Paul Ferraresi

The latest release of Internal Revenue Service data on individual income taxes comes from calendar year 2005, a year in which the economy remained healthy and continued to grow, as well as a year with higher-than-average price inflation.

This year’s numbers show that both the income share earned by the top 1 percent and the tax share paid by the top 1 percent have reached all-time highs. In 2005, the top 1 percent of tax returns paid 39.4 percent of all federal individual income taxes and earned 21.2 percent of adjusted gross income, both of which are significantly higher than 2004 when the top 1 percent earned 19 percent of AGI and paid 36.9 percent of federal individual income taxes.

Wait! I thought the system was to be fair and equal. The top group earned 19% of the income, but, paid 36% of all taxes. It should be that those 19% should pay 19% – Isn’t that right… all you socialist out there… that feel it should all be equal?

(Note: For a detailed paper on the distribution of the entire U.S. fiscal system, including all federal and state and local taxes, read Who Pays Taxes and Who Receives Government Spending? An Analysis of Federal, State and Local Tax and Spending Distributions, 1991 – 2004.)

The IRS data also shows increases in individual incomes across all income groups. Just as the highest earners lost the biggest percentage of their incomes during the recession of 2001, so they have prospered the most as the economy has continued to rebound. For example, from 2000 to 2002, the adjusted gross income (AGI) of the top 1 percent of tax returns fell by over 26 percent. In that same period, the AGI of the bottom 50 percent of tax returns actually increased by 4.3 percent. However, since 2002, as the recession has ended, AGI has risen by 61 percent for the top 1 percent and 10.7 percent for the bottom 50 percent.

In sum, between 2000 and 2005, pre-tax income for the top 1 percent group grew by 19.1 percent. On the other hand, in that same time period, pre-tax income for the bottom 50 percent increased by 15.5 percent.

This pattern of income loss and growth at the top of the income spectrum is the same during every recession and recovery. The net result has also been a sharp rise in federal government tax revenue from 2003-2005 compared to previous years.

You see… tax income has gone up. The problem is that government spending has increased faster than income.

The IRS data below include all of the 132.6 million tax returns filed in 2005 that had a positive AGI, not just the returns from people who earn enough to owe taxes. From other IRS data, we can see that 90.6 million of the tax returns came from people who paid taxes into the Treasury. That leaves 42 million tax returns filed by people with positive AGI who used exemptions, deductions and tax credits to completely wipe out their federal income tax liability. Not only did they get back every dollar that the federal government withheld from their paychecks during 2005; but some even received more back from the IRS. This is a result of refundable tax credits like the Earned Income Tax Credit, which are not included in the aggregate percentile data here.

Including all tax returns that had a positive AGI, those taxpayers with an AGI of $145,283 or more in 2005 constituted the nation’s top 5 percent of earners. To break into the top 1 percent, a tax return had to have an AGI of $364,657 or more. These numbers are up significantly from 2003 when the equivalent thresholds were $130,080 and $295,495. Top incomes in 2005 are also continuing to surpass the peak they reached in 2000. At the height of the boom and bubble, $313,469 was the threshold to break into the top 1 percent, and then it fell to $285,424 in 2002 only to finally recover fully last year.

The top-earning 25 percent of taxpayers (AGI over $62,068) earned 67.5 percent of the nation’s income, but they paid more than four out of every five dollars collected by the federal income tax (86 percent). The top 1 percent of taxpayers (AGI over $364,657) earned approximately 21.2 percent of the nation’s income (as defined by AGI), yet paid 39.4 percent of all federal income taxes. That means the top 1 percent of tax returns paid about the same amount of federal individual income taxes as the bottom 95 percent of tax returns combined. Now is that fair? NO!

Average tax rates increased once again as the economy continues to grow, even though there were no significant pieces of tax legislation enacted in 2005. Overall, the average tax rate for returns with a positive liability went from 11.9 percent to 12.1 percent from 2003 to 2004 and then up to 12.5 percent for 2005. (Note this does not include any refundable credits.)

The 2003 tax cut was the second in three years, but the tax code still remains highly progressive. The average tax rate in 2005 ranges from 2.98 percent of income for the bottom half of the earning spectrum to 23.13 percent for the top 1 percent.

Table 1. Summary of Federal Individual Income Tax Data, 2005 (Updated October 2007)

Source: Internal Revenue Service

Look at the chart above. Find the top 10%. Then go to column 5. The top 10% pay 70% of all the taxes. That is not fair!! 10% should pay 10% etc.

We are all paying for government services with our taxes. How would you feel if when you went in to buy a gallon of milk some of you paid 10¢, others $1, some even pay $10. The price was based on your income. You would be angry. Same thing for gas….some pay 10¢/gallon, some at $12/gallon. Again, the price would be based on how much you earned. You would scream…that’s not fair. Why? Because we are all paying different prices for the same product/services.

Once again, you pay your taxes for government services. In my experience and opinions I find those that pay the most in taxes demand the least in government services. At the same time those that demand the most in government taxes, pay the least for it. That isn’t fair!

If you’re among the two-thirds of credit-card holders who carry an outstanding balance, you might have noticed that your interest rate was hiked recently, or your billing cycle shortened. Failure to navigate card providers’ payment terms successfully can earn you one of several consumer-unfriendly fees.
Some of the industry’s more creative practices, like including the balance from a prior billing cycle in current finance calculations. Alas, these protections won’t take effect for up to 18 months.
The minefield of credit-card booby traps is being cleared, but not soon enough for consumers struggling with debt.
In spotting unfair or deceitful lending practices, several shopping/news Websites like CardTrak.com, Credit.com and CreditCards.com can help. They report on new credit-card pitfalls, provide calculators and other tools for comparing card offers, and translate the arcana in credit-card terms and conditions.
CardTrak.com and CreditCards.com give a big picture view. CreditCards.com identifies the top five card issuers. CardTrak.com notes late fees and over limit charges have tripled since the 2001 recession. The average ding for each is $35 now, and those penalties are assessed much more readily than before.
Even more damaging to your wallet may be the growing “spread” between the prime rate and interest rates charged by the dominant card issuers. Trip over some of the terms in your credit card agreement and you may be graduated up to an annual percentage rate of 28% or more.
Fewer cardholders have been making progress reducing debt lately. Sixty-day delinquencies have jumped nearly 24% since August, according to industry monitor Fitch Ratings (www.fitchratings.com), which expects complete charge-offs to rise 33% this year. Issuers’ portfolios continue to be profitable, however, precisely became they’ve been able to raise rates on cards users, notes Fitch. Credit.com offers an extensive list of cards across categories, and a free questionnaire that will give you a quick estimate of your FICO score.
CreditCardClients.com’s Savings Agent is another useful search tool. Enter your current card balance and a few other credit details (without any identity information), and Savings Agent will compare your needs to about 200 of the newest cards offers, indicating the 10 cards that will save you the most money relative to your current card.
IndexCreditCards.com also follows the credit card industry closely, and lets you rummage around a frequently updated database of more than 1,200 credit offers. Besides having encyclopedic listings of cards by category, both LowCards.com and CardRatings.com review individual cards.
BadCreditOffers.com, on the other hand, is dedicated to finding credit cards and other kinds of loans for people with bad credit histories. The terms might not be optimal, but even in today’s market BadCreditOffers.com lists more than 12 potential credit lines, both secured and unsecured, for those with low FICOs. But be careful: Applying for a new card usually will knock a few points off your FICO score.
It’s best, of course, to pay credit balances in full every month. But if you must play (and pay), at least know the rules of the game.

The economic turmoil that now embraces the planet of which we hear is more of a U.S. problem should not surprise anyone. You are witnessing the consequences of reckless indebtedness. The subprime mess was just the tip of the iceberg. The leaders in government were very indifferent as to “subprime” being a problem at all.
A little history….Bill Clinton in 1997 signed legislation to allow (demand) that banks lend money to “less fortunate people” (those who could not afford to pay for a home) in order for everyone to enjoy the American Dream. Alan Greenspan, head of the Federal Reserve at that time, accommodated this request by lowering interest rates. These low rates led to many years of “irrational exuberance” and the stock market finally died in the 2000 tech wreck, 911 made the economy stop and we had a recession. Greenspan lowered rates again, but this time the bubble was not in stocks, rather, in real estate. Fannie Mae and Freddie Mac were given the green light by Congress to accept all levels of credit loans. Wall Street wanted into the act and “securitized” these loans and sold them as “good” loan packages.
In 2001 President Bush presented to Congress his concerns over this sub-prime mortgage program with Freddie and Fannie but it was brushed aside and no investigation or legislation was enacted. In 2005, 2006, 2007 and early 2008 Chris Dodd, head of the Senate Finance Committee and Barney Frank, head of the House Committee on Banking, both fought against adding any more regulation to Fannie and Freddie. Both individuals stood firm and said boldly that these two agencies were strong, did not need any more regulation or oversight. The rest is history.
Now there has been a pattern of excessive aggregate indebtedness for quite some time at the corporate, government and household level, so, everyone is to blame. At the same time the tax code, in this country, encourages borrowing and discourages saving and investing. It seems everyone has a poor attitude of paying back debt. As a result when things begin to go sour on some debt, starting with subprime, the cascading effect was beyond what anyone ever predicted. Very few expected anything this severe, yet, the seeds were sown more than a decade ago (similar to when you watch friends over eat or over drink for a long time…sooner or later they pay the piper for the over indulgent behavior)
Looking ahead for you….unfortunately retail investors and institutional investors make their investments as if they are driving down the highway but looking through the rear view mirror. They all favor what has worked in the past. But, there is a powerful pattern of mean-reversion in the markets (that which is hot today is cold tomorrow and vice versa).
So the idea of looking at markets today and asking… what has been hit really hard, and as a consequence, may be priced at attractive levels. Well, this is contrary thinking to most people, including sophisticated investors. The temptation to buy what has done well recently and sell what has done poorly is the single greatest pitfall in investing and the main reason why a disciplined approach to asset allocation works very well.
With this in mind…..be careful of Government Bonds. These bonds have done very well recently, but, after a short deflationary cycle, which we are in, we will be hit with a huge inflationary cycle. This will lead to higher interest rates which translates into a loss in bond values.
Keep your eyes open to opportunities in emerging markets, gold, commodities, U.S. stocks and REITS. I have not seen deals and valuations like this since 1973-1974 when the DOW was at 570.
Remember you are looking at a 3-5 year investment window timeframe and not a bump up in prices tomorrow. Take advantage of this fire sale in the market now for a reward in 5 years. Or, will you drive down the highway in 5 years from now looking back through the rear view mirror after these items have gone up?! Then, like the masses do…will you buy when prices have gone up? You know the formula for the poor.. “buying when prices are high…and then selling when they are low.”
No, the correct formula is the opposite for the wealthy.

One of the most vexing questions plaguing investors these days is whether or not we’re headed for price deflation or price inflation. There are two offsetting influences…that will undoubtedly determine the direction of price growth.
History has shown that credit contraction is one of the harshest sources of deflation. The most recent Federal Reserve survey of senior credit officers showed that nearly 70% of surveyed banks have tightened their mortgage-lending standards. Stinginess among lending institutions is largely responsible for the 16% decline in our nation’s $22 trillion housing stock. Margin lending has been cut in half, forcing leveraged investors, like hedge funds, to disgorge marketable assets. The pullback in housing and equities, combined with plunging commodity prices, helped push consumer prices lower recently. Yet without the impact of food and energy, prices were essentially flat.
Persistent deflation is bad for the economy. Faced with declining sales and fixed interest obligations, companies will find it increasingly difficult to stay current on their debts. Consumers, facing similar challenges, will defer spending. Deflation fears have prompted lenders to require yields approaching 17% when purchasing below investment grade bonds. Offsetting the downward pricing spiral is unprecedented monetary and fiscal intervention in the form of stimulus and bailout programs.
The Fed’s balance sheet has expanded by $1.3 trillion in the past year. The Treasury has backed banks and money-market funds, has taken in the government sponsored mortgage companies and is toying with…bailing out the big auto makers. Eventually, this monetary expansion will push prices higher. Meanwhile, the Treasury market suggests prices will decline before they expand. The break-even inflation rate between inflation-protected Treasury notes and fixed-rate Treasury notes is nearly minus – 0.5% for the next five years. We recommend that investors brace for transitory deflation this year that will give way to inflation in 2010 and beyond. Take positions now to benefit from inflation and a dropping dollar.

Following up on Part I…what are some of my core beliefs on investing?
First of all, and I include myself in this, people tend to be impatient. Good investing, especially from an individual standpoint, is where you have the luxury of not having to participate in the market at all times. You can pick and choose the most appropriate times when the odds and probabilities of success are highly in your favor. I try to keep that in mind as a professional investor as well.
It’s only through time and patience that you actually tend to build wealth through the power of compounding of returns. But doing that requires perseverance and saving, which involves sacrifice. One of the things I was most influenced by is the writing of Charles Ellis, who said you win by not losing and your primary objective in investment management is to control risk.
A successful investment requires a great deal of courage. And it requires steady nerves to invest in those areas where the greater opportunities are, even though that’s not where the consensus is, and it’s very lonely. The best opportunities to buy stocks occur when it’s been very hard to pull the trigger and buy, yet, all your disciplines would suggest that is exactly the right thing to do.
With the markets in wild disarray it reminds me of a quote I have been keeping in front of me lately. As Warren Buffett said: “Be fearful when people are greedy and greedy when people are fearful.” We have gotten to the point where it pays to be a bit greedy, because there are some unusual opportunities being created right now.
So when markets are either frothing, or, in a deep trough, keep in mind you can be out in the middle of the ocean and not know what’s ahead, so you need to be prepared for stormy seas. It just provides better ballast to a portfolio in case there are surprises. As much as you think you’ve got it all right at various points in time, you always want to protect yourself.