The Cost and Benefits of Economic Rescue In This Week’s News

By Joshua K. Beecher, Guest Blogger

Editor's Note:  The first five posts in this blog focused on changes in the tax law that are currently scheduled to occur.  As this is a tax and money blog, we have invited Joshua K. Beecher to comment on money news of the past week, particularly as it relates to the current status of the cost and effectiveness of the economic stimulus and bailout activities.

This past week was an interesting one in terms of major figures in the financial world making very public statements.  Ben Bernanke, head of the Federal Reserve Bank, while in Germany this week, publicly defended the Fed’s decision to pump an additional $600 billion into the financial system by buying up U.S. Treasuries; claiming that the persistent high un-employment rate justified the action.  For those who follow finances at all know that this is a very unusual move for the Federal Reserve period, let alone its head.  Since when did it ever attempt to “publicly” explain their reasoning behind any decision?  And more importantly, since when did its head publicly call out China (and other emerging economies mind you) in regards to suppressing their currency value right in line with the White House’s administration?  Certainly another disturbing item that makes you wonder how politically neutral the Fed truly is.

As interesting as Mr. Bernanke’s speech was, even more interesting is the Op Ed piece that Mr. Warren Buffett wrote into the New York Times, and which they published this past Wednesday.  He goes on to praise the efforts of a litany of department heads: Fed Chairman Bernanke, Treasury Secretaries Henry Paulson and Tim Geithner, etc. stating that they acted with “courage and dispatch.”  No details were provided in his article on the costs and/or benefits of the government’s various rescue efforts, but it does make you wonder.  Is the true cost to U.S. taxpayers for the bailout the pittance they would have us believe?

One of the more interesting websites to check out on the topic is one entitled ProPublica (bailout.propublica.org).  On their site, you can track everything that has been paid out from the government to the various entities that have received assistance.  You can also track how much of that money has been paid back.  As of this very moment, a total of $546 billion has been spent, loaned or invested by the Government, and a total of $264 billion of that has been returned and paid to the Treasury as interest, dividends, fees or to repurchase their stock warrants.  This leaves $282 billion outstanding which is far less than the publicly touted cost of the Troubled Asset Relief Program (TARP) for banks which alone was supposed to cost $700 billion.  In addition, this figure is likely to come down even further as more banks continue to make repayments.

Earlier this spring, Mr. Geithner predicted that TARP (along with assistance for GM, Chrysler and homeowner’s facing foreclosure) would cost roughly $119 billion, once everything was paid back that would be repaid.  Fannie Mae and Freddie Mac would add an additional $85 billion, and with the government actually standing to make money on the Fed’s finance programs for the banks, to the tune of $115 billion, that left the government’s total rescue tab at a mere $89 billion.  Most would agree that this is a very small price to pay to avoid the financial Armageddon and collapse to which we were headed, but is this truly the end of the story?  It is incredibly difficult to have a full and exact accounting of the entire rescue effort given how wide spread the government’s efforts were, but I’d like to take a look at just a few of the intangibles that certainly paint the picture a little differently than what our Washington leaders (and those like Mr. Buffett) would have us believe.

First up is an interesting take from a New York Times financial columnist, Gretchen Morgenson, who back in April of this year began to question the numbers being touted by Treasury Secretary Tim Geithner and Co.  She points out that the Treasury’s numbers leave out the effects of the Fed’s near-zero interest rate policy, which of course was put into place originally to increase lending.  However, the fact of the matter is that it punishes investors and heaps mountainous profits and benefits on the banks.  Through this policy, the banks have been able to pay depositors next-to-nothing while taking that money and loaning it out.  Considering the fact that the average credit card rate in the nation is 14% you can see how the profits add up quickly.  There is no simple way to calculate a figure for this transfer of wealth to banks, but Morgenson calls it “enormous.”

Next let’s take a look at the overlooked losses the Federal Deposit Insurance Corp (FDIC) has accrued by taking on 43 failing banks this year alone.; total cost to the Insurance fund stands at $6.65 billion.  While that fund is financed by bank fees, what of the loss-sharing arrangements the FDIC was forced to make to convince healthy banks to buy up troubled assets from failing ones?  Christopher Whalen, the editor of the Institutional Risk Analyst (a weekly newsletter produced by Institutional Risk Analytics), expects to see that figure top $400 billion when all the dust settles and all is said and done.

And while we’re at it, let’s not stop there.  TARP was also designed to give the banks a reprieve and instant cash injection by changing long-standing accounting rules to allow them to maintain bad assets on their books at unrealistic levels (Mr. Whalen has labeled this provision as “extend and pretend.”)  This portion of TARP is still ongoing as of yet those toxic assets’ true value (and losses) have not been absorbed on the banks’ balance sheets.  This of course helps explain why many banks have been so hesitant to loan out any money, which in turn has prolonged the economic downturn.  As with all these “intangibles” there’s really no real way to calculate the total cost, but Mr. Whalen has said, “The refusal of the Washington political class to address the issue of bank insolvency quickly via restructuring and recapitalization has extended the economic recovery process by years.  Lending will continue to shrink and real economic activity is suffering. The cost of ‘extend and pretend’ goes into the trillions of dollars in lost economic activity.”

As stated earlier, there is no real way to put a dollar figure on the cost of the government’s actions to “rescue” our troubled and failing financial system; however, if for nothing else it is worth taking a second look at assessments provided by our government (and then intentionally praised by those in high esteem like Mr. Buffett) with the heavy dose of salt that they deserve.

Sources

•Warren Buffet’s Op Ed Piece in the New York Times: http://www.nytimes.com/2010/11/17/opinion/17buffett.html

•ProPublica’s tally on Government Bailout/Rescue Spending: http://bailout.propublica.org/main/summary

•Gretchen Morgenson’s article in the New York Times, 04/17/2010, questioning the Bailout was/is a bargain: http://www.nytimes.com/2010/04/18/business/economy/18gret.html

•Ben Bernanke’s defense of the Fed’s recent announcements and actions; including issuing a warning to China on its currency policies: http://money.cnn.com/2010/11/18/news/economy/Bernanke_Frankfurt_defense/index.htm?source=cnn_bin

•Christopher Whalen’s Institutional Risk Analytics: http://us1.institutionalriskanalytics.com/www/index.asp

Get Your Tax or Financial Questions Answered In A Future Blog Post

I choose topics for my blog posts based on the questions I receive most frequently from you.  I appreciate your input!  Feel free to comment at http://www.dougbeecherstaxandmoneyblog.blogspot.com/

Important Note!   The information in this article is intended to inform you of some of the financial opportunities provided in the tax laws or elsewhere.  These laws are very complex and thus this article is not intended to give you specific advice for your personal situation.  If you need such advice, please contact a qualified professional.

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© 2010, Joshua K. Beecher, all rights reserved. This article, either as a whole or in part, may not be reproduced or transmitted in any form without the prior written permission of the copyright holder. When such permission is granted, the user must state that the material was used by permission of the copyright holder.

The Small Business Jobs Act of 2010 Lets Me Expense More Equipment. Should I Do It?

President Obama signed the “Small Business Jobs Act of 2010” on September 27.  I mentioned this previously in my October 9 blog post.  One of the things this act does is to extend and increase the amount of equipment that you can write-off in the year of purchase, instead of depreciating it over several years.  It is good for the economy and it is good for jobs to encourage these kinds of purchases.  We can expect increases in equipment orders, which will help hiring.  The businesses buying the equipment will also need to hire people to operate the equipment, or at least increase the hours of existing employees in many cases.

The question I would like to explore today is, once you decide buying new equipment makes economic sense for your business, are you better off taking the tax deduction in the current year or by claiming it as depreciation over several years.  The quick answer is:  It depends.  Let’s look it further by considering a sample case.

Suppose a manufacturing company can get new orders if it buys a new $400,000 machine that is more effective at making custom designed metal parts.  The factory wants to make the sale, so it offers low interest terms of 4% -- with 10% ($40,000) down and $4,920 monthly payments that pay off the machine over 7 years.  Let’s suppose you know that worst case you could get enough orders to pay not only labor, materials, and other expenses but to have more than enough left over to make the monthly payments.  But you don’t have enough for the down payment after you pay your taxes.  This is the situation the tax law writers were hoping to help.  You save enough in taxes by buying the machine that you can reduce your quarterly estimated tax payments and use that to have the down payment.  Then you hire new workers and you pay more taxes on your higher income in the future.  You, your workers, the government, and the economy all benefit.

The timing of when you claim the deduction for the machine can make a difference.  Let’s look at a simplified example that illustrates the point:

Assume the business is organized as a pass-through entity (such as an LLC or an S corporation), so the business owner pays the taxes for the business as part of his or her personal tax return.  Let’s suppose the owner is married filing a joint return and that the owner and spouse together have $200,000 in taxable income per year (but they live on $80,000 after paying taxes and setting aside money needed for working capital to keep the business operating).  Lets also assume there are no changes in tax rates for the next 7 years (I know, a big assumption, but we’re trying to keep things simple here) and that there won’t be any long term difference in state taxes either way – so we’ll look at federal income taxes only.

One option is to claim the whole $400,000 in the year of purchase.  We can’t use expensing rather than depreciation to create a tax loss, so we will take $200,000 in year 1 and the other $200,000 will carry forward to year 2, completely eliminating federal income tax in both years.  In the following 6 years, the business owner will be in the 28% bracket on all taxable income above $137,300, and federal income tax will be $44,243 per year for a total of $265,458 for 8 years. 

Another option is to claim standard (called MACRS in tax language) depreciation, which would provide a deduction of $57,160 in year 1, $97,960 in year 2, $69.960 in year 3, $49,960 in year 4, $35,720 each in years 5, 6, and 7, and $17,800 in year 8.  These deductions add to the same $400,000, but over 8 years.  Applying these deductions to $200,000 in taxable income each year results in federal income tax of $28,238 in year 1, $17,872 in year 2, $24,872 in year 3, $30,254 in year 4, $34,241 in years 5, 6, and 7, and $39.259 in year 8, for a total of $243,218 for 8 years.

The second option results in total federal income tax savings of $22,240 over an 8 year period.  Your actual economic benefit would be different for several reasons.  Depending on the interest rate you pay to borrow working capital, or the interest rate you receive on reserves you keep for working capital, there is a benefit to paying more tax later in order to pay nothing in the first two years. 

There are also a number of variables in the tax law we ignored to keep this example simple that you would have to consider in your own situation.  For example, at $200,000 of taxable income you would be subject to partial phase-out of your itemized deductions, if you have children you probably lost the child tax credit, if you have education expenses those were probably eliminated at your income level, etc.  You would need to evaluate all of these for your own situation.  There might be a benefit in taking more depreciation in one year and less in another to best deal with the timing of how these other tax law provisions interact with the depreciation deduction.

Chances are this exact set of facts don’t look anything like your own.  You may be a contractor for whom one crew cab truck would better carry 4 workers and equipment to a job site, with less use of fuel, than multiple trucks would.  You may be a service company with a network of computers that would work better if they were replaced.  You might be a child care provider that could attract new children with new playground equipment.

Obviously, each situation is unique and individual.  My point here is to simply illustrate that it is worth the effort to make the calculation several ways – the decisions you make, along with changes in the law, can make a big difference in the tax you pay over a period of years.  And when you are doing the math, also remember there are a lot of moving parts in the tax laws.  No matter how hard you try, you are likely to overlook something.  Professional help can often save enough in taxes to pay for itself – several times over.  We’d love to hear from you!

Get Your Tax or Financial Questions Answered In A Future Blog Post

I choose topics for my blog posts based on the questions I receive most frequently from you.  I appreciate your input!  Feel free to comment at http://www.dougbeecherstaxandmoneyblog.blogspot.com/

Important Note!   The information in this article is intended to inform you of some of the financial opportunities provided in the tax laws or elsewhere.  These laws are very complex and thus this article is not intended to give you specific advice for your personal situation.  If you need such advice, please contact a qualified professional.

© 2010, Doug Beecher, MBA, CPA, all rights reserved. This article, either as a whole or in part, may not be reproduced or transmitted in any form without the prior written permission of the copyright holder. When such permission is granted, the user must state that the material was used by permission of the copyright holder.