struck down. Using his recent re-election as momentum, he issued a "court packing" plan, in which he would be able to expand the Supreme Court up to 15 Justices, ensuring a liberal majority. While this legislation did not ever come up for Congressional vote, it's looming pressure seemed to have an impact on New Deal and minimum wage controversy. This tipping point occurred in West Coast Hotel v. Parrish, where the Supreme Court ruled for the first time that the state's imposition of minimum wage laws were constitutional under the fourteenth amendment. This cleared the way for the imposition of the Federal Fair Labor Standards Act in 1938, which established a standard forty hour work week, the right to overtime wage, minor employment standards, and a minimum wage.

Is Tesla a Bubble?

Purveyors of the Efficient Market Hypothesis have conceded that while market bubbles can and will occur, but it is nearly impossible to ordinary investors to capitalize on them by gaining out-sized returns. Their argument flows from an issue of market timing (knowing exactly when to get into/out of the bubble) and costs of such investments (it is very costly to fight the majority of the capital flows in the market). However, other investors who reject the Efficient Market Hypothesis argue that if you understand the reason for bubbles to form, you can recognize them in the market and use this information to your advantage. Under the recognition method utilized by Robert Shiller, namely that catchy "stories" lead to investment bubbles, may suggest that the company Tesla (TSLA) may be currently experiencing such a bubble.

The rejection of EMH as explained by Robert Shiller is that the market does not behave perfectly rationally. Instead, he argues that bubbles that arise out of mass investor psychology may be products of irrational market behavior. Shiller argues that investors in the market have a tendency to want to consume stories about stocks:

Psychologists have argues there is a narrative basis for much of the human thought process, that the human mind can store facts around narratives, stories with a beginning and an end that have an emotional resonance...We need either a story or a theory, but stories come first.

This story line basis of thoughts by humans (and by extension, human investors) can disrupt the so called "efficient markets". When a large portion of investors get introduced on a story, say the internet craze of the early 2000s or the real estate market of '03 to '07, they tend to latch on the positive ideas that it offers and get hooked on the idea of a payoff. This causes investors to behave irrationally, investing in the idea rather than the numbers behind the company itself.

When looking out on the market today, one such story that has gripped many investors is the story of Tesla. The company has seen tremendous price appreciation since it went public in the middle of 2010, currently up over 875%. However, investors who have driven this price up might not necessarily be looking at the numbers behind Tesla, focusing more on its founder and CEO Elon Musk. A perfect example of this irrational investment came from a recent tweet of Musk:

Elon Musk, the billionaire technology entrepeneur, has announced a "major" new Tesla line that is "not a car", in a cryptic tweet which has left millions guessing...Shares in the electric car [company] jumped nearly 4 percent in just 10 minutes-adding a staggering $900 million to the company's market cap in just 115 characters.

While the prospect of a new revenue and profit stream for the company can perhaps move the needle of the valuation of the company, I believe that the market has reacted with irrational behavior to something that almost no one knows about. They increased the stock by 4% because of a simple tweet, implicitly assuming that everything creative genius Elon Musk touches will be gold. A more rational investor may look at this statement and attempt to wait to see what in fact the new product line will be or recognize that extending into product lines that may not align with the core competency of the company may ultimately dilute the share value.

Natural Rate of Unemployment

With the release of the most recent jobs report by the Bureau of Labor Statistics, the discussion of the headline unemployment number centered around the fact that unemployment had fallen to 5.5%, or equal to the so called "natural rate" of unemployment. With the rapid increase in hiring that has been seen over the past twelve months, an average jobs gain of 275,000 jobs per month, the unemployment rate has fallen substantially, reaching its lowest level since May 2008. Now that the unemployment rate has reached the natural rate level, the discussion around the Federal Reserve raising rates has increased. While the speculation is that the Fed will seek to take its foot off of the pedal of the economy to stabilize employment around this level, there may be benefits to increasing employment past the natural level.

Using the analysis of data provided by the St. Louis Federal Reserve Economic Database, there is an impressive relationship of the unemployment rate falling below the natural rate and the advent of a recessionary time period. A close analysis of the graph (below), shows that when the Civilian Unemployment Rate (red line) has fallen below the Long-Term Natural Rate of Unemployment (blue line), there has been a recessionary period. It is interesting to note that recessions further in the past, specifically ones before 1990, had significantly lower unemployment rates than the NROU before the onset of the recession. However, with the recent recessions, the unemployment rate has not been able to dip so far below the NROU before climbing with the economic contraction.

However, there has been increasing calls for the Fed to push the unemployment rate well below the natural rate level. Specifically, a paper from economics professor Laurence Ball at John Hopkins University argues that the fed should push the unemployment rate well below even the 5% mark. He argues that this recession is unique in that there are a significant number of long term unemployed and discouraged workers. His plan to push unemployment temporarily below 5% would help solve this problem:

It [the Fed] should seek to push the rate "well below 5%, at least temporarily," he writes. That could help bring some discouraged workers to reenter the labor market, as well as help the long-term unemployed find work and involuntary part-time workers find full time jobs, he said. "A likely side effect would be a temporary rise in inflation above the Fed's target, but that outcome is acceptable."

This is an interesting take on the economic issue that remains to be at hand, many years after the official end to the recession. While the headline number of unemployment, the U-3, has fallen significantly since 2010, other, more broad measures of unemployment such as the U-6 have not shown as much improvement. The plan that he suggests would be a greater focus on returning these more broad measures down to their "natural" levels. In addition, the side effect of an increase in inflation could be a positive for the economy. Currently, US inflation has been under the Fed's target for almost three years; for the Fed to come out and say that they are going to continue to pressure unemployment down, there could be an increase in expected inflation within the market, helping them get closer to their medium-term targets.