From the very beginning of this blog, I’ve stated an emergency fund is critical in life. It’s also certainly not just me: Dave Ramsey preaches it; every financial advisor advocates for it. The very first step in my being able to quit my job was having an emergency fund. I’ve mentioned it repeatedly in past blog posts, so why bring it up again?
Because I just had to spend nearly all of mine.
It’s one thing to have an emergency fund — that cash set aside in case life intervenes — and sleeping easy at night knowing you’re prepared for what might come the next day. It’s another thing to watch it drain out over the course of a few weeks. Over the past six months, I had bulked my emergency fund up to cover six full months of expenses in case something happened to my wife’s job or my business. There was no need to panic, it was just good financial sense.
So what happened?
In early March, I had a simple medical procedure done as a prevention measure. My mother was diagnosed with cancer in her mid-40s, so me in my late 30s have been pressured by my doctor to have some preventative testing done. As it turns out, the procedure is not covered by my insurance (because they deem me “too young” to have the testing done — even though it could save them millions in the future). Bill #1 was over $1,340.
This year was my first year of paying quarterly taxes. When you own your own business and you’re not on a payroll, it’s common practice (and the IRS can issue penalties if you don’t) to do a mini-tax return every 3 months and mail in your own withholding. So April 2021 was my first quarter 2021 taxes (January – March). Fine, I was prepared for that. What I wasn’t so prepared for was my CPA discovered my previous 2019 tax return wasn’t filed properly by my former CPA, and there was significant back taxes and interest owed because of it. Bill #2 was $8,100.
This month 2020 taxes were due. The number was slightly higher than anticipated, and my tax savings account decimated by the 2019 taxes, so I had to pull from my emergency fund to cover the shortfall. Bill #3 was $2,200.
Three tax hits in a row and a medical bill. I had gone four rounds with Murphy’s Law and could get back up. But Murphy wasn’t done.
Last week not one, but two major appliances in my house went. My LG refrigerator (do not ever buy a LG fridge) had the compressor go and has slowly been getting warmer and ruining the food in the freezer and fridge. My washing machine had its motor burn out. Bill #4 and #5 were $2,400.
That’s over $14,000 in 60 days that had to be covered. Imagine if I hadn’t had an emergency fund to draw from? Or if I hadn’t decided to beef up to 6 months of expenses saved — it would have been life altering. I would have had to go into debt to cover the medical costs and appliances, making payments and paying interest. Even worse, the IRS does not take credit card. Taxes must be paid in cash. If I hadn’t had the emergency savings to pay all the taxes, the IRS would have set up an installment plan — with more penalties and fees — and I’d have to pay them back monthly for years.
This is why you need, NEED, NEED, NEED an emergency fund.
So my six months of expenses is exhausted. What now? The process restarts. I will set aside money to ‘regrow’ the emergency fund. Life always regroups and will come around again. You can keep Murphy at bay, but he’s never truly gone. I will set aside what I can each month to rebuild, and given the extent of these past two months, I have resolved to save beyond six months expenses. Maybe a year this time?
If you plan to quit your job and build your life, you can’t do it without an emergency fund. If you have an emergency fund, let this post inspire you to add a little extra to it! Life strikes randomly. Things happen. We can’t plan for everything or know everything, but we can do is be prepared.
In The Big Short, there’s a scene where Michael Burry (Christian Bale) is confronted by two of his biggest clients over Burry’s claim of a housing bubble. The first client, Lawrence, tells Burry that “actually, no one can see a bubble. That’s what makes it a bubble.” Burry responds: “That’s dumb…there’s always markers.”
It’s true. There are always indicators, as history has shown. We are currently in the midst of the longest running bull market in history, going all the way back to March 9, 2009. Last February began a large, COVID-induced selloff that corrected course by summer and actually put the market in the green by the end of the year. It was the first time ever a market dropped by 30% and ended green in the same year.
So are we on the verge of the next “Big One?” Here’s five reasons that say we are.
1. Wrong Side of History
As mentioned, we are currently in the longest running bull market of all time. Prior to the 2009-to-present run, the longest was the 1990s, which ran for 113 months. Our current run is at 143 months. Market commentators called last year’s 30% drop the “end of the bull market” but because it came immediately back and then broke the old high I do not consider it the end of the market run. The correction was hefty, but the long term trend line was not broken.
Looking at the list above, prior to our current run starting in 2009, the average bull market lasted 56.83 months. The current run is nearly three times that. Not only that, but the S&P percent change if you include 2020 and 2021 is up to 437.54% taking out the old record from the Roaring 90s.
Simply put, we’re far overdue for an ending to this bull market.
2. Margin Debt is at a Record High
Margin is the difference between the total value of the investment and the amount you borrow from a broker. Basically, you’re using cash or securities you already own as collateral to make more investments in hopes of making a profit. As with other loans, you have to pay back the money you borrowed plus interest. But margin trading comes with risks. If the amount you borrowed gets too large relative to the value of your securities, you will have to deposit more funds. Otherwise, your broker may sell off some of your assets. And remember, even if you lose your entire investment, you’ll still have to repay what you borrowed, with interest.
Website for Robinhood
Any investment bought via credit always runs the risk of margin calls and, eventually, liquidation.
Barry Ritholtz
Margin debt in 2020 reached a record high. Advisor Perspectives has compiled the amount of outstanding margin debt in the S&P 500. The correlation between the amount of debt and the S&P 500 level is not an accident; after all, buying stocks on credit allows you to buy more than you could just on cash alone. By borrowing money from a bank or brokerage to buy stocks (in hopes they go up), funds and investors drive up the market.
The expansion of credit also correlates with past bubbles (and crashes) in the market: the dot com bubble of the late 90s, the housing crash starting in late 2007, and the sharp drawdown in 2020. However, in Jan 2021, the outstanding margin is higher than it’s ever been, lost to the point of going parabolic. The chart below gives a better illustration as to the growing debt burden (or negative credit) overall in the market:
Margin can only expand so far. A bank or brokerage will only lend so much before either the servicing payments or interest becomes too great. There’s also the possibility that a drop in price will precipitate a margin call and the brokerage has the legal power to start selling securities in your account to repay loans. The risk at that point becomes systemic, with multiple brokerages liquidating accounts to get their money back.
For example: I have $100 and I buy 5 shares of AT&T (T). The shares go up in value. I can then use them as collateral to borrow another $100 from my brokerage to buy more shares of T. It goes up, so I borrow another $100 to buy more, and so on. My parents did this during the housing boom in the 2000s: take out a home equity loan to improve the house. The value of the house went up, so the line of credit in the home equity went up, so more could be borrowed for more improvements…and so on. So in my brokerage account, I have over $300 in T stock, only $100 of which was my own money. If T’s stock price drops, the value of the collateral drops, so I get margin called. Worse, if it drops below the price I bought it with my original $100, I could be wiped out. I owe the brokerage $200 regardless, so if all the shares I bought are sold for $200, I have no money left and no shares.
Total wipeout.
Margin debt relies on the “greater fool” theory that pervades every stock market bubble. Essentially, I’m willing to take on the risk of borrowing money to buy stock because I believe there will always be someone (a “greater fool”) to buy it from me. Eventually, there wont be any buyers because prices will reach a point where no one wants (or can) afford a stock. Now you’re stuck with stock quickly losing value that you bought with credit. And if everybody holding that stock tries to sell at the same time or is forced to sell via margin call…well it turns into a landslide.
According to the Financial Industry Regulatory Authority, outstanding margin debt at the end of 2020 was $778.04 billion.
3. Record New IPOs
Jordan Belfort Takes Steve Madden Public in The Wolf of Wall Street (2013)
An Initial Public Offering, or IPO, is when a private company “goes public” by offering shares of the company on the stock market. It is the late stage of start ups: venture capitalists or investors invest money into a company (or person) with an idea, build the company up until it’s functioning and offering a product or service, then sell it via IPO, recouping their investment plus profit. Imagine investing in Apple or Tesla before it went public, then being able to sell off your shares of the company at big returns.
Large amounts of IPOs are also generally seen as a market top or bubble — just look at the dot com craze of the late 90s. Internet startups were dropping shares all over the NASDAQ, with investors desperate to grab anything with “internet” or “dot com” in the name. It eventually became a racket — companies like pets.com that had no real business model or even revenue were being sold to the public.
Defying expectations, investors piled into initial public offerings at a record rate in 2020, and few expect the euphoria to wear off soon.
Companies raised $167.2 billion through 454 offerings on U.S. exchanges this year through Dec. 24, compared with the previous full-year record of $107.9 billion at the height of the dot-com boom in 1999, according to Dealogic.
The coronavirus pandemic turned the typical rhythm of the IPO market on its head, with $67.3 billion raised in the fourth quarter. That amount is roughly six times the total for the first three months of the year.
A lot of this could be driven by retail investors over the course of last year. Axios calls this “The Robinhood effect.” If you recall in my last post titled “Gamestonk,” retail investors (more on them in a minute) dove headfirst into trading stocks using stimulus checks and Federal unemployment bonuses to buy up companies like Tesla.
Even as I write this, the IPO for dating-app Bumble just opened 77% higher than it’s IPO price on its first day of trading. The app disclosed 2.4 million paying users as of September 2020, but also a net loss of $84.1 million…with a net loss margin of 22.3%. With it’s current stock price, the dating app company is valued at $14 billion.
Make no mistake — this is mania. Retail traders are buying shares in IPOs of companies they recognize: AirBnB, Uber, Lyft, Pinterest, and Slack. These are apps and software they know. And they all want to get in on the ground floor in case the stock is the next Tesla or Apple. Just like people didn’t want to miss out on pets.com being the next…well, whatever. Perhaps even more maniacal is the ubiquity of SPACs or “Special Purpose Acquisition Company.” Without going too far down the rabbit hole, here’s The New York Times’s definition: “
These vehicles have only one purpose: to find a private company and buy it, usually within two years. SPACs are sometimes known as “blank check” companies — as in, investors give them a blank check to go buy a business, sight unseen.
Those checks are getting bigger and bigger, with SPACs raising nearly $26 billion in January, a monthly record in an already red-hot market.
In case you don’t know what a P/E ratio is, I threw out the formula from the get go. More bluntly, it’s the measurement of how far from reality a company’s stock is. If a company that has 1,000,000 shares makes $2,000,000 than its earnings per share (EPS) is $2.00. Now the same company’s stock is $200/share. So $20 divided by $2.00 is a P/E of 10. Therefore, the higher the share price (or lower the earnings per share), the higher the P/E. A P/E of 10 means it would take 10 years to earn back your initial investment through company profits. Another way of looking at it is, people are willing to pay $10 for every $1 a company earns.
This little bit of math is important to understand the impact of a runaway P/E. For the most part, P/E is used as a way to compare valuations between companies. A company with a P/E of 20 might be not be seen as overbought as a company with a P/E of 50. Remember, a P/E of 50 means it would take 50 years to earn back your initial investment through company profits.
Now take a popular stock like Tesla (TSLA), that had a huge run last year due to retail investment interest and cheerleading by ARK’s Cathy Wood. It’s current P/E ratio is 1,268.
If you bought Tesla right now, it would take you over twelve hundred years to earn back your initial investment through Tesla’s profits. Other stocks like Shopify (SHOP) and Square (SQ) have current (as of time of this writing) P/E ratios of 900 and 413, respectively. As a point of reference, a P/E in the mid-20s is traditionally considered “high”. These stocks have become detached from any real financials.
Now expand P/E to the entire stock market, where you aggregate all the companies’ P/E to determine the market P/E. The historical average P/E for the S&P 500 is between 13 and 15. The current P/E for the S&P 500 is 39.87.
For long term P/E analysis, a lot of companies will use something called CAPE — Cyclically Adjusted Price Earnings — or “Shiller PE”. This is the price of a stock divided by the average earnings of the last 10 years. It’s a better way of showing trend over time. Here is the the Shiller PE ratio going back several decades (courtesy of longtermtrends.net):
The cyclically adjusted price-to-earnings, or CAPE, ratio for the S&P 500 hit 33.1 in November, above the 32.6 level it was at in September 1929, the month before the crash that preceded the Great Depression.
“The fact that we’re beyond the September 1929 levels is obviously an important milestone, and will only add to concerns that current US equity valuations have become disconnected from real economic performance,” Jim Reid, a research strategist with Deutsche Bank, wrote in a note.
To be fair, the article also chalks some of the frothiness “was dismissed by some equity analysts due to the uncertainty of the coronavirus and its impact on forward guidance from companies.” But there’s no denying P/E ratios — like Tesla — are certainly overvalued.
5. Rise of the Retail Investor
“Early in 1928, the nature of the boom changed. The mass escape into make-believe, so much a part of the true speculative orgy, started in earnest.”
John Kenneth Galbraith
I covered a good portion of the boom of the retail investors in 2020 in my Gamestonk post two weeks ago. As of July 2020, retail investors made up over 20% of the entire stock market, fueled by stimulus checks and unemployment bonuses. This was up from 10% only a year prior. A retail investor is defined as someone who buys and sells stock for themselves and not for an entity, fund, or organization.
Global X published an article in October 2020 called “The Renewed Rise of the Retail Investor” and highlighted a key component of the retail investor boom: leverage.
A growing trend within the retail community is the use of leverage to enhance returns. A Yahoo Finance/Harris poll found that 43% of respondents have used margin, options or both since the beginning of the pandemic.19 Traditionally, investors use margin to enhance the returns of small-gain strategies. But it seems that many inexperienced traders today want to supercharge already highly volatile portfolios, bringing them closer to the gains they desire.
Clients are regularly denied access to margin and options strategies due to their inexperience. This wasn’t the case with Robinhood, where higher-level options access originally required a high risk tolerance profile and a certain number of options trades entered on the platform.20 This progression-based system encouraged traders to increase their options activity while potentially overlooking the education component necessary for responsible use. The firm has since updated their options offering, increasing eligibility requirements and educational content.21
Investing can seem easy for the uninitiated when the market’s surging. This makes sense when all you’ve seen is a strong bull market, punctuated by quick pullbacks, over the last decade or so. In this environment, mistaking luck for skill is easy…
Long story short, there’s a party going on right now in Robinhood with loose credit and unchecked greed from inexperienced traders. This sounds exactly like the Investopedia definition of “euphoria”, which occurs in a bubble environment before ‘smart money’ begins profit-taking. “Caution is thrown to the wind as asset prices skyrocket.” It also reeks of pre-crash 1929, with retail investors taking out loans to buy stocks. Financial Times recently published an articled titled “Investor Anxiety Mounts Over Prospect of Stock Market ‘Bubble'”, noting that the rise of “inexperienced amateurs as a particular concern.”
As the old Wall Street maxim goes, the trader on the street is the last one in and the last one out.
The combination of inexperience, high leverage, and total risk aversion is what usually leads the herd to drive the bubble to the point of popping, usually when the credit runs out. There’s also another big obstacle coming in the next 60 days…
A lot of these ‘newly minted’ retail traders starting buying stocks during 2020’s pandemic lockdown out of boredom and checks coming in from the government. With the surge in the market last year, a lot of the common-name stocks saw profits. Now those same retail traders are going to owe capital gains taxes on any profits realized — and given so many of them were short-term investments (owned one-year or less) they’re taxed at ordinary income rates. With the tax bill for 2020’s investing gains due, traders may have to sell current stocks to pay the tax bill. Given that so many Robinhood traders last year were new to buying stocks, they may not be fully versed on how capital gains tax works, and could be in for a shock.
But it’s not over yet.
For those who lost their job or were furloughed and received the $600 weekly unemployment bonus from the Federal government, those checks are also taxed. For a lot of these pandemic stock traders, huge tax bills could be coming. Some may be aware, others may not. As of May 2020, 20 million Americans were receiving the extra $600 Federal unemployment bonus — most of them on the hook for income tax on money collected. With an unexpected tax bill, a lot of these novice retail investors may look to start selling stocks (taking further short-term profits that will be taxed for 2021) to cover tax bills. Remember, these retail investors currently make up over 20% of the stock market. If a large portion begin to sell to cover taxes, well…
The fuse is lit.
6. Companies Pressured into Debt
Last week Bloomberg noted that companies were being pushed towards taking out more debt due to demand in Junk bonds. In “Junk Buyers Desperate For Debt Are Pressing Companies to Borrow,” the authors call to attention the huge demand for “junk bonds and leveraged debt” that investors want to buy up. Junk bonds are typically considered risky, which is why they pay higher yields (junk bonds are also known as “high yield” bonds). The fact that junk bonds are in such demand means investors are clamoring for high yield or better returns on their investments. This means money managers need to keep issuing new junk bonds to meet demand. And to issue a junk bond, a company needs to borrow money — a shaky company that is at risk to justify the high yield.
This likely means companies that probably shouldn’t be going further into debt are being pressured to go further into debt so money managers can sell their junk bond.
This seems freakishly similar to the housing boom, when banks were offering NINJA (no income, no job verification application) loans just to get the mortgages so they could sell them off. Mortgages were being sold to buyers who were unlikely to afford them, or buyers who already had one or more mortgages on other properties. Cue that other scene in The Big Short:
“I own five houses. And a condo.”
Eventually, risky companies are going to be saddled up with debt payments, and it only takes one or two of them to be unable to make payments and the junk bond is defaulted on.
Honorable Mention: The Buffet Indicator
What kind of post would this be if I didn’t mention America’s favorite investor? The ‘Buffet Indicator’ is a ratio favored by Warren Buffet; simply defined as the entire value of the stock market divided by the U.S. Gross Domestic Product (GDP). The idea is to see how the stock market measures in relation to the country’s economy: a ratio of 1 would be a stock market in parity with economy, basically comfortably supported by the products and services of the nation. To measure the ratio, Buffet likes to take the Wilshire 5000 Total Market Index and divided by the most recent quarter GDP number. Buffet himself calls this “probably the single best measure of where valuations stand at any given moment.”
The Buffet Indicator just hit a record high of 195% this past week.
If you look at the chart above, you can see just how far the ratio has pulled away. In the dot com crash of 2000 and the housing bubble of 2007-2008 the indicator isn’t even close where where it is now. The recent parabolic spike comes as no surprise either — lockdowns and COVID-19 have impacted the service and travel industries, reducing the GDP. But the market continued to go up.
“It highlights the remarkable mania we are witnessing in the U.S. equity market,” said Michael O’Rourke, chief market strategist at JonesTrading. “Even if one expected those (Fed) policies to be permanent, which they should not be, it still would not justify paying two times the 25-year average for stocks.”
They don’t Buffet the ‘Oracle of Omaha’ for nothing.
…
I never intended for Quit Your Job to become an investment blog, but investing is a key component to getting out of your soul-crushing 9-to-5 and becoming financially free. Anyone who read my post on Robert Kiyosaki’s Cashflow Quadrant knows the cruciality of the “I” Investor Quadrant. Being an investor means more than buying Apple (AAPL) stock and holding into infinity. You have to know what’s going on in the market, in companies, in economic trends, or you can find yourself wiped out.
And back to the 9-to-5 in no time.
Disclosure: I am not short the market at this time, nor do I have any positions that would benefits from a market drop. I am not a professional investment advisor, nor do I hold any certifications or degrees in finance or economics. I’m just a guy who reads a lot.
Edit: This article was originally published as “5 Signs We’re In a Market Bubble” on February 13, 2021, but after discovering just how high the Buffet Indicator had gotten I wanted to include it in this post. I revised the post from 5 to 6 and added in the BI.
Uber and Lyft Threaten to Leave California over AB5
Last September I wrote a blog post entitled “California and the Death of the Gig Economy” about California Assembly Bill 5 and the reclassification of contractors as employees. I had my concerns over how companies like Uber and Lyft would react to AB5 and the cost overloads of suddenly having a million new employees added to their balance sheet. Would Uber ramp up automation? Would fares go up? There was also the risk of them up and leaving. So how did it turn out?
Uber and Lyft initially fought back against AB5: The companies, along with DoorDash, filed paperwork in late 2019 for the Protect App-Based Drivers & Services Campaign, a California ballot measure that would create an exemption to AB5 for app-based driver contractors. In 2020, Uber altered its app in an attempt to circumvent the law, letting drives set their own payment rates.
Neither measure worked and this past May California sued the ride-sharing companies to make their contractor drivers into employees. Three days ago, on August 10, 2020, a California judge ruled that Uber and Lyft must comply with AB5 immediately.
So, to recap: A company developed an app and service to bring a lower cost service to consumers. People begin to work for the company to provide said service and were compensated for doing so. The same people now want more, so they go to their state representatives to pass law to force the company to give them more. As California Assemblywoman Lorena Gonzalez put it, “It makes sure that the one million independent contractors in California get the wages and benefits they deserve.”
This was from my blog post last year:
From the first glance here it appears Assembly Bill 5 could have disastrous effects on personal income in the state of California. People working as contractors on their terms will be forced to conform as an employee or lose out on their former gig. Jobs could be lost to automation. Some companies may up and move, taking their jobs with them or choose to cut back because they can’t afford to take on these contractors as employees.
And what happened?
Faced with the massive tidal wave of increased costs for operating in the state of California, Uber and Lyft announced that they’re leaving California. From The Verge:
Lyft said it would shut down operations in California if forced to classify drivers as employees, the company’s executives said in an earnings call with investors on Wednesday. Lyft joins Uber in threatening to pull out of one of its most important US markets over the question of drivers’ employment status…
Both companies have said they would appeal the ruling, which was stayed for 10 days.
But if their appeals fail, Lyft may join Uber in closing up shop in California, the company’s president John Zimmer said. “If our efforts here are not successful it would force us to suspend operations in California,” Zimmer said on a call announcing the second quarter earnings of 2020.
To some, it may look like a grumpy former startup is taking their ball and going home. This article from The Hill has comments full of vitriol toward the “greedy corporations” “extorting” California. Some in the comments call for revoking business licenses for Lyft and Uber — it’s a lot like saying “you can’t quit because you’re fired!”
It’s easy to see why Californians are mad. Scores of Lyft and Uber drivers thought they would suddenly get benefits, paid time off, and a minimum wage are now getting nothing at all if these companies shut down. Don’t forget: these companies have never had a quarter of profit! There’s also the unmentioned damage COVID-19 and the lockdown has done to their businesses. Lyft suffered a 61% revenue drop in the second quarter this year while Uber experienced only a 29% decrease, buoyed by Uber Eats delivery while people were stuck at home.
You can’t get blood from a turnip.
I just don’t see how adhering to AB5 could possibly work at this point. As of March 25, 2020 Uber had about $7 billion in debt (Lyft currently has none). With already not being profitable and suffering corona-related revenue drops, Uber would be forced to borrow more to cover the increased costs associated with converting contractors to employees in California. The choice here is essentially an existential one: Does a company with $7 billion in debt that’s never had a profitable quarter take on more debt to conform to California’s AB5 or do they cut the market loose and spare the debt load? If they take on increased debt to cover 2020’s employee expenses during a pandemic year where they most definitely won’t turn a profit, they’ll have to borrow more again next year to for 2021’s employee costs. They would go deeper into debt with larger debt-servicing payments cutting into yearly expenses against falling revenues.
Even without a current debt load, Lyft would likely have to do the same. After all, these are sudden costs for which money wasn’t previously allocated. Debt would have to be taken on to finance the costs. It becomes existential for Lyft as well. And what if the companies cave to California’s demand and it embolden’s other states to pass their own version of AB5?
The fallout from this will impact millions. All the Uber and Lyft drivers who drive or work for these companies will lose income if the companies shut down (or relocate). To continue to drive for Uber or Lyft these contractors would have to move to a state where they still operate. Less income means less taxes taken in locally and federally from these contractor’s yearly 1099s. This puts California deeper in the current tax revenue hole. Uber — publicly traded as of last year — stock has taken a hit on the ultimatum, reducing the value of retirement accounts and personal brokerage accounts that hold shares.
It will be interesting to see how this plays out, but it does not look good. I wonder if taxi drivers are the only ones celebrating here.
I know what you’re thinking. Why does a blog centered on quitting your job post about minimum wage and taxing the rich? While they’re mostly though experiments, to be financially free and entrepreneurial you must know your economic and political environment. Having a business or investments is highly impacted by what goes on in the political Thunderdome.
But does it work? It has been tried before and abandoned, so why would it work this time? Is it moral or fair? Does “tax the rich” merely promote classism? Is it biting the hand that feeds? Or is there social stability to be gained from it? It’s time to dig into it.
What is Rich?
When a politician says they want to “tax the rich,” what defines rich? In many cases it’s left intentionally vague — the “rich” being a boogeyman of sorts, the anachronistic caricature of a monocle and top hat wearing Rich Uncle Moneybags from the game of Monopoly. It’s Mr. Scrooge or the bourgeois of The Purge films. So who are The Rich?
So we have a starting point (somewhere between $32 and $50 million) for what qualifies for a “wealth tax.” Federal and state income tax brackets vary wildly (some states have a flat tax while others have no income tax), so we’ll stick with the proposed Federal “wealth tax” as a guideline for what is considered rich.
Do Higher Taxes Equal Higher Revenue?
“Nothing is more calculated to make a demagogue popular than a constantly reiterated demand for heavy taxes on the rich. Capital levies and high income taxes on the larger incomes are extraordinarily popular with the masses, who do not have to pay them.”
Lugwig von Mises
The purpose of raising taxes on the wealthy — or instituting “wealth tax” — is to raise the amount of funds taken in by the state or federal government. But does it always go as planned?
The fallacy of taxing the rich to me is the assumption that those being heavily taxed will just sit there and take it. Take the case of actor Gerard Depardieu after France instituted a 75% “supertax” on their wealthy citizens. The actor famously renounced his French citizenship and moved to Russia, later threatening to sell all his French assets left behind. Depardieu wasn’t alone: an estimated 2.5 million French citizens left their home country to live elsewhere and the loss of labor, combined with “discouraged investment”, crushed French tax revenues by a 14 billion euro shortfall of the 30 billion euro estimated intake. The French wealth tax, called the “solidarity tax on wealth,” was eventually repealed in 2017.
Other European countries tried a wealth tax and eventually repealed it: Austria, Denmark, Finland, Germany, Iceland, Italy, the Netherlands, Luxembourg, and Sweden. (Sweden in particular become notorious for its wealth tax after Swedish children’s book author Astrid Lindgren paid 102% in income tax in 1976. Because she was self-employed, she was subject to both regular income tax and employer’s fees, resulting in being taxed over 100% for that year. The Pippi Longstocking author later wrote satirical children’s book about the incident called Pomperipossa in Monismania)
But back to the wealthy just “taking it” when higher taxes are instituted. It seems asinine to think that a wealthy person wouldn’t act according when faced with the prospect of the government taking more. University of Toronto economist David Seim found that “an increase in tax is likely to stimulate evasion” in his paper Behavioral Responses to an Annual Wealth Tax: Evidence From Sweden. He found that when a wealth tax went into effect, those targeted would shift taxable assets to tax-exempt assets, thereby legally lowering their taxable net worth below the threshold. In addition, wealth taxes — including Warren and Sanders’ proposed American taxes — is a tax on net worth. This means debt is deductible. So borrowing money would thereby reduce overall taxable net worth — and if you’re borrowing to invest in tax-exempt assets, you’re reducing your taxable net worth even further.
The problem is trying to hit a moving target. Those the wealth tax focuses on are affluent, mobile, and have the ability to fight back (more on that in a moment). It’s human nature to respond to someone (or something) that’s coming to take what you have. The rich business owner defends the assets he’s acquired as a caveman defends the prey he killed. The London Times wrote in 1894 in regards to Britains first progressive tax rates that “even the half starved crow will not wait to be continuously shot at.”
Ronald Reagan’s tax planning is just one simple example of how the rich can easily avoid the upper tax brackets. Someone noticed what a fine golf swing Reagan had, and the answer was that when he reached the top tax bracket, he stopped working and played golf for the rest of the year. Many wealthy doctors (and others) do the same thing, closing down their medical practice around August and then taking a vacation from earning money for the rest of the year. A government cannot force a wealthy taxpayer to work if the taxpayer finds the tax rates personally intolerable, especially if they are targeted for attack.
Charles Adams
Or you just leave altogether like Depardieu or Facebook co-founder Eduardo Saverin, who left the U.S. for Singapore and saved hundreds of millions of dollars in taxes.
Magnus Henrekson and Gunnar Du Rietz studied the history of the Swedish wealth tax. They found that “people could with impunity evade the tax by taking appropriate measures,” including taking on excessive debt to buy exempted assets. The Swedish wealth tax also prompted large outflows of capital and the expatriation of well-known business people, such as the founder of Ikea, Ingvar Kamprad. Henrekson and Du Rietz conclude, “The magnitude of these outflows was a major motivation for the repeal of the wealth tax in 2007.”
The point is, politicians expect to collect x amount in tax revenue assuming that those taxed do not respond or act in any way. Charles Adams wrote an article in 2004 called “The Rich Wont be Soaked” (source also for the quote above) showing that it’s always been this way:
History is full of amazing examples, like the first income tax in the United States, in 1916, when the top bracket was 7 percent; a few years later the top bracket was raised to 77 percent, or 11 times higher. Yet the 77 percent rate did not produce 11 times as much revenue; in fact it shocked the Treasury by producing almost the same revenue as the 7 percent rate did. At the 7 percent top bracket, about 1,300 returns were filed; with the 77 percent top bracket, only about 250 returns were filed. Where did all the top bracket taxpayers go? The rich simply rearranged their affairs to avoid the 77 percent tax rate.
Which brings us to the Laffer curve. Arthur Laffer believed people would adjust their behavior “in the face of incentives created by higher income tax rates.” The result was the Laffer curve, a graph showing more dwindling returns the higher the tax percentage. It essentially is a visual representation of the points mentioned above.
Courtesy of Investopedia
As the tax rate becomes more burdensome, the behavior to avoid increases. This could be through changing investments to tax friendlier ones or not investing at all. The end result either way is less tax revenue.
Enforcement
There is also the matter of enforcing the new laws and costs associated with them.
Recently, the IRS admitted to congress that the poor are far more likely to get audited than a rich person, because it’s easier and cheaper; the IRS told Congress it could be solved by an increase to the IRS budget. Elizabeth Warren’s plan specifically mentions “a significant increase in IRS spending” to help ensure no eligible wealthy person evades audit. After all, Warren, Sanders, and other wealth tax plans are a tax on all worldwide assets. The IRS is going to need to assess assets and wealth held overseas as well.
An even larger problem lies not in logistics but valuation. “All household assets” will be including in a wealth evaluation for the wealth tax. Cash, stocks, and property are somewhat easy to assess. But what about art? Family heirlooms? Will the IRS hire jewelers to assess the value of the family pearls or diamond rings? Maybe the Pawn Stars guys can evaluate what’s in the basement and attics of rich Americans. There seems to be no guidelines on estimating the worth of fringe assets. How about a privately-held businesses owned by the taxed wealthy? With no quarterly earnings report, an auditor will have to assess the full value of the private company — down to desks, equipment, and credit card bills. The valuation of a company can change even daily given the flow of business. And how do you value a multi-national company when taking into account currency exchange rates and overseas assets?
Valuing assets for the purposes of the Ultra-Millionaire Tax will provide an opportunity to tighten and expand upon existing valuation rules for the estate tax:The IRS already has rules to assess the value of many assets for estate tax purposes. The Ultra-Millionaire Tax is a chance for the IRS to tighten these existing rules to close loopholes and to develop new valuation rules as needed. For example, the IRS would be authorized to use cutting-edge retrospective and prospective formulaic valuation methods for certain harder-to-value assets like closely held business and non-owner-occupied real estate.
Bernie Sanders takes it a step further, requiring a “wealth registry,” something not defined on his website but presumably a government record of assets held by an individual.
Both of these creates a dark precedent: the government will come into homes to assess “assets”, taking record of what you own, and assign value to it. While there are guidelines to valuation, they’re ultimately left up to the IRS. Does this mean the IRS would also begin to operate internationally? The Foreign Account Tax Compliance Act already requires U.S. nationals with foreign assets or holdings to claim such holdings and for banks to report the individual’s funds to the U.S. government. But what about art or cars at foreign homes?
Enforcement at home and abroad comes with a cost. More tax officials and inspectors, more paperwork, more travel and expenses just to enforce the wealth tax. These costs go against any revenue raised by the taxes themselves. But do they effectively offset? There’s an issue of scale here: to fully realize maximum tax receipts, expenses associated with enforcement must also be maximized. Costs of enforcement could also rise over time while tax receipts could go down; in theory, the entire intake of tax revenues could be spent on enforcement.
Unintended Consequences
Because this is a thought experiment, we can assume the above headache of multi-national asset holding valuation gets done on Amazon CEO Jeff Bezos (a favorite target for Warren and Sanders). His numerous holdings and assets are assessed and valued. It comes in close to Forbes’ October 2019 valuation of $103 billion. Under Elizabeth Warren’s plan, Bezos would be subject to 6% wealth tax (2% tax since it’s over $50 million and additional 4% billionaire surtax since the number is over $1 billion). 2% tax on $1 billion is $20,000,000. The 4% surtax on $102,999,999,999 is $4.2 billion (rounded up). Combined, that’s $4.22 billion owed in wealth tax (which does not include Federal, state, and local income tax or capital gains taxes). And this amount is conservative compared to CNBC’s estimate of $9 billion Bezos would pay under Sanders’ 8% wealth tax.
Here’s where it gets interesting. The likelihood Bezos has that amount in pure cash is highly unlikely. His personal wealth comes from his ownership in Amazon, specifically his shareholdings. To cover the $4.22 billion owed, Bezos would have to sell 2.5 million shares of Amazon stock (based on its current valuation of $1,745 per share). But even then that wouldn’t be enough because Bezos would owe capital gains tax on sellingthe stock. He would have to sell additional shares just to cover capital gains on the 2.5 million shares AND the shares he was selling to cover the tax (as of this writing, long term capital gains tax on Bezos’ tax bracket is 20%)
The result is that Bezos is forced to reduce ownership in his own company to pay wealth tax; the selling of 2.5 million shares by the CEO would also likely cause panic in stock (including knowing he’d have to sell more the following year), driving it down in price as investors get spooked. Since Amazon is a commonly held stock in 401ks, IRAs, and pension portfolios, all are hit by the selling. Bezos is not alone in the tax. Other billionaires will be forced to sell company stock to pay wealth tax bills, thus retirement funds will bear the brunt of reduced stock value from each of these companies.
The other choice Bezos and other owners have is to liquid company assets to pay the tax bill. This is money taken out of the company — money that could be reinvested for growth or was originally earmarked for new projects and initiatives. The loss for the company translates into higher costs passed on to customers or cutbacks in jobs or pay. This would also likely result in a stock price decrease.
In either case, by the time the next tax season rolled around, the overall valuation would be less — either by selling off $4.22 billion (plus capital gains tax) in stock or by reduced stock price in the company due to devaluation. Maybe the following year, Bezos is worth less than $100 billion. Yes, he’d still be subject to the wealth tax at 6% (or Sanders’ 8%) but the tax receipts would be less than the previous year. So the amount of tax receipts would drop, offsetting less of the enforcement costs and costs to social programs instituted by the president candidates.
Think of it this way: Social program (SP) plus additional wealth tax enforcement costs (EC) equal the projected tax receipts from the eligible billionaires in the United States.
SP + EC = Billionaire Tax Revenues
The balanced equation gives the presidential candidates what they want – their taxes pay for their new spending. But if Bezos and other billionaires suffer a reduction in net asset value, the tax revenues will go down over time. Now the social program and enforcement costs are not being covered by tax revenues and there’s a shortfall. Now you have to either reduce the SP spending (which would be unpopular), or reduce EC spending, which makes it more difficult to enforce the tax which would likely result in even less tax revenues. The only other choice is more government debt to make up the shortfall.
What happens if Bezos pulls a Depardieu and leaves? Now he isn’t contributing any tax revenue (except for his one-time exit tax) and the shortfall is that much larger. He may decide to do just that: at some point, Bezos will have sold enough Amazon stock to threaten his voting ownership and control of his company. The value of Amazon stock could plunge if he lost control due to lack of ownership — further reducing the value of American pension plans and retirement portfolios.
This also raises the moral question of is it right to take away ownership of someone’s company just because it was successful to a high enough degree? Wouldn’t this de-incentivize future entrepreneurs and business people? After all, why build a company beyond a certain point if a wealth tax will cost you ownership? It’s Ronald Reagan hitting the green all over again.
So there you have it. While the wealth tax attracts populist attention, the reality behind it is murky at best. It has been tried in the past and ultimately withdrawn due to failure to meet results. If anything, the shift in behaviors will create disruptions in the economy — and worse the possible flight of capital to foreign shores. With less to wealth to tax, the shortfall needs to be made up somewhere, either in increased government debt or taxes on lower classes who can’t leave.
Based on this thought experiment, do you think a wealth tax is still viable? Comment below!
Think back over your school days. In elementary school we had the basics: writing, grammar, English. Maybe American history. Math. Nature studies. Middle school? English literature, algebra, European history, and civics. High school? College level classes, more English literature, biology, physics, and more history. There were shop classes and home economics. And there was always gym classes.
If the purpose of education is to prepare a young person to go out into the world, find a job, make it in society, then our students are woefully unprepared. After twelve years of education, not one student is better prepared to manage their personal finances — or even understand how taxes and interest work. Over the course of our lives we, of course, use English. We use some math. History might come in to play at some point in the future. But we use financial knowledge. Every. Single. Day. So why is it not taught?
This latest post began while watching an interview with Robert Kiyosaki about the origins of Rich Dad, Poor Dad:
Kiyosaki recalls asking his fourth grade teacher why they don’t learn about money (10:30). She replied that they “don’t teach money at school” but couldn’t answer his question as to why. Kiyosaki continues, saying he eventually asked his father — who worked for the department of education — why money isn’t taught in school. His father’s reply? ‘Because the government doesn’t let us teach it. It’s not in the curriculum.’
So I began to wonder: how is education curriculum set? Why doesn’t the government allow personal finance to be part of public schools? (Note: I never attended private school, so I cannot speak to if it is taught there or not, but feel free to comment if you did. I’d love to know!) It seems not only common sensical that it would be taught, but given these horrendous metrics, Americans are in desperate need of financial literacy:
41% of Americans use a budget (inversely, 59% of Americans don’t track or understand how much they spend every month)
The average American college graduate leaves school with $37,172 in student loans, most with no immediate plan to pay them off
Two-thirds of Americans would have trouble scrounging $1,000 for an emergency
35% of Americans (!) have debt in collections with the average amount being $5,178
A National Endowment for Financial Education study found only 24% of millennials show “basic financial literacy” while 69% of the surveyed rate their own financial knowledge as ‘high.’
So what’s the deal? Before diving into a ‘Conspiracy of the Rich’ that keeps the average person money stupid, I wanted to learn the origins of our public education curriculum. I began to dig to find out just why what’s taught is taught.
It begins with the Prussian Education system.
The Prussian Education system was founded in 1763 by Frederick the Great. The system became the model for compulsory attendance (e.g., you have to go to school), national testing, and, per Wikipedia, “prescribed national curriculum for each grade, and mandatory kindergarten.” It also maintained a specialized training for teachers, essentially teaching teachers how and what to teach. This might be the most important facet, as teachers were not existing specialists or professionals, but professional teachers. The person teaching math or science would not be a mathematician or scientist.
The Prussian system was imported to the United States in the early 19th century, with early advocates including American education reformer Horace Mann (who eventually went to Germany to inspect German schools first-hand). The Prussian system was designed to serve the kingdom, training the populace to be soldiers, farmers, and eventually factory workers when the Industrial Revolution arrived. This is why you hear contemporary education referred to as “factory model” or “industrial era.” Indeed, it freaked me out a little bit when I realized that the reason for “bells” to signal start and end of classes was to train young people for the bells and whistles of the factory, denoting shift changes.
The Prussian system would later be refined in 1892 by the Committee of Ten. The committee’s recommendations became the basis of our modern education system: 12 years of education, eight of which are elementary followed by four years of high school. Curriculum was focused on English, mathematics, and sciences (such as chemistry, physics, and astronomy). The higher sciences such as psychics and chemistry were reserved for the high school level. English, mathematics, civics, and history would be taught at every level.
In the report linked above, there is no mention by the Committee of Ten of finance, money, or taxes.
So is our current system just outdated? What would it take to add personal finance to the curriculum? Why hasn’t it been? In 2013, a poll from Harris Interactive (sponsored by Bank of America) showed 99% of adults agree financial literacy should be taught in school. A 2013 Timemagazine article entitled “Why We Want-But Can’t Have-Personal Finance in Schools” cites four major reasons finance has not been part of the curriculum:
Only one in five teachers feels qualified to lead a personal finance class, according to a University of Wisconsin study. So we don’t have enough instructors.
Personal finance concepts are not part of standardized tests like the SAT or ACT. As the saying goes in education circles: If it’s not tested, it’s not taught.
Education is run at the state level. So there is no federal authority to mandate personal finance classes, and each state has its own ideas on how to go about it.
There is little academic agreement as to what kind of personal finance instruction works. Many educators are waiting for clarity before they sign on.
There seems to be a catch-22 in regards to ‘feeling qualified’ to lead personal finance classes. Teachers don’t feel qualified to teach it because they never learned it themselves. In fact, these surveyed teachers may be struggling with their own financial literacy.
I’ve personally always been amazed that taxes are not taught at some level in school. These are something every American must file once per year, yet there’s no education or even explanation on how it all works. But, according to the Time magazine article above, teachers don’t really understand it either. I would say financial literacy should start at home, but parents weren’t taught in schools either. A 2011 Charles Schwab survey of 1,132 teenagers between 16 and 18 revealed 42% wanted their parents to talk to them about how money works. Only 32% of the surveyed teens knew how credit cards and interest worked. But if the parents aren’t knowledgeable (or comfortable enough) to talk about it, then the ignorance is passed on. It’s a death spiral of financial ignorance.
I couldn’t find an explicit reason why finance was left off the educational menu. One could infer that it wasn’t important in the 19th century — money still existed, bills had to paid with interest, although there was no personal income tax (except from 1861-1866 where it was enacted to pay for the Civil War) but property taxes and tariffs existed. Kiyosaki seems to insinuate that it’s more sinister, that financial education is left off the table explicitly to keep people dumb about money. His entire modus operandi for his Rich Dad series is to teach people about financial literacy because it’s not taught in schools.
He is right in that the failure to teach financial literacy in school falls on the government. Some states have taken the initiative, but it appears lacking, according to “Survey of the States“, a Council for Economic Education report. Seventeen states require high school students to take at least one course in personal finance. However, the report also shows “there has been little increase in economic education in recent years and no growth in personal financial education.” So states are aware of the problem, some have made an attempt to change it, but overall it appears to be half-assed or not a priority. I suspect it will take adding personal finance to standardized testing to get the ball rolling, coupled with education of teachers so they can teach the subject.
Until then, hopefully people like Robert Kiyosaki or Dave Ramsey will continue to get guide people. Or maybe blogs like this one can help someone find their way. Perhaps it will be those who are financially literate that will teach future generations.
Over the past weekend I was traveling when two separate incidents caught my eye and made me start to think about the current push for $15 per hour federal minimum wage. The first was a visit to McDonald’s (my first in 20 years!) I visited a McDonald’s in Columbus, OH and found only a handful of employees working along side a phalanx of automated order machines. The other was an article showing that Bernie Sanders own campaign staffers were making less than $15 per hour, even though a large part of his campaign platform is $15 per hour minimum wage for all. I usually don’t wade into the political forefront, but I thought this would be an interesting thought exercise.
There has been a lot of noise about the Fight For $15 recently since multiple presidential candidates have taken up the banner. The movement stems from November 29, 2012 when over 100 fast food workers walked out of their respective restaurants in New York City to protest, creating the largest strike in the history of fast food. On July 29th of the following year, over 2,200 fast food workers went on strike. Since, the movement has expanded out of just the fast food industry to a national call of the federal minimum wage being raised to $15 (it currently sits at $7.25 per hour).
But is $15 per hour feasible? Is it even responsible? After all, we’re talking an increase of over 100%. According to presidential candidate Bernie Sanders’ campaign website feelthebern.org, he believes increasing the minimum wage actually benefits small businesses and will raise the standard of living. If raising the minimum wage is good for all, why not do it?
I own a business. I have several employees and contractors, and I determine their rate based on what my company is paid for a given job or contract. I also have to make sure my compensation is competitive for their skillset, or else I risk losing an employee to another business. I also have to take into account business expenses incurred to run the business and my own compensation as owner. These three factors play into what the employee is ultimately compensated. I pay too much, I risk the business and my own income; I pay too little, I risk losing the employee to better compensation.
But for this post, let’s assume I own a restaurant and pay five employees minimum wage. $7.25 per hour x 40 hours x 5 employees costs my company $1,450 per week in labor. The labor cost is factored into the cost of my business, which also includes the lease, utilities, insurance, ingredients, appliances and equipment, etc. My restaurant specializes in hamburgers which cost $1/ea. I take home a salary of $40,000 per year, which isn’t much but it makes running the business worth it to me and allows me to cover my own personal expenses. If minimum wage goes to $15, it would be a 106% increase in my labor costs or $2,987 per week. That’s a $1,537 increase per week, $6,148 a month, or $73,776 a year increase to my business. So now, I have to decide how this new increase can be afforded. I can’t cut back on equipment costs, because I need the equipment to make the hamburgers. I can’t cut back on ingredients, otherwise I won’t have hamburgers to sell. I could cut my own salary, but the increase is more than I even make and if I take a pay cut, I can’t afford to work there either. The lease and utilities must be paid or the restaurant closes down. I could increase the cost per hamburger to make up for the shortfall, risking a downturn in sales or losing customers to competitors (or home cooking) at which point I’m going out of business or cutting employees altogether. The only other alternative is to cut hours or go to automation (just like those kiosks in the Columbus McDonald’s)
This is exactly what business in cities with $15 per hour minimum wage have been doing. In Seattle, employers began cutting hours when the minimum wage hit $13 per hour. When his staffers complained of making under $13 per hour over the weekend, the Sanders campaign promptly cut hours to make the math equal $15 per hour.
Another unintended consequence of raising the minimum wage in Seattle was workers began requestingless hours because their yearly income increased to the point where they were at risk of losing welfare or various assistance programs. But wasn’t the intended effect? Wasn’t one of the speaking points of higher minimum wage to boost people off of welfare?
Another unintended consequence of high minimum wage is that it creates a barrier of entry to unskilled and young workers. If you’re 16 years old looking for your first job, you have no skills or experience. If an employer is required to pay over $30,000 per year for a full-time employee, the chances are they’ll never hire an unskilled teenager. I know I wouldn’t. If I had to pay that much for an employee’s salary, I want the best qualified person — this means skills, experience, and maybe a college degree. It makes it harder for teens to land that first job and begin acquiring skills and experience. From governing.com:
A long line of studies about the minimum wage has revealed that it can drive down employment at the low end of the wage scale, but those losses are made up for by increases in higher-paying jobs. The University of Washington findings, however, suggest that there’s some merit to the usual complaint that gets lodged against minimum-wage hikes — that they’re not only expensive for employers, but threaten to cut the first rung on the career ladder out from under teenagers or others just getting their start in the labor market. “The evidence that we’re picking up is consistent,” says Jacob Vigdor, an economist at the University of Washington. “We’re pricing out low-skill workers.”
“In Seattle, Minimum Wage Hike Comes at a Cost to Some Workers” Governing.com January 2019
This began happening in Seattle after the minimum wage began its journey to $15 per hour. In the linked article above from reason.com, “entry-level job growth stalled”:
Job growth continued in the rest of Washington state but not in Seattle.
“It’s presented by minimum wage advocates as a win-win…no negatives,” complains a skeptical Erin Shannon of the Washington Policy Center in my latest video.
Shannon points out the negatives. For example, stores that once hired inexperienced kids and trained them, giving them valuable starter experience, stopped doing so once Seattle raised its minimum wage.
If it’s not working so great (or, at least, as intended) in Seattle, why are presidential candidates pushing for it on a national level? First, it makes for great political rhetoric. It sounds appealing to low income workers while making the candidate appear as a fighter for the “little guy.” But there is also another reason for the government’s push for $15 per hour that no one is talking about.
It increases taxes.
If you’ve read any of my other posts about Robert Kiyosaki’s The Cashflow Quadrant, you know that employees get taxed the highest rates. A $15 minimum wage means increased payroll taxes from millions of American works. Workers will suddenly find themselves bumped up into higher tax brackets due to annual income increases. A 106% pay raise means a lot more in federal, state, and local income tax. But it’s not just income taxes — Social Security and Medicare taxes are also taken out of paychecks and based on a percentage of the paycheck. So with an increased minimum wage, the government gets a windfall of additional Social Security and Medicare income. According to IRS.gov, the 2019 withholding rates are 6.2% for each employee and employer for social security and 1.45% for Medicare. If you were making $7.25 per hour, your wages would be $290 for the week, $580 for the pay period and you’d pay $35.96 in Social Security and $8.41 for Medicare. Under a $15 per hour rate, you’d make $1,200 in the same pay period, paying $74.40 in Social Security and $17.40 in Medicare taxes. In case you missed it, the employee is only responsible for HALF of their Social Security and Medicare withholding (6.2% is half the 12.4% that is Social Security tax, 1.45% half the 2.9% Medicare tax) Under payroll taxes, the employer is responsible for the other half. So the employee pays $74.40 and the employer must ALSO pay $74.40and$17.40 to the government.
So all governments — federal, state, and local — increase their take with a $15 per hour minimum wage. Maybe the government hopes that the higher wage relieves some of the the looming Social Security trust fund shortage. According to the 2019 annual report by the trustees of Social Security and Medicare, the program is already paying out less than it’s taking in and it will run out by 2035. A $15 minimum wage could help shore up that fund. In theory. But payroll taxes also incentivize employers to keep hours down to reduce their 50% share of the Social Security/Medicare tax cost.
Back to my little restaurant: If I cut back hours to compensate for the increase in wages, I suddenly don’t have enough coverage. I was paying $7.25/hr for 40 hours, but with a $15/hr wage, I’d have to cut it to 20 hours to get labor back to where it was in order to keep my hamburger price consistent. Now I have a shortage of 100 hours (5 employees x 20 less hours). What can I do now? I can either make up the 100 hours as the owner (working 140+ hours per week is equal to working almost every single hour of every day) or I cut back the restaurant’s hours. This means less hamburgers sold. Which means less revenue. Which means it becomes difficult to pay my 5 employees and myself. If I fight to keep the restaurant open, the next step is to cut an employee (I can’t raise hours because I can’t afford it and I can’t stay open longer because I can’t physically do it myself). Now I have 4 employees, and I’m forced to cover even more myself.
Do you see the death spiral here? Eventually, I’ll close either by insolvency or it not being worth it to me anymore. If I’m working 100 hours per week, it’s not definitely not worth it plus I’ll never have the time to expand my business or open a second location. And I’ll never be able to find someone to take over, because no one wants to work 100 hours in a struggling business. Eventually, I’ll shutter the restaurant and all of us will be unemployed.
The other alternative to cutting hours is to raise the price of my hamburgers to sustain the increased cost. Imagine being a customer of my restaurant: years of $1 hamburgers when suddenly you come in one day for lunch and find it costs twice (or more) to eat there. You’ll likely not come back or tell your friends. The human consumer is quite perceptive to price changes. Raising the cost of my hamburgers will expedite driving customers away…and less money coming in from sales. Which causes me to cut another worker…which causes me to reduce the hours the restaurant is open…which reduces sales…
The other question I began to think about is “Why do we have a minimum wage?” I mean this in the purest of thought experiments. Where did the minimum wage come from? Essentially, it’s a social safety net, ensuring American (or other national) employees make a certain amount of money. The first minimum wage appeared in the United States in 1912 in Massachusetts. Eventually, the federal government established a national minimum wage in 1938 under the Fair Labor Standards Act (FLSA), set at $0.25 per hour (adjusting for inflation, about $4.45 today). It was basically a protection for American workers during the Great Depression. The argument for raising it is that the current $7.25/hr isn’t a “livable wage.” Or, in other words, it doesn’t cover the cost of living.
Essentially what the government is doing is setting price controls — they dictate the absolute lowest an employee can be paid, regardless of skill or experience. So where did they get $15 from? Who chose this number? The only origin story I could find comes from SeaTac, Washington in 2013. It was the first city to have a $15 minimum wage and was a byproduct of an attempt by union organizer David Rolf to unionize workers at Sea-Tac airport. The $15 per hour rate was part of a bluff to get the airport to allow unionization. From the same Marketplace article:
There’s the $15 number itself, nice and round, easy to fit on a bumper sticker. The figure first came to people’s attention in a series of strikes by fast-food workers that started in 2012. The workers didn’t achieve their goal of unionization, but $15 stuck.
“The Accidental Origin of the $15 Minimum-Wage Movement” Ben Bergman, Marketplace Jan 30, 2015
So $15 was arbitrary: a randomly chosen number used by a union organizer to play hardball with an airport in Washington state. Eventually it caught on. To some, $15 isn’t enough. Just this past week Representative Rashida Tlaib (D-Mich) began calls to make the federal minimum wage $20 per hour. Jeff Spross of The Week published an article this week called “Is There a Case for a $20 Minimum Wage?” where he mentions that by some productivity measures, the minimum wage should be $22.49 per hour by 2024. If we’re chasing arbitrary numbers, why stop at $22.49? Wouldn’t $50 or $100 per hour cure all poverty? Wouldn’t we all be rich?
Part of the problem is such a high minimum wage disrupts a larger portion of the workforce. If you’re a McDonald’s worker making $20 per hour, that’s $40,000 per year over a full-time schedule. According to Glassdoor.com, the average McDonald’s Store Manager annual salary is $46,354. Someone taking orders or flipping burgers at McDonald’s makes almost as much as the Store Manager! The inevitability is that the Store Manager will now seek an increase as well. He has a lot more responsibilities, a higher skill set, and is in charge of several other employees, but his compensation now lags compared to those that work under him. To maintain the previous ratio, his salary would need to double to match the workers’ increase. Worse, it could lead to disillusionment or de-incentivizing to move up or learn new skills.
“We all earn the same. I earn the same as the girl who presses a button to open the door,” said Arcaya, who has worked at the university for 19 years. “I studied and I worked hard. And now it turns out none of that was worth it.”
Workers at hospitals, the Oil Ministry and insurance companies all said the pay hierarchy had been distorted following Maduro’s shock measure.
“‘We All Earn the Same’: Venezuela Minimum Wage Hike Angers Skilled Workers” Corina Pons, Reuters September 26, 2018
The other part of the problem has to do with economics, as countries like Venezuela and Greece can attest to. Let’s say that the minimum wage does go to $15 per hour and no jobs are lost. Let’s say every business can afford it and all low-wage labor gets a bump. (We can do this because it’s a thought experiment) This means that the amount of spending by millions of workers has now increased. More bills are paid. More loaves of bread and gallons of milk are purchased because they can be easily afforded. There’s a lot more money going out and spending is up. Prices will respond in kind. This “excess liquidity” will be mopped by up prices of goods and services. You have more money chasing the same amount of goods and services, the result inevitably being price inflation. In addition, companies will raise prices to maintain the higher hourly wage. This is called Wage Push Inflation. Soon, the $15 wages don’t buy as much as they used to and we’re back where we started. Why are politicians and workers complaining that the current $7.25/hr isn’t enough?
Because it doesn’t buy what it used to.
In effect, raising the minimum wage is a result of currency inflation. Because the value of the dollar decreases, it requires the minimum wage to be raised or else things become unaffordable. If things become unaffordable, they don’t sell. The choice is to lower the price so they do sell, or that item is replaced by one that does sell. Raising the minimum wage will ensure that goods becoming unaffordable remain purchasable. Investopedia gives an example of Wage Push Inflation: “If a state raises the minimum $5 to $20, that company must compensate by increasing the prices of its products on the market. But because the goods become more expensive, that raise isn’t enough to propel a consumer’s purchasing power, and the wage must be raised again, therefore causing an inflationary spiral. “
So what’s the takeaway from this thought experiment? My fictional little restaurant didn’t do so well. There’s no economic or logical choice for a $15 per hour minimum wage; I couldn’t find any economic studies that could show why that specific number is valid as a target. It seems to be chosen only because of the PR value and catchiness of “Fight for 15.” The other question is, will $15 per hour minimum wage really solve anything? The consequences could outnumber the (temporary) gains, and Wage Push Inflation and price inflation could quickly negate the sought after results.
I don’t deny the catchiness of “Fight for $15” or the hero status it gives political candidates. It sounds good to many people. But the math behind it just doesn’t seem to work. When it comes to government setting prices we must remember The Laws of Unintended Consequences: The actions of people, and especially government, always have effects that are unanticipated or unplanned for. On July 18, 2019 the House of Representatives passed a bill to raise the minimum wage to $15. The Congressional Budget Office reviewed the bill and admitted that the bill would produce a financial boost to nearly 30 million workers…but that “it would also result in 1.3 million jobs lost by 2025.”
Update Edit: Just after originally publishing this post, I came across the story of Emeryville, California’s minimum wage hike. Emeryville (home to Pixar animation) has the highest minimum wage in the country at $16.30 per hour (as of July 1, 2019). According to a Wall Street Journal article, Emeryville is the scene of a standoff between restaurant workers and their employees over the high minimum wage:
The economy is booming in the Bay Area, but at Patatas Neighborhood Kitchen, located in this small city just north of Oakland, owner Marcos Quezada recently eliminated the dinner shift and laid off six of his 10 workers.
He struggled with the decision but felt he had no choice after Emeryville increased its hourly minimum wage in July from $15 to $16.30, the highest in the U.S. “I just didn’t see how I was going to survive it,” said Mr. Quezada, who opened the eatery in 2017.
Remember what happened to my fictional restaurant? In several other cases mentioned in the WSJ article, the menu prices sharply increased to offset the new cost — in the case of Emeryville cafe Rudy’s, the price of their Crunchy Asian Salad went from $10 to $15.50, a more than 50% increase. From the same WSJ article:
“There is a tipping point,” said Erik Hansen, the owner of Moomie’s, who is deciding whether to raise sandwich prices by as much as $1.50 or lay off one of his three employees. “We may have the highest minimum wage, but I don’t think the people in Emeryville will feel like paying the highest prices in the country.”
Things have gotten even more complicated recently. In June 2019 Emeryville instituted a ‘pause’ in the wage hike for “small, independent restaurants.” The city council voted to halt increases for select restaurants meeting various criteria. So now the new minimum wage rate is only applicable to a certain size restaurant or above (according to July 26 update to the HR watchdog article, this ruling is now “in flux and may not be valid.”)
This article has been expanded into several parts. You can continue reading Part 2 here.
If you’re reading this blog, I imagine you’re unhappy with your current employment. Why do you want to quit your job? Maybe it leaves you unfulfilled. Maybe it’s your co-workers, your boss, the company you work for. Maybe you just don’t want to work in retail, or in a cubical, or weed gardens. You want to dance, or sing, or paint, or maybe your wish is to join the circus or run your own nudist colony.
Maybe you don’t have a calling, you just know you can’t work for anyone else any more.
Believe me, I feel your pain. I spent over a decade working jobs (they were good jobs too, paid well with excellent benefits), trading time for paychecks. I spent years staring out windows, burning spare time reading about my passions, and never fully committed my brain to anything. All I know is, I wanted out.
Know why you want out. It leads to setting a goal. That leads to making a plan. A plan gives you steps to follow to lead to the goal.
Still lost? That’s okay. The Matrix has you. If you take a moment to really look around — look at your coworkers, your neighbors, your friends and family — how do they live? Maybe they all meander in jobs too. They don’t talk about quitting to live their dream, they talk about their next vacation, what they just bought, or that new promotion at work. They are trapped in The Matrix too. Together, you serve a company with your time, energy, and mind. As Seth Godin says in The Icarus Deception:
“The overwhelming impact of more than a century of cultural indoctrination can’t be overstated. We have embraced industrial propaganda with such enthusiasm that we have changed the very nature of our dreams…Being a human today means more wealth, better health, and the leverage to influence others. But it also a fundamentally different existence from the one we had for a millennia before this…The industrialist needs you to dream about security and the benefits of compliance. The industrialist works to sell you on a cycle of consumption (which requires more compliance). And the industrialist benefits from our dream of moving up the corporate ladder, his ladder. [Godin’s emphasis]”
What Godin means by “industrial” and the “industrialist” in his book is the large, “too big to fail” type companies that are the byproducts of the Industrial Age. This Age has shifted the company culture many decades ago, and includes the Baby Boomer’s mantra of “go to school so you can get a good job to stay at until you retire at 65.” While this advice may have been prudent in the 1940s and 1950s, today it is a TRAP.
There are many reasons to quit your job. Probably countless personal reasons. But if you want to escape the Matrix and an outdated work culture, here are five of the biggest reason to do so:
#1. You Are A Replaceable Part
Most companies are built around systems. What is a system? To borrow an example from The E-Myth Revistedby Michael Gerber, McDonald’s is the perfect example of a business system. To build it, McDonald’s designed policies and procedures to dictate how their burgers were to be made, the items on the menu, how their restaurants were to be run, and every employees job responsibilities. The idea was to have it all in place so ANYONE could be hired and plugged into this system. You didn’t need a college degree, you just had to be able to follow policy.
This makes opening McDonald’s restaurants that much easier, and it ensures a similar experience to the customer regardless of which location they visit. McDonald’s had consistency across the board. For the employee, this means you can be replaced. Sure, you know the policies backwards and forwards, you have lots of experience and can handle pretty much anything that pops up. But if you quit, they can plug anyone in to replace you. You are not special. You hold no power over the company.
Back to Godin: “In the industrial age, the age of standardization and interchangeable parts, it’s all about being safe. The system is so valuable, the processes to polished, that safe guarantees productivity and profits. Keep it moving. Keep it efficient. Keep it reliable.”
#2. You Have No Control
I worked for two large companies in Apple and T-Mobile; I’ve seen the games played in the ranks of middle management. I started out at the lowest rung of both companies: part-time sales representatives in retail stores. As soon as I poked my head up to explore the possibility of moving up, I could quickly see the games and politics being played. Give a former entry-level employee a little bit of power as a manager, and it quickly goes to their head. Suddenly, they are POWERFUL, they make the decisions and rule over the lives of those under them (in making the schedule dictating raises and pay, etc). It only gets worse for their managers and the managers above them.
If you take an entry level job, there is always the hope or plan to move up. To make more money, be bequeathed that meager amount of power, to carve out a little larger piece of life. But the truth is, it’s not always up to you.
Not long before leaving T-Mobile, I applied for promotion to a regional business sales position. I had the best business sales in the market, plus I owned my own business so I could speak the language of business owners and their needs. Moreover, not long before I applied I had had an awesome month of sales: In May 2018 I finished second in the company in sales numbers. Out of nearly 15,000 retail sales reps, I was number 2 overall. I thought these qualifications would make me a shoe-in for the job. Furthermore, the position had been open for months as no one else applied. I threw my hat into the ring, followed up with the manager who opened the position, and waited. And waited. And waited. I followed up again and was assured interviews were happening the following week. They never came. Months later I found out the manager of the position I applied for didn’t want to hire anyone. Hiring someone meant his sales quota would go up, which he didn’t want. It was easier to leave the spot vacant to protect his numbers. Were there any repercussions? Did T-Mobile care one of their successful, achieving employees was denied a promotion because of a manager’s covering of their own butt? Of course not.
Games. Politics.
You may be the most qualified person for a promotion in the world, but there’s no guarantee you’ll ever get it. Here’s another one: My brother-in-law worked for a Brazilian restaurant for 14 years. He loved it, loved the company, and wanted a career with them. He had moved up from server to head waiter. He knew a lot of the company brass. Last year he was fired from the company by a newly-hired regional manager. The reason? The new regional manager just didn’t like him. Job lost. Career derailed.
You can work as hard as you want, but there are no guarantees. You do not control your own destiny when you are an employee.
#3. Time
This was always the biggest one for me to quit my job. Maybe your job isn’t terrible. Maybe you like your co-workers. But the truth is, your job eats a lot of your time. It eats hours, days, weeks, and years of your time. It eats away the best years of your life — years of good health and energy. If you work until you’re 65, you’re finally released back into the wild but with less energy and health. Maybe you retire and immediately spend more time in the hospital. You’ve traded away your time for a steady paycheck.
One of the most prescient (and scary) things I’ve ever heard about working as an employee is “Your paycheck is your bribe to delay your dreams.” It hit me like a ton of bricks because it’s TRUE! I think the greatest sin in the world is people giving up on what they truly want to do with their life out of complacency. The system has made it easy — and socially acceptable! — to enter the workforce and not pursue what we want most. There’s no stigma to it. How many times have you heard someone say “I always wanted to be…” but they never did it because they “had to work.” They looked around and everyone else was doing the same thing. Giving up on your dreams has become a herd mentality.
#4. You Are Being Fleeced
You’ve heard me mention The Cashflow Quadrant in this blog before, but I always go back to Robert Kiyosaki when it comes to the “E” quadrant and taxes. As an employee, you will always be in the WORST tax situation! Employees have no tax deductions. Employees have no write-offs. Employees are paid in wages, which are taxed at the maximum levels. Employees collect their pay AFTER taxes are taken out.
It’s not just wages. Worked hard for a project or event and made some overtime? Taxed at the maximum level. Do a great job and get a bonus? Bonuses can be taxed even HIGHER than earned income. Does your company offer free stock? T-Mobile did, and when the shares vested, nearly 40% were taken for bonus taxes. Then, if you sold the shares you did get, you were taxed again for capital gains. Invest in company 401k? If you draw from it after retiring, it’s taxed upon every withdrawal. If you pull money from it before retirement age, it gets taxed PLUS penalties.
When working people complain the rich don’t pay enough (or none at all) in taxes, I always have to laugh. The rich aren’t doing anything illegal or unsavory, it’s the tax code that’s designed to be that way. If you remain an employee, you will always be taxed the hardest. The rich are not employees. Still not hitting home on you yet? Imagine you make $40,000/year for 40 years (leaving out raises and bonuses). That’s $1.6 million dollars in earned income over a career. Nearly $500,000 of that will be paid in income taxes. This also assumes taxes don’t go up for 40 years (which they ultimately will). Don’t forget you’re also paying additional fees like unemployment insurance, which, if you stayed employed for 40 years, you never drew from and ultimately never used.
Next time you get a paycheck, take a good look at the withholdings. Your end of year W2 is also a good statement of how much you’re losing to taxes and withholdings.
#5. The Worst Thing That Could Happen is You Get Promoted
So you work a job at a company. If you’re lucky, you’re putting in 40 or so hours and you get your weekends off. Some people refer to this as the “5/2 rule” or “5 for 2 rule.” You work five days to get two. (Again, this is a product of the industrial age as the M-F 9-5pm American work week coincides with the child’s school schedule) But, you’ve committed to your job and career (even if you hate it). You hope to move up, get a bigger office with a little more pay. Maybe you get to make some decisions. You finally get a little control.
The problem is you’re now working way beyond 40 hours a week. In retail, you’ll find the pay structure changes at the management level — managers are salary. Why? Because they work way beyond 40 hours and have to be on call at all times. There’s no escape.
When I was promoted from my Apple retail store to Apple corporate, I was given a laptop and an iPhone. Awesome! The catch? I had to have them both with me AT ALL times — even vacations! I once took a conference call on Christmas Eve just before family dinner. I was hunkered in my childhood bedroom on a call while the rest of the family enjoyed themselves. Getting promoted makes you a larger piece of the machine. You’re a bigger cog. The bigger office and more pay sound appealing, but you’re trading even more of your life away.
At T-Mobile I had been promoted to assistant manager in a retail store. Pay went slightly up, while commission went down. But I was suddenly responsible for a lot more, went to more meetings and sat on more calls. I had to come in on days off if a sales person called off. More time was lost for an minuscule increase in compensation. I stepped down after 6 months, going back to sales. I didn’t notice the change in my paychecks.
Honorable Mention: You Will Be Replaced
Not everyone is (currently) at risk of this, but automation and robotics are beginning to threaten those in the lowest level of the labor pool. For so many companies, human labor is the most costly element. Outsourcing jobs to foreign countries was only a half-measure. Complete computer automation for companies is coming very soon.
A kiosk that takes orders at McDonald’s is not paid a wage. It has no overtime, no workers comp. It never needs to take a break and will never call off. It doesn’t have a 401k or medical benefits package. Sure it may break down, but the cost of repair or replacement is certainly less than an employee requiring medical leave or surgery. If am employee costs $40,000/year and a machine that can do the same job costs $40,000 and lasts for 10 years than the machine is the better investment. It may sound cold, but it’s a numbers game: $40,000 vs $400,000 (not including medical benefits and perks).
It’s the 21st century and human machines will be replaced by metal ones.
Quit Your Job 