Randomly Noted

If you are looking to make a contrarian macroeconomic bet in 2011, how about this one: real progress will be made in the U.S. at the federal and state level on reducing large, structural budget deficits.

I know it is a doozy. And I did say contrarian, which means if you believe it most people will say you are crazy. But contrarian sometimes does happen.

It’s pretty easy to build a case against deficit-cutting progress. Sky-high budget deficits at the federal level were just recently met by continued tax cuts, which makes the deficit worse. Messing with Social Security or Medicare still means flirting with the ‘third rail’ of American politics. State and city promises to retired workers are massive and underfunded. A divided government in Washington promises nothing but hostility and inaction.

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Ever since it became apparent that tax legislation would not include an extension of the popular Build America Bond program, the traditional tax-exempt muni bond market has been in somewhat of a tailspin. Prices have fallen, yields have risen and investors have been pulling money out of long-term municipal bond funds.

That trend continues. The latest data from the Investment Company Institute showed more money flowed out of longer-term funds in the week ended Dec. 8.  Apparently, investors are concerned that municipal issuers, without the BAB program, will be flooding the traditional municipal market with new bond issues. Thus, there will be to much supply and not enough demand.

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As many note the passing of  long-time New York Yankees’ owner, George Steinbrenner, and discuss his outsized impact on New York City and on baseball, perhaps his celebrity will prompt the U.S. Congress to finally come to terms with an important tax issue.

It feels unseemly to discuss financial matters right after a person’s death. But it’s a financial news event whenever an American of significant wealth dies because of Congressional inaction. The news is that right now, no matter how wealthy the person who passes away, there is no federal estate tax.

This is not a call for any specific level of estate tax, itself a subject of heated debate in Congress and in the country. It’s a call for Congress to have a consistent level of tax for a reasonable number of years.

As press reports have noted, Steinbrenner’s fortune – Forbes estimated his net worth at about $1.15 billion – wouldn’t be subject to estate tax because in 2010 there is no federal estate tax.

In 2009, the federal estate tax rate was 45%. In 2011, if Congress doesn’t act, the rate will be 55%.

This stunningly irresponsible set of circumstances occurred because of Congress’s inability to act on deadlines it essentially set for itself back in 2001.

At that time, tax-cutting was in vogue, but there was a compromise achieved by essentially making annual reductions in the estate tax temporary. Said another way, Congress kicked the can down the road.

After a declining rate starting from 2001, the rate went to zero for 2010 and then reverts to 55% in 2011. The idea presumably was that no one who voted on the measure would want the zero rate or the 55% rate to ever be put into practice.

Those two opposing-ends-of-a-bell-curve numbers were put there essentially as a warning from Congress to itself. We put off a decision, but we have a whole bunch of years to work things out. They haven’t yet worked things out.

Some have speculated that if Congress finally does get around to stepping up and settling the state tax issue, it will try to apply the rate retroactively, making the heirs of those who pass away in the tax-free year of 2010 pay something.

The idea of retroactivity has raised legal questions. More imporatnt, it assumes Congress will finally do something to settle the estate tax issue.

Pardon our skepticism on that score.

First, it was Wall Street that got hit hard. Then it moved to corporate America. Unemployment rose and recession set in. The last to get hit in these economic downturns are state and local governments. And there are indications that more is to come on that front.

The U.S. Census Bureau was out with a report today that showed just awful state and local government tax revenues. Click here for the summary report. Individual income tax receipts were down 11.7% in the third quarter from a year ago. General sales tax receipts were down 9%. Corporate income tax receipts were down 18%. Somewhat surprisingly, property tax revenue, the big driver of local government revenues, was up 3.5%. One has to believe, though, that as residential home foreclosures work their way through the system and more commercial real estate problems surface, this revenue source comes under pressure as well.

All of which is to say: we may have avoided a financial meltdown and we may be on our way out of a recession. But state and local governments have some very hard decisions to make. They can’t raise taxes and wil have to cut costs. And that means elimination of popular programs and perhaps even jobs.

Lael Brainard, the Obama administration’s nominee for Treasury undersecretary for international affairs, made some tax mistakes – and as a result, it seems, a Senate hearing on her nomination has been delayed for about six months. Brainard’s error: she paid property taxes late on a Virginia home for four consecutive years and was slapped with $1,401.09 in interest and penalties. Gasp! She was late on another $485 in personal property taxes on a pick-up truck, and may have erred on a home-office tax deduction. Horrors! All in all, it’s a fairly humdrum litany of tax mistakes that surely shouldn’t have held up an important government nomination. On these grounds, I will most certainly never ascend to Washington, D.C.,’s heights. My husband and I have had our shares of minor tax bloopers over the years, largely thanks to the fact that we lived overseas for nine years, making dealing with tax authorities that much more difficult (an understatement.) But even if you never leave this shores, it’s awfully easy to fumble a tax return as one’s personal finances grow more complex. I see the Brainard affair as just another example of how Washington doesn’t work. Somehow, the Senate pooh-bahs on the Finance Committee would rather have no undersecretary than one who, like you and I, isn’t all that good at dealing with the IRS on routine matters. My colleague, Martin Vaughan, reports that the Senate is now going to give Brainard a hearing. Long overdue.

Below the headlines about 50% compensation cuts being ordered for top earners at the seven fallen angels under his control, the so-called federal pay czar, Kenneth Feinberg, is apparently also forcing some changes in governance.

Feinberg, who technically is called the special master of compensation at the U.S. Treasury Department, didn’t just cut pay for the 25 top people at the humbled seven. He also delved into some of the corporate governance issues that have been talked about for years in U.S. boardrooms and among activist investors.

He will insist on a split between chairman and chief executive jobs, a model already followed in other nations. Staggered board terms will be eliminated. and boards of directors will have to create risk committees.

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Credit Suisse signals its determination to expand its private banking operations, despite the troubles that have beset the wider industry and the blows to Switzerland’s role as a tax haven. Many private banking institutions – notably CS’s Swiss rival UBS – have suffered from the recent crackdown on tax evasion and the uncertainty about which banks will weather the credit crisis.  Credit Suisse clearly sees an opportunity, and wants to raise the number of CS private bankers from about 3,400 today to 4,000 by 2012. It says that Swiss institutions can’t rely on Switzerland’s tax advantages any more and have to have to compete through the service they offer and through expansion into new markets.  CS provided evidence it is benefiting from the travails of some of its rivals – it said that senior private bankers made up three quarters of its hires in the first half of 2009, compared with less than half in 2008. Senior bankers tend to be better at generating business, reflected in the much higher levels of net new funds transferred to the bank per advisor in the six months after hiring.

Read Katharina Bart’s article at http://online.wsj.com/article/SB125360550023830229.html

Today, with the official announcement of a Swiss-U.S. tax deal over UBS client data, the chairman of the once-mighty investment bank is talking about repairing its reputation. It’s too late. Memories are short and of course over time some people will forget about UBS’s tax tangles. But what they won’t forget is this: UBS has lost its raison d’etre. No longer able to promise secrecy and invisibility to its customers – thanks to a crackdown on bank secrecy laws in Switzerland and other havens – and still suffering from costly financial missteps that cost it clients and assets, UBS faces an uphill battle reinventing itself. Last week, Oswald Grubel, the CEO, told the WSJ’s Stephen Fidler UBS will seek its future in emerging markets such as Asia and the Middle East. But those areas are crowded – packed with banks whose reputations have stayed relatively intact amid the global financial crisis. UBS, for its part, bled CHF123 billion in asset outflows last year as clients, spooked by the bank’s exposure to so-called “toxic” assets, fled with their money; the outflows have continued this year as it became embroiled in tax woes. DJN quotes the bank’s chairman, Kaspar Villiger, as saying the tax pact with the U.S. “will allow the bank to continue moving foward to rebuild its reputation through solid performance and client service.” That’s do-able but very tough.

The economic stimulus package put forth by President Obama and passed by Congress in February contains a host of provisions to jump start the weak economy through a series of tax breaks, spending plans in areas like health care and infrastructure and an increase in unemployment benefits.

It also contains a tax deferment component that makes debt buybacks by companies with the cash to do it much more attractive. Stanley Works, the company known for hand tools like hammers and screwdrivers, is one such company taking advantage of the new law (officially known as the American Recovery & Reinvestment Act of 2009).

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Bad news for states and a little more short-term worry for people who invest in municipal bonds. As Stan Rosenberg reported for Dow Jones Newswires today, the Rockefeller Institute of Government said state tax collections declined 12.6% in the first quarter of this year compared to the same period a year ago. The study from Rockefeller, a public policy research arm of the State University of New York, showed a 15.8% decline in personal income taxes – the largest decline since 2002.  The report (click here to see it) breaks down data from eight major regions and individual states that participated (the study has 47 of 50 states worth of data). Biggest decline in personal income tax collection was South Carolina, with a drop of 38.3%. The biggest drop in sales tax collection was Georgia with a drop of 16.3%. Kansas saw corporate tax collection drop 97.7%. “Deeper revenue short falls and more budget cuts are likely on the way for most states” through the rest of the year, the report said. The question will be if the declines in tax collections begins to slow, indicating a bottom. More to come.