Job protection, wage insurance, and universal benefits

Become a Patron!As readers may have observed, I've been doing a lot of research lately on paid family and medical leave policies around the country, and I've found myself frustrated by the way several different ideas are confusingly and unnecessarily combined. Today I want to spell out the relevant issues, and try to explain how they do and don't interact with each other.

Job protection

The most basic protection workers can be provided for family and medical leave is job protection. That's because even if someone can afford to go without pay while recovering from childbirth, bonding with a child, or caring for themself or a relative, no one can afford to do so without knowing they have a job to return to.Currently, the only form of nationwide family and medical job protection is the Family and Medical Leave Act of 1993. For qualifying events, the law provides:

• 12 weeks of leave in a 12-month period;
• to employees who have worked for at least 12 months, and at least 1,250 hours in the previous 12 months, and 
• at private-sector employers who employed 50 or more employees in 20 or more workweeks inthe current or preceding calendar year.

Note that the qualifications are non-transferrable. In order to qualify for job-protected leave, it's not enough to be continually employed for 12 months and work 1,250 hours in the previous 12 months: you have to be employed for 12 months at the same employer. That means workers with working two jobs with 20 hours per week at each will never be eligible for job-protected leave from either employer, since their 1,040 hours of work each 12 months leaves them short of the 1,250 minimum.When we isolate job protection in this way, we can imagine all sorts of possible improvements:

• Increase the quantity of job-protected leave. If we think 12 weeks of leave is inadequate, we might increase the amount of time workers have to return to their jobs after taking family and medical leave. The public health consensus seems to be that about 6 months of leave after having a child is optimal for child and maternal health, so we could increase our job-protected leave from 12 to 26 weeks.
• Make more workers eligible for job-protected leave. The obvious way to do this is linking eligibility to the individual's work history instead of their employment at a specific firm. Instead of requiring 1,250 hours and 12 months of employment at a specific firm, eligibility could be based on total hours worked at all employers over the preceding 12 months. Likewise, the number of hours and required length of employment could be reduced.
• Require more firms to provide job-protected leave. Like many social phenomena, employer size has the curious characteristic that while most workers are employed by large employers, most employers are small employers. Reducing or eliminating the number of employees before a firm is required to provide job-protection is an obvious way of expanding access to job-protected leave.

The reason it's worthwhile to isolate job protection from other features of a family and medical leave policy is that job protection is valuable whether a worker's leave is paid or unpaid. That is to say, there is a difference between going 12 weeks without pay after giving birth knowing you'll have a job to return to, and going 12 weeks without pay after giving birth knowing that you'll be unemployed at the end of the 12 weeks and need to seek out a new employer.

Wage insurance

The second piece of a family and medical leave policy we can isolate is wage insurance, also sometimes called wage replacement, during a period of leave. The argument for wage insurance is that whether or not a worker is entitled to job-protected leave, they may not be able to afford to go weeks or months without a paycheck, and so return to work earlier than would be ideal for their own or their child or dependent's health.The United States has no national system of wage insurance, and consequently a substantial number of new parents return to work without using their full 12 weeks of FMLA leave, even when eligible, because they can't afford to go without a paycheck any longer. Fortunately, as demonstrated in the states operating their own paid family and medical leave systems, wage insurance is extremely cheap to provide. From a recent National Partnership for Women and Families fact sheet, the total employer and employee cost, wage replacement rate, and maximum benefit of each state's program is:

• California: 1% of employee's first $118,371 in annual wages, replaces up to 70% of average weekly wages, up to $1,252.
• New Jersey: up to 1% of employee's first $34,400 in annual wages, replaces up to 85% of average weekly wages.
• Rhode Island: 1.1% of employee's first $71,000 in wages, replaces 60% of average quarterly wages up to $852 per week.
• New York: up to roughly $139.17 per year, replaces 55% of average weekly wage, up to 55% of state average weekly wage (rising to 67% in 2021).
• District of Columbia: 0.62% of wages, replaces 90% of average weekly wage up to $1,000.
• Washington: 0.4% of employee's first $132,900 in wages, replaces 90% of average weekly wage, up to $1,000.
• Massachusetts: 0.63% of wages, replaces up to 80% of weekly wages, up to $850.
• Connecticut: up to 0.5% of wages, replaces up to 95% of average weekly wages, up to 60 times the Connecticut minimum wage.
• Oregon: up to 1% of employee's first $132,900 in wages, replaces up to 100% of average weekly wages, up to 120% of the state's average weekly wages.

Note here again that job protection and wage insurance are conceptually totally unrelated. You can provide wage insurance without providing job protection, and you can provide job protection without wage insurance. Indeed, that's precisely the situation in the 42 states that don't provide paid family and medical leave.Once you've conceptually isolated them, you can suddenly imagine all sorts of combinations: you could leave job protection at 12 weeks and expand wage insurance to 26 weeks. You could expand job protection to 26 weeks and wage insurance to 40 weeks for folks willing to forego job protection.

Universal benefits

There's a final set of benefits that are sometimes pulled into discussions of paid family and medical leave but that are rightly considered separately, and that is universal or near-universal benefits. Universal benefits in this context are those you're eligible for regardless of work or earnings history. The great advantage of universal benefits is they allow us to put the material welfare of people above incoherent attempts at social engineering.Job protection protects only those with eligible jobs and work histories. Wage insurance supplements the income of workers whether or not they are eligible for job protection. Only universal benefits are aimed at ensuring the material well-being of people regardless of their employment status or wage record.The closest thing we have in the United States to a universal benefit is the refundable Child Tax Credit, which increased to $1,400 per year in 2018, or roughly $116 per month per child.The problem with the Child Tax Credit, of course, is that it's only claimed once a year; a parent who gives birth or adopts a child in January won't see any benefit until as late as April the following year, and has to wait a full additional year to receive their next cash infusion. This is an absurd system and, oddly, another better system is already in place: Social Security Child’s Insurance Benefits. These cash payments are available to the minor children of disabled and retired workers, and are received monthly, either by paper check or direct deposit.Besides providing benefits to parents, patients, and caregivers with insufficient work and earnings histories, universal benefits are also capable of reducing the stakes involved in job protection and wage insurance. As indicated above, the maximum weekly wage insurance benefit in most states is around $1,000. Mechanically, a $1,000 monthly universal basic income would allow that maximum wage insurance benefit to fall to just $750, leaving the maximum income of parents with work histories unchanged (at $4,000 per month) but increasing the income of non-working parents from $0 to $1,000.

Conclusion

This post isn't intended to convince you of any one particular policy solution. Personally, I think we need more job protection, more universal wage insurance, and more universal benefits, but I don't know for sure whether we need 26 weeks or 40 weeks of job protection, whether we need 66% or 100% wage insurance, and whether we need fully universal benefits or a mixture of universal benefits and wage insurance and job protection.Rather, this post is meant to help you ask the right questions when your state, your congressperson, or your senator makes a paid family and medical leave proposal: does it extend job protection to additional workers, or beyond 12 weeks? Does it provide wage insurance, and if so, for whom and at what rate? Is it universal or is it means-tested?If you ask the right questions, you at least have a chance at making the policy better. And if you don't know what questions to ask, we'll be stuck with the stingiest welfare state and unhealthiest population in the developed world.Become a Patron!

How the Republican tax heist surgically targeted businesses in progressive states

Become a Patron!This post gets pretty deep in the weeds, but it's an issue that was brought to my attention by someone who works on family and medical leave policy and I was shocked to discover that it may disqualify certain employers from claiming the temporary paid family and medical leave credit included in the CPA Full Employment Act of 2017.I've written at length about that credit, which is set to expire at the end of 2019, so first pop over to my earlier post to get caught up on what it is and how to claim it.

Only benefits in excess of state requirements are eligible for the paid family and medical leave credit

The 8 states and the District of Columbia which have enacted paid family and medical leave typically administer it through the state's existing temporary or short-term disability insurance program, through a separate state-run program, or through private insurers. Some states, like New York, also allow businesses to self-insure.These insurance policies are funded either through employee contributions (as in New York State), employer contributions (like in the District of Columbia), or a combination of both (in Washington State).This puts firms in states that require paid family and medical leave at a severe disadvantage, because the IRS has announced that "[a]ny leave paid by a State or local government or required by State or local law is not taken into account for any purpose in determining the amount of paid family and medical leave provided by the employer" — and this is true whether or not the leave is paid for by the employer!This creates the absurd situation where virtually identical employers are treated completely differently by the federal tax code. An employer in Connecticut that provided 55% wage replacement for all their eligible employees in 2019 for all Family and Medical Leave Act purposes would receive a tax credit for 25% of the replaced wages; an identical employer in New York would receive nothing, simply because the benefit is required by state law.In the specific case of New York, you might think this makes sense, since family and medical leave insurance premiums are, by default, paid for by employee payroll deductions; since the employer doesn't pay anything, they aren't entitled to a tax credit for the resulting benefit. But New York also allows employers to pay their employees' insurance premiums (just like employers can pay for insurance in any other state), and even employers who pay in full for their employees' leave are not entitled to the tax credit, unlike their competitors on the other side of the Long Island Sound.

Conclusion

If you squint just right at the rules around the tax credit, you can see the kind of broken-brained Congressional logic at work here: the tax credit is intended to encourage additional employers to provide paid family and medical leave. Firms which are already required by state or local law to provide paid leave by definition don't need any additional encouragement.But that logic has the deranged result I described above: two firms with identical payroll and identical paid family leave policies will face different federal tax rates based solely on whether their paid family leave policy is or is not required by state law.In other words, a tax credit intended to encourage firms to adopt paid family leave policies has the perverse consequence that New York State could increase the amount of federal tax credits flowing to its businesses by repealing its paid family leave policy, which would immediately deny access to paid family leave for millions of New Yorkers.Fortunately, the paid family and medical leave credit is currently set to expire at the end of 2019. For all our sakes, let's hope we get it right next time.Become a Patron!

Are there 529 plans so bad they aren't worth their state's income tax benefits?

Become a Patron!A lot of financial planning and advice can start to seem pretty routine over time: maximize contributions to tax-advantaged savings vehicles, invest in a basket of diversified, low-cost assets, and periodically (but not too often!) rebalance.I'm always interested in identifying places where that kind of routine advice breaks down, and the other day, I got to thinking: many states allow certain state income tax deductions for 529 college savings plan contributions, but only when contributions are made to plans sponsored by the state where you take the deduction. Since the fees and expenses of 529 plans can vary considerably, I wondered if there are states where the costs of using the in-state plan instead of a cheaper alternative exceed the value of the state income tax benefits.

Deductions, credits, and rates

To investigate this question, I had to isolate several different dimensions:

• Does a state offer a tax deduction or a tax credit? Four of the 35 states offering state income tax benefits offer a tax credit for contributions: Indiana, Utah, Vermont, and Minnesota. The rest allow for contributions to be deducted from state income instead.
• What are the limits on the state tax benefit? Colorado, New Mexico, and West Virginia allow taxpayers to completely eliminate their state income tax liability through 529 contributions. The remaining states place a cap on the amount that can be deducted.
• What are the state income tax rates? A deduction is more valuable in a state with high income tax rates than in a state with low ones. I used the lowest and highest non-zero income tax brackets for each state to identify the range of potential values of a state income tax deduction.
• Does the state only allow deductions for in-state plan contributions? Seven states allow income tax deductions for contributions to out-of-state plans: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania.
• And finally, what is the cheapest appropriate investment option in each plan? For this comparison, I selected the lowest-cost broad US equity option in each plan, which was typically a US large cap, S&P 500, or total stock market fund.

Whether or not you're interested in my particular research question, you might find the resulting spreadsheet useful on its own, and you can find it here.

Reminder: state tax benefits are worth less to federal itemizers

Before I go on, I want to remind folks who choose to itemize their federal deductions that state tax credits and deductions are worth less to them, since reducing their state income taxes mechanically reduces their state and local tax deduction and increases their federal income taxes.Take, for example, a South Carolina resident in the 7% state income tax bracket who owed exactly $10,000 in state income tax and no other state or local taxes in 2018. If they chose to itemize their federal deductions, for example due to a large deductible charitable contribution in 2018, then the $10,000 is also deductible from their taxable federal income.Since South Carolina allows 529 plan contributions to be deducted against an unlimited amount of state income, the taxpayer can save $10,000 in state taxes by contributing a bit over $100,000 to a South Carolina 529 plan. But this will reduce their state and local tax deduction by the same $10,000, increasing their federal income tax liability by up to $3,700.Such corner cases cover only a tiny number of taxpayers, but it's something to be aware of in case you happen to be one of them.

First impressions

Taking a look at the spreadsheet, the first thing that should jump out at you is that these plans are all over the place. Investment costs start as low as 0.035% (for Rhode Island residents to invest the "U.S. Stock Portfolio"), and run as high as 0.65% (for Mississippi's "U.S. Large-Cap Stock Index Fund Option"). Note that these are the lowest-cost equity investment options in each plan — fees for other investment options can run much, much higher than this.The second noteworthy observation is that some of these supposed tax benefits are trifling. Rhode Island will give a married couple with over $145,600 in taxable income a deduction worth a little less than $60 for contributing $1,000 to their in-state plan. For a low-income single filer, the deduction is worth less than $20. What exactly is the point supposed to be?At the high end, the state tax benefits can be considerable. In addition to the states with unlimited deductions I mentioned above, high-income married taxpayers in Alabama, Connecticut, Idaho, Illinois, Indiana, Iowa, Mississippi, Nebraska, New York, Oklahoma, and Vermont can all save $500 or more by making contributions to in-state plans. Single filers have it tougher, but can still save more $500 or more in Mississippi and Oklahoma state income taxes.

If you're just maximizing state tax benefits, don't diversify!

This is a corollary of what I wrote above: since I chose the lowest-cost equity option in each plan as my benchmark, if you don't use that option, you will likely end up paying more in fees. For your primary 529 account, you should have an appropriately diversified portfolio that scales back risk as your beneficiary nears enrollment. For your tax-scam 529 account, just put however much money you need to maximize the state tax benefits into the cheapest equity fund and forget about it.If you're lucky enough that your primary account is also your tax-scam account (Utah, I'm looking at you), then feel free to disregard this warning.

It's almost always worthwhile for non-zero rate payers to maximize their in-state tax benefits

Remember the original question we started with: are there states where the cheapest investment option is so expensive it outweighs the state income tax benefits?And the answer, to a first approximation, is no. What I was looking for is a state with a very low income tax benefit, like Rhode Island, and very high investment costs, like Mississippi or North Dakota. But those states mostly don't exist: for taxpayers with any state income tax liability at all, making the maximum deductible contribution to the cheapest in-state 529 investment option will almost always create a greater reduction in state income taxes than the increased expenses compared to the cheapest 529 plans available.There are two exceptions: in states with fixed account maintenance fees in addition to investment costs, low balances may incur much higher proportional expenses, in the same way that fixed fees on origination can increase a loan's APR far above the stated interest rate.The second exception is folks without state income tax liability. If you aren't taking advantage of your state's tax benefits for in-state plan contributions, don't feel compelled to make in-state plan contributions: find the cheapest plan with the best investment options and use that instead.Become a Patron!

Why workers should fight for entrepreneurs and entrepreneurship, too

Become a Patron!Even though this blog is committed to promoting entrepreneurship, I often say I don't think everyone should become an entrepreneur, for the fundamental reason that not everyone wants to become an entrepreneur. Plenty of people want to go to work, do their job as well as they can (or as badly as they can get away with), and get paid a predictable amount on a predictable schedule.But the flip side of that is plenty of people do want to become entrepreneurs, but don't because of the unfathomable complexity of our system (which I obviously strive to make as fathomable as possible).I compare entrepreneurship to the decision whether to live in a city, a suburb, or a rural area. It's true that living in a city is much more environmentally sustainable than living in a suburb or rural area, due largely to shorter driving distances, increased access to public transit, and the higher heating/cooling efficiency of multifamily structures compared to single-family homes. But I don't think everyone should live in a city because not everyone wants to live in a city. My view is simply that since more people want to live in cities than can currently afford to, and given the environmental benefits, we should strive to make city living more easily accessible.In the same way rural residents benefit from the lower greenhouse gas emissions of city residents, what's often missing in this conversation are the ways workers benefit from entrepreneurship — even workers who do not themselves become entrepreneurs.

The most important job an entrepreneur creates is their own

The idea of a "labor market" is a metaphor strained so hard you can see it coming apart at the seams. Virtually no one shows up to the "labor market" each day and puts out labor offers which are matched by labor bids from employers until the "market" clears. There are exceptions, of course: in certain neighborhoods in certain cities in certain parts of the country, I'm told, you really can drive up to the Home Depot parking lot and bargain one-on-one with day laborers for exactly one day's work.But that's a curio: most laborers are not day laborers, and most "day" laborers are not actually employed by the day (it takes a couple days to replace a roof).Still, the "labor market" is a metaphor that's stuck around for a reason: you can see with the naked eye the fact that when firms are profitable, growing, and in need of additional workers, they become more desperate to hire, and when they're unprofitable, shrinking, and laying off workers, they only replace absolutely essential personnel. If you squint at this observation just right, it kind of looks like a "labor market."But if you take the metaphor of a "labor market" even half-seriously, then it has an extremely important implication: when entrepreneurship removes a worker ("supply") from the labor market, it increases the market price of all the labor remaining in the market. And, importantly, this is true regardless of the success or failure of the enterprise.

Eliminating barriers to entrepreneurship is pro-worker

Operating a profitable business is hard, but lots of things are hard, so that doesn't bother me much. What concerns me are barriers to entrepreneurship. To give some obvious examples:

• the lack of a universal national health insurance scheme means employees, who pay workplace health insurance premiums, have to decide whether to go uninsured, switch to a public health insurance program, or buy insurance on an ACA exchange when starting a business. What is easy and simple for an employee requires a sprawling spreadsheet for an entrepreneur.
• the different rules for workplace-based savings schemes like HSA's and 401(k)'s mean workers have to weigh the loss of one set of tax benefits against the benefits of gaining another.
• special treatment for business distributions compared to wages means that workers have to calculate whether a lower pre-tax business income may actually increase their take-home pay.

While these specific concerns are obviously tailored to problems in the United States, I want to make clear that the United States has an unusually good environment for entrepreneurs and entrepreneurship. In the United States, it is still possible to become an entrepreneur. These problems are even more significant in countries where the administrative burden simply puts entrepreneurship out of the question.

The problem is complexity, and it will run out of control if we let it

This is, obviously, at its core a political problem. But it is not a partisan problem. Republicans, famously, want to weaken the position of workers by making them increasingly reliant on their (stingy) workplace benefits. Democrats, famously, want to strengthen the position of workers by making them increasingly reliant on their (generous) workplace benefits. But the problem in both cases is the workplace as the locus of the welfare state.Barack Obama was not a perfect president and the Affordable Care Act is not a perfect law, but since its pro-worker provisions affected so many more people, its pro-entrepreneur provisions have gone less noticed: Medicaid expansion was explicitly supposed to be a form of health insurance for new entrepreneurs; premium subsidies provide affordable health insurance for more profitable businesses; guaranteed issue and community rating provide health insurance for successful businesses.The sabotage of this system by Republican officeholders is an urgent crisis, but we need to be realistic about the problems in the system itself: it relies, first and foremost, on workplace benefits, and as long as it does so, it is an obstacle to entrepreneurship, and so is definitionally anti-worker, no matter how generous the benefits are.

Conclusion: workplace-based policies are a guarantee of stagnation and decline

Back in April I wrote about a little-known giveaway included in the Smash-And-Grab Tax Act of 2017: the paid family and medical leave credit. Under that law, employers who provide their workers with paid family and medical leave (by the end of 2019) receive a rebate of a portion of their after-tax wage cost in the form of a refundable business tax credit.But entrepreneurs don't, and you see this tendency across the board: every policy that promotes employment has an equal and opposite effect on the appeal of entrepreneurship. The more money the government spends subsidizing workers, the less appeal there is in entrepreneurship, and the higher the supply of labor, depressing any hypothetical benefits that might flow down to workers themselves.Before we succumb to the stagnation of other developed countries that have gone all-in on workplace-based policies, we need to start asking some simple questions:

• is a benefit universal, or is it means-tested?
• is a benefit universal, or is it employer-based?
• is a benefit universal, or is it location-based?
• is a benefit universal, or is it family-based?

Today the United States has an underdeveloped system of means-tested, employer-based, location-based, family-based policies. If we're going to expand that system as much as we need to, we also need to expand it in a way that is universal and leaves room for entrepreneurs to exit the labor market and workers to demand higher wages.Become a Patron!

The wealthy Illinois degenerates were good and right for getting their kids a free education

Become a Patron!Last week, the nonprofit journalism enterprise ProPublica wrote a breathless expose about a number of wealthy Illinois families, and their law firm collaborator, who were able to secure generous financial aid awards for their children to attend certain Illinois public universities.The article served as a brilliant kind of Rorschach test for how readers feel about public services, means-testing, and the administrative state. If you haven't read it yet, go check it out first, then head back here.

What happened in Illinois

Unfortunately, the ProPublica authors didn't consult me or anyone else who understands how financial aid works, so the article is missing some important details.How financial aid works in the United States is that there is a single, federal application called the Free Application for Federal Student Aid, or FAFSA, which is used by the federal government to determine statutory eligibility for certain federal programs, including Pell Grants, subsidized and unsubsidized federal student loans, and some smaller programs like SEOG. The FAFSA produces an aid eligibility determination based on family size, income, assets, and a few other variables.One of those variables is "dependent status." In general, all undergraduates are considered dependent unless they meet any one of several tests:

• Will you be 24 or older by Dec. 31 of the school year for which you are applying for financial aid?
• Are you married or separated but not divorced?
• Do you have children who receive more than half of their support from you?
• Do you have dependents (other than children or a spouse) who live with you and receive more than half of their support from you?
• At any time since you turned age 13, were both of your parents deceased, were you in foster care, or were you a ward or dependent of the court?
• Are you an emancipated minor or are you in a legal guardianship as determined by a court?
• Are you an unaccompanied youth who is homeless or self-supporting and at risk of being homeless?
• Are you currently serving on active duty in the U.S. armed forces for purposes other than training?
• Are you a veteran of the U.S. armed forces?

If an undergraduate applicant meets any one of those tests, they're considered "independent," and only their own income and assets are used to determine federal financial aid eligibility. This means, for most independent undergraduates, that they're entitled to the maximum amount of federal student aid.Above, I've bolded the test used by the Illinois families in the ProPublica story to trigger maximum financial aid eligibility: by asking a court to grant legal guardianship of their progeny to a friend or relative, they were able to remove their own income and assets from the federal financial aid determination of their children at Illinois public universities.

Why it worked

So far so good, right? Not quite. there are two important additional reasons why these Illinois families were able to maximize their financial aid awards.First, Illinois has a low/nonexistent requirement for guardianship orders. While the federal FAFSA condition for independence is obviously meant to identify students who are escaping abusive or inadequate living situations, guardianship orders are handled by state courts, and as ProPublica explains:

The Illinois Probate Act, the law that governs guardianship, does not specify circumstances in which guardianship should be denied. According to Illinois law, a court can appoint a guardian if the parents consent, the minor agrees and the court determines it is in the minor’s best interest. Even if a parent is able to care for the child, the court can approve the guardianship if the parents voluntarily relinquish custody of the child.

The federal government doesn't have a mechanism to overrule state guardianship orders because family law is exclusively a state competency.The second advantage these Illinois families had is that the universities their children applied to rely entirely on the FAFSA for student aid eligibility decisions. As I've explained in the past, many public and virtually all elite private universities rely on a second screening tool, the College Board's CSS Profile. This application requires parental information regardless of FAFSA dependency determinations.While federal financial aid determinations are based entirely on the FAFSA, in order to receive generous in-state and institutional aid, the Illinois families needed to send their kids to a school that doesn't use that additional information.

The Utopia of Rules

The anthropologist David Graeber's 2015 book "The Utopia of Rules: On Technology, Stupidity, and the Secret Joys of Bureaucracy" describes a key reason why, despite its frustrations and absurdities, we're attracted to bureaucracy: it gives us some confidence that, no matter how annoying we might find our interactions with the system, that the system is not targeting us or singling us out for persecution. In that way, the impersonality of the bureaucracy puts everyone on a level playing field, with rules defined in advance. You can't plead with your sister who works at the DMV to give you a drivers license because no one can plead with your sister.Rules are rules — and the Illinois families followed the rules.

The problem is means-testing and more rules won't help

Whenever these "scandals" come along there are immediately calls to "tighten up," "strengthen," and "fortify" the rules governing means-tested programs. But even if that's what you think you want, it's not true. What you want is to live in a just society, and the idea of people "exploiting loopholes" in the rules pisses you off because you think it makes society less just.The problem is, means-testing also makes society less just. It discourages people from applying for the food, health, and housing benefits they need. It discourages people from going to college. It discourages people from starting businesses. There's nothing just about a society full of hungry, sick, homeless, unemployed people.To condemn the Illinois families for taking advantage of the rules, as written, is to say the rules were wrong. But that only gets you halfway home. Were the rules too loose, and need to be tightened, so that every Illinois family needs to jump through even more hoops if they want to send their kids to college? Or were the rules too tight, too carefully constructed, too delicately balanced, and what we really need is public education free to all without the increasingly tortuous barrier of means-testing?

Conclusion

The reason I love the Illinois case as a test is that it demands we answer two, equally important questions:

• what should the rules be?
• and how should we feel about people we don't like following the rules?

Most wealthy people have no problem accepting deferred compensation in their 401(k) accounts, or making "backdoor" Roth IRA contributions, or squirreling away tens or hundreds of thousands of dollars into HSA accounts. Those are the rules, and they're maximizing the benefits of them, as they're written.Now how do they feel about a single parent of 3 who reports exactly $14,250 in earned income and claims a refundable credit of $6,431? Are those parents still "just following the rules" or are they "exploiting a loophole?"If you want to make the rules stricter on low-income parents, but looser on high-income investors, you're making an important point, but the point you're making is about you and your values, not about the rules.Become a Patron!

The Fidelity "dead accounts" study is fake, not wrong

Become a Patron!I've noticed an interesting phenomenon, which I call "common knowledge about common knowledge" (doesn't exactly roll off the tongue, I know). It's when some piece of conventional wisdom becomes so banal that someone decides to refute it, and then the refutation becomes as widely known as the original factoid, if not more so.To give an easy example, "everyone knows" that vitamin C strengthens your immune system. But "everyone" also "knows" that's ridiculous folk wisdom based on a single poorly conducted study in the early 20th century.The problem is this can cause people to overcorrect, and end up saying "actually vitamin C has no health effects."Except vitamin C really is essential to human health!

There's no Fidelity "dead accounts" study

An ancient piece of financial lore holds that one day, the beancounters at Fidelity decided to study the performance of every account at the firm in order to identify what characteristics were shared by the accounts yielding the highest returns. Small stocks, big stocks, domestic stocks, foreign stocks, frequent trading, infrequent trading, they looked at everything.After months of crunching the data, the beancounters made a shocking discovery: there was one account type that consistently outperformed all the others. The accounts of dead people! It turned out that people who did no trading in their accounts whatsoever had higher long-term returns than any other strategy.Now, if you think about this for even a moment, you'll realize it doesn't make any sense. How many accounts could Fidelity possibly have in the names of dead people (another version sometimes includes "people who had moved and forgotten about their accounts")? If Fidelity could easily identify dead accountholders, why hadn't they notified the appropriate authorities already?Today, people gleefully debunk the apocryphal Fidelity study.

The Fidelity study is fake, not wrong

Whenever I see a reaction like this building, whether it's "actually vitamin C doesn't make you healthy" or "actually a dead person's account would not achieve better returns than an actively managed account," I like to take a second to ask, what if the conventional wisdom was right all along?To find out, I used Morningstar's portfolio tool to check the performance of two portfolios: a simple 60/40 portfolio using the Vanguard 500 (VFINX) and Vanguard Total Bond Market (VBMFX), and a Boglehead 3-fund portfolio substituting a 12% allocation to Vanguard Total International Stock (VGTSX). The 2-fund portfolio performance goes back to 1986, and the 3-fund portfolio to 1996. In both cases, I selected reinvested dividends and capital gains.For each portfolio, I checked its annual return (and the final value of an initial investment of $100,000) with a monthly, quarterly, semiannual, and annual rebalance, and with no rebalance at all.For the 2-fund portfolio dating back to 1986, the average annualized returns (and final value) for each rebalance selection were:

• Monthly: 8.73% ($1,526,134)
• Quarterly: 8.79% (1,553,836)
• Semiannual: 8.71% ($1,517,894)
• Annual: 8.73% ($1,526,244)
• No rebalance: 9.02% ($1,665,050)

Here are the same values for the 3-fund portfolio since 1996 (the pattern is similar for the 2-fund portfolio over the same period):

• Monthly: 7.06% ($486,314)
• Quarterly: 7.16% ($496,945)
• Semiannual: 7.28% ($510,056)
• Annual: 7.32% ($514,528)
• No Rebalance: 7.07% ($487,180)

Conclusion

I like this data precisely because it lends itself to multiple interpretations. Looking at the two-fund portfolio since 1986, you'd conclude no rebalancing at all yields the highest returns — the fake Fidelity was right all along, the best investor is a dead investor!On the other hand, the three-fund data since 1996 suggests annual rebalancing yields the highest returns — having a pulse matters after all.If you're reading this, I'll go ahead and assume you have a pulse, so allow me to split the difference: if you're invested in a simple 2-fund, 3-fund, or 4-fund portfolio, you're almost certainly rebalancing too often. If you're rebalancing monthly, consider switching to quarterly. If you're rebalancing quarterly, consider switching to semiannually (perhaps on the equinoctes?). And if you're rebalancing semiannually, consider switching to annually. If you're rebalancing annually, your blood is already ice cold and you don't need my advice.The logic is simple: when you rebalance a portfolio, you're by definition selling your winners and buying your losers. But the tendency of assets, especially over short periods, is for winners to keep winning and losers to keep losing, meaning frequent rebalances move you out of assets that are performing well and into assets that are performing poorly.There are good reasons to do that, for example if you are targeting a particular balance in lower-performing, more stable assets, in anticipation of a near-term expense. One of the benefits of diversification is that it tends to increase your risk-adjusted return. But while risk-adjusted returns are an important metric when designing a portfolio, you can't eat them. For that, you need the ordinary kind.Become a Patron!

What will the Social Security funding "crisis" look like?

Become a Patron!When ignorant people want to sound serious, they start solemnly intoning about the Social Security funding crisis and the need for a "long-term" "fix" to the "problem." This serves three useful purposes: it allows the speaker to change the subject from any actual problems existing today, it provides the superficial cover of concern for vulnerable populations, while also giving a sheen of non-partisanship to plans that will decimate the working class.This makes it extremely important to understand what the Social Security funding "crisis" will look like in the real world.

Nothing at all will happen until 2034

The most important chart to understand in the Social Security Trustees' report is Figure II.D2, which I'll reproduce in its entirety:What this chart says is that until 2034, under current law, with no additional benefit cuts or additional taxes or funding streams, the Social Security Administration is projected to be able to pay 100% of scheduled benefits, including old age, disability, and survivor benefits. So whether or not any changes are made to Social Security, nothing will change for any new or existing beneficiaries for the next 15 years.If you are not a current beneficiary, or planning to begin receiving benefits soon, you may find this pedantic, but if you're already receiving benefits you should know: under current law your benefits will not change in any way for the next 15 years.

What happens after 2035?

After 2035, the Social Security trust funds are projected to begin exhausting the Treasury bonds they accumulated during the years the funds took in more money than they paid out in benefits. Unlike a private company that does not receive enough income to repay its debts, the Social Security Administration cannot, and does not have any need to, "declare bankruptcy" or "go bankrupt."Instead, as Figure II.D2 shows, benefits will be reduced to the level payable through annual payroll contributions. In 2035 the actuaries predict there will be a 20% reduction in payable benefits, which will increase excruciatingly slowly to a 25% reduction by 2093.This is an important moment to remind you that the exhaustion of the trust fund cannot "reduce your promised benefits," because these are the benefits promised by the Social Security Act, as amended. If you're happy with 20-25% lower benefits in old age, disability, or widowhood after 2035, you don't need to do anything and you don't have a dog in this fight.

Should we allow this benefit cut to take place in 2035? Probably not!

If, like me, you think the American welfare state is not generous enough then, like me, you probably don't think we should suddenly cut Social Security benefits in 2035.But if you think the American welfare state is not generous enough, then you have the luxury of other, lower-hanging fruit. The Trump administration is planning to reimpose a cumbersome asset test on SNAP beneficiaries nationwide, denying 3.1 million people access to nutritional assistance. Another 500,000 elementary and secondary students are expected to lose access to free school lunches.Meanwhile, Republican officials are using a laughable legal argument to pursue the invalidation of the Affordable Care Act, including its protections for pre-existing conditions, subsidies for low-income workers who don't receive health insurance through their employers, and Medicaid expansion. And thanks to the Republican effort to amateurize the judiciary, there's no reason to believe they won't win in front of the Gorsuch-Kavanaugh Supreme Court.If you're elevating a fantasy problem in 2035 over the real problems we're facing right now, your priorities say a lot about you and nothing about Social Security's funding mechanism.

My boring solution to the imaginary Social Security funding crisis: magic it away so we can address real problems

The total funding shortfall between now and 2093, in the Social Security Trustees' actuarial report, is a bit under $14 trillion, or $186 billion per year for the next 75 years.So here's my boring solution: let's round up, and deposit $14 trillion in special issue Social Security bonds into the relevant trust funds, out of nowhere. This will, of course, increase the debt service costs of the US government as it pays interest on those bonds, and that increased cost will need to be financed through reduced spending, increased taxes, or seignorage.But this is, of course, the exact issue the Social Security funding "crisis" is supposed to present: should we reduce spending, increase taxes, or print money? It may be that we should reduce Social Security benefits, especially for higher earners. It may be that we should increase them, especially for low-income workers and those with a limited official work history.But since there's obviously no reason Social Security benefits should be tied to the year-to-year revenue produced by FICA taxes, we can easily make sure they aren't.

Conclusion

In reality, no one in politics wants to solve the imagined Social Security funding "crisis." When the Greenspan amendments to the Social Security Act were made under Reagan, they were explicitly designed to create another funding crisis further down the line, so that benefits could be cut further.Whether we want benefits to be cut or not is up to us. We can eliminate the cap on Social Security taxes and treat capital gains and dividends as ordinary income and eliminate the "funding gap" tomorrow. Some of us support those policies, others oppose them, but no one should support or oppose those policies because of their downstream effect on Social Security benefits: whether or not Social Security benefits are suddenly cut 15 years from now doesn't have anything to do with the program's funding mechanism.Rather, it's a question about who we are and what kind of country we want to live in. That's the question Roosevelt had to answer in 1935 when Social Security was created, and it's the question we have to answer today. Nothing an actuary says is going to get you out of having to answer it for yourself.Become a Patron!

What do the wealthy need from their financial advisors?

Become a Patron!I've had two conversations lately that got me thinking about a question which, for obvious reasons, doesn't come up in most people's lives: what do you do after you've exhausted all the obvious financial planning tools?

Financial planning isn't complicated, it's just hard

Most people have been trained to think about financial advice in terms of investment decisions, so when they say "give me some financial advice," what they usually mean is, "give me a stock tip." If the stock goes up, they think you're a financial genius, and if the stock goes down, they think you're a con man.That's why I always try to tell people, I have no idea what the stock, bond, commodity, real estate, or any other market is going to do over any time horizon. Not just over 6 months, but even over 30 years, the performance of individual investments is something I have no insight into.That makes asset allocation inherently unsatisfying work, as important as it is. At the end of a 30-year period, a well-diversified portfolio will have some holdings that have increased in value by much more than others, which may have even fallen in value over the previous 30 years. What is the point of diversification if it means you end up holding crap that weighs down your overall return? Why not just buy winners?Financial planning for most people can be boiled down to three inputs, in order:

1. savings rate
2. asset location
3. asset allocation

This is an inconvenient for some people because it doesn't feel like saving is something your financial advisor is doing. But if you raise your IRA contributions by 9.091%, from $5,500 (the 2018 contribution limit) to $6,000 (the 2019 limit) I can guarantee your contributions will be 9% higher. Holding your savings rate fixed, I can make at best an educated guess about the effects of asset location (predicting future tax rates) or asset allocation (predicting future market performance).The flip side of this is that by far the most important thing anyone can do to get their financial house in order feels to most people completely impossible. You earn $80,000 a year? Not anymore. Now you're contributing $19,000 to your 401(k) and $6,000 to an IRA and you make $55,000. Thinking about having a kid? Congratulations, now I need you to save even more.In other words, one of a financial advisor's most important jobs is to make you feel much poorer than your friends, family, and colleagues.

What financial advice do the wealthy need?

This is a question I want to pose as carefully as possible, since the wealthy want the same thing from their financial advisors as everyone else: a good stock tip. But obviously the wealthy need a good stock tip even less than everyone else: if you're earning more than a couple million dollars per year, you can keep your money in cash and you'll still die a millionaire.I think there are at least five important buckets financial planning can fall into for the very wealthy:

• Permission to spend. This is the flip side of financial advice for the working and middle classes. A financial advisor severely restricts the amount of spending money a middle class professional has available by directing as much of it as possible into tax-advantaged accounts. But someone who maxes out their contributions in January of each year may still be flying across the country in economy twice a week when they can easily afford business class. They may need permission from someone they trust to spend money on their own comfort.
• Permission to give. There's a cliche in financial planning circles to insist people "save every raise." In other words, if you can keep your living expenses flat, you can contribute more and more money to your retirement accounts each time you receive a promotion, raise, or cost-of-living adjustment to your salary. But this is obviously irrelevant to people who earn far more than any of those contribution limits, which is why I suggest "giving every raise." If your living expenses are already fully covered by your existing pay, then in a year where you earn a significant raise or bonus your quality of life won't be affected by giving it away.
• Permission to stop. When people luck into high-income fields there's an almost inevitable temptation to "run up the score" and earn as much as possible as long as the gravy train is running. But obviously there's no material reason to continue working once you've saved enough to satisfy your needs, and some people aren't able to give themselves permission to stop. That's another role a trusted advisor can perform.
• Permission to change. If "permission to stop" means retirement, "permission to change" means redirecting your time and energy towards other activities. Change is hard, in some ways harder than retirement: the very idea of a "serial entrepreneur" is based on the premise that someone who successfully gets rich once, increasing an initial investment 1,000- or 1,000,000-fold, has some ability to replicate that performance. But of course, after founding one successful social network, Mark Zuckerberg didn't found dozens of additional social networks, because he recognized he simply got lucky the first time. Instead, he incorporated another company to dispose of his wealth, which seems to keep him busy and happy.
• Estate planning. I put estate planning last on this list because it's what most people think of first when they think of financial planning for the wealthy. And obviously there are techniques you can use to reduce the tax and administrative burden on your heirs when you pass. But it doesn't take more than a glance at the techniques actually employed to evade estate taxation to wonder what, exactly, the point is supposed to be? I don't mean that wealthy people should feel a "patriotic duty" to pay estate taxes in order to "reduce the deficit" or any such nonsense. I simply mean that I find it absurd that the wealthiest people in the wealthiest nation in human history spend any time at all worrying that their heirs will have to pay taxes on their inheritance, let alone organize all their affairs around minimizing those taxes. It seems to me that what many wealthy people need to hear from their financial advisors is simply that "your heirs will be fine." That's not an easy thing to hear, but financial advisors aren't supposed to give easy advice; they're supposed to give true advice.

Conclusion

As I mentioned, this is an issue that has recently come up in a number of different contexts, and I plan to revisit it from multiple angles in the future. Hit the comments to let me know what you think: what financial advice do wealthy people need — with a special emphasis on the advice they need but don't want?Become a Patron!

Why I just changed my 529 asset allocation

Become a Patron!I've written before about what I consider the two best 529 college savings plans: the Nevada-sponsored Vanguard 529 plan and the Utah-sponsored my529 (formerly UESP). In general, most people making contributions in excess of their in-state tax deduction for 529 plan contributions (if any) should consider using one of those two plans, thanks to their broad range of low-cost, passively-indexed investment options.On July 11, I received an interesting e-mail from my529, where I keep my own 529 assets, which contained references to the following program changes:

• "Reduction of the Administrative Asset Fee for all investment options
• "Elimination of the Public Treasurers’ Investment Fund investment option
• "Increase in the Utah state income tax credit/deduction
• "Update of year-end deadlines
• "Reduction in some underlying operating expense ratios"

Obviously any reference to "reductions in fees" gets my attention, so I opened up the new Plan Description and dug into the details.

My529 introduced variable administrative asset fees

When I wrote in February, 2018, my529 charged a flat 0.20% administrative asset fee in addition to the expense ratios of your underlying investment options. As their e-mail states, that fee has fallen for all investment options, but it is also no longer constant: their pre-packaged investment options now charge between 0.10% ("Fixed Income") and 0.13% (all others), while customized investment options now charge 0.18%.To be clear: no one is paying more under the new fee regime. However, those who invested their my529 assets in pre-packaged options saw a bigger fee cut than those of us in customized investment options.

Consider simplifying your my529 asset allocation

Since I don't have any children yet, my 529 assets are invested for the very long term, i.e., entirely in stocks. When my529 charged a flat 0.20% asset allocation fee, I used the "customized static" option to allocate 65% of my account to the "Institutional Total Stock Market Index Fund" and 35% to the "Total International Stock Index Fund."Under the new variable fee regime, that asset allocation cost a total of 0.218%: a weighted 0.038% fund expense ratio and a flat 0.18% asset allocation fee.Meanwhile, the pre-packaged "Equity—30% International" investment option has a total cost of 0.156%: a weighted 0.026% fund expense ratio and a flat 0.13% asset allocation fee.I want to stress that these options are not exactly identical: the pre-packaged portfolio has a slightly smaller allocation to international stocks, and the international component is invested only in developed markets, while the Total International Stock Index Fund I had been using includes some exposure to emerging markets. Nonetheless, those differences struck me as minor enough to happily make the switch, on the basic premise that the fewer fees I pay, the more money I get to keep, no matter what the stock market does.

How do the new my529 fees stack up against Vanguard?

Of course, these changes weren't made in a vacuum: Vanguard has also been aggressively reducing the cost of their investment options. Vanguard uses a slightly different method to calculate expenses, but their "Vanguard Total Stock Market Index Portfolio" costs a total of 0.15% and their "Vanguard Total International Stock Index Portfolio" costs a total of 0.195%," which means (almost) replicating the my529 "Equity—30% International" allocation would have a weighted all-in cost of 0.1635%.

Conclusion

Most people don't have 529 college savings plans, and most people who have 529 college savings plans don't have more than a few hundred dollars in them. They were conceived, birthed, expanded, and are passionately defended by the wealthiest people in the country, those willing to do absolutely anything to minimize the taxes they pay on their investment income.If that describes you, make sure you're not overpaying for your investment allocation, and don't be afraid to switch between plans if lower-cost investment options become available (however, note that under some circumstances rolling 529 assets from one plan to another may require you to repay any in-state tax deduction you took for your contributions in prior years).Become a Patron!

Book review: "Maid" and the problem of the undeserving poor

Become a Patron!I just finished a fascinating and important book called "Maid," by Stephanie Land, which seems to have been shepherded to publication by Barbara Ehrenreich, the author of the best-selling sensation "Nickel and Dimed," and founder of the Economic Hardship Reporting Project.I say the book is important because it strips away virtually all the cultural baggage of the war on the poor and, I assume unintentionally, asks the simple question: what do you do about people who are poor because they are idiots?Library shelves groan under the weight of books about the underlying causes of poverty stemming from racism, sexism, free trade, sudden sickness, economic dislocation, alcohol and drug addiction, and so on. But Stephanie Land doesn't suffer from any of those problems. She grew up in a white middle class household in Alaska, went to public schools, moved to Washington State, and was admitted to the University of Montana in Missoula (more on that later).And then her life went to shit, for no obvious reason.

Why is Stephanie Land a maid?

Despite "Maid" being the title of the book, this question becomes more and more bewildering as the book progresses. As the narrative opens, she's living a carefree life in Port Townsend, Washington, an isolated, aging hippie community, where she works at a cafe, hangs out in bars, and meets Jamie, the soon-to-be father of her soon-to-be child, Mia.After discovering the pregnancy, which she decides to keep, and being violently threatened by Jamie, who she decides to continue living near so he can have a relationship with his daughter, she moves into a series of inadequate transitional housing arrangements, and begins her career as a maid.Why she does this is never adequately explained, and as the book goes on it becomes increasingly bewildering. She hates all her co-workers. She hates driving between houses and she hates paying for gas, neither of which she's reimbursed for and the combination of which leave her making much less than minimum wage. She terrorizes her clients by constantly blurting out uncomfortable information about her personal life, and hates most of them as well (the central section of the book is a recitation of all the grievances she developed against every one of her clients in the roughly two years the book covers).But most of all, she hates filth. "Disgust sensitivity" varies widely between individuals and cultures, and is even correlated in some studies with political orientation, which you can see in people like Donald Trump who describe immigrants as a kind of filthy, sick, penetrating, and contaminating force that has to be stopped and sterilized. Stephanie Land suffers from an extremely high level of disgust sensitivity, which is not particularly unusual, but makes cleaning people's kitchens and toilets an obviously strange career choice.

The Strange Story of the Car Accident

About two thirds of the way into "Maid," Land recounts a breathtaking story, which I'll try to share the highlights of:

"'Can I have my window down?' [Mia] asked, her sick voice squeaking a little. 'I want Ariel's [a Little Mermaid doll] hair to blow like in the movie.' I did it, not caring how ridiculous that seemed. I just needed to get to work. I needed to finish work. I needed to sleep..."I glanced to my right as an older brown Ford Bronco passed us. I locked eyes with the other driver, and he gave me a smile, then pointed to Mia's window, just as I saw a flash of red hair in the back window behind Mia's seat..."Over the next bend was a stoplight where I could do a U-turn. I have time, I thought. I could turn around, stop on the eastbound side of the highway, jump out, grab her doll, and then take the next exist, go under the bridge, turn back around, and we'd be on our way..."As I stepped from my car out onto the asphalt, the wind from cars speeding by felt hot, blowing through my favorite green t-shirt that had thinned over the years. I scoured the grass that divided the east- and westbound traffic, my ponytail smacking toward my face, so much so I used one hand to hold it against my head. I must have looked odd, searching for a doll amid the candy wrappers and soda bottles full of piss that had been dumped in the median..."Then I saw the shape of the tail, fanned into two sections, but no sign of her shell-bikini-clad upper body. 'Shit," I said again. I bent down to pick it up, and heard it."The sound of metal crunching and glass exploding at once. It was a sound I knew from accidents I'd been in as a teenager, but I had never heard it like this."A car. Hitting another car. My car. My car with Mia sitting in the back seat."That sound was the window next to my baby girl's head exploding, popping like a glass balloon."

Her daughter is unhurt in the accident, but her car is totaled and she's unable to work for several more days until she's able to borrow a car from a different casual boyfriend. Weeks or months later (the book's timeline is always a little bit confusing) she collects an insurance check and is able to replace her car.

The Strange Educational Journey

Throughout "Maid," Land relates her studies at Skagit Valley College, a 2-year public college in Washington State, mainly through the prism of the Pell grant that covers her tuition there. But there is no sense that she learns anything from Skagit Valley College. She takes online math and physics courses, and passes open-book tests after putting her daughter to sleep. She even passes physical education courses by lying about her workout routine. She is doing all this based on an intuition or hunch that doing so will somehow, someday, "improve her life."Hilariously, what actually improves her life is going down to the financial aid office and taking out a student loan, since once she does that she finally has enough cash to put down a deposit on an apartment that's not infested with "black mold," one of the many contaminants she's obsessed with fighting. The fact that she could have done so on page 1, instead of page 200, of her harrowing tale genuinely never seems to have dawned on her.

The Strange Case of Missoula, Montana

Finally, as promised, let us return to the question of Missoula, Montana, which happens to be my hometown. Stephanie Land moved from Alaska to an isolated community in Washington State in order to be closer to Missoula, Montana, where she planned to study writing at the University of Montana. This is not an unreasonable thing to do: I myself often refer to the "conveyor belt" running between Missoula, Seattle, and Portland, Oregon.But here is the strange part: having made it all the way to Washington State, she then stopped. Despite spending 20+ hours in her car every week driving on county roads between isolated mansions, it's only in the final pages of the book that she is able to hop onto I-90 and drive straight east, arriving in Missoula about 9 hours later. I've done this drive dozens of times. It's no big deal.Once she arrives in Missoula, she realizes that all of her dreams were true, Missoula really is paradise on Earth, and she transfers to the University of Montana creative writing program.The same program she had been admitted to years earlier, in the opening pages of the book.

Conclusion: we need a welfare state that accommodates the existence of idiots

"Maid" is written in a way that seems almost deliberately designed to elicit as little sympathy as possible. That's not to say it's poorly written: in the car accident scene I paraphrased above I gasped when the other driver's car smashed into hers from behind. But all of Land's problems flow directly from her own actions: her pregnancy, her housing choices, her career choices, her educational choices, and her life choices are all made freely, with none of the kind of coercion we're used to seeing in emotional pleas to stamp out poverty. She's simply terrible at navigating the basic structure of life in the United States of America circa 2010.And I think that is ultimately the most powerful message one can take from this book. If it doesn't fit in with your existing preconceptions about the deserving and undeserving poor, "Maid" won't change your mind. But if you're the kind of person who already believes the key to fighting poverty is a generous and comprehensive welfare state, "Maid" can serve as a reminder that not everyone in poverty is the victim of this or that misfortune, historical injustice, natural disaster, or the policy decisions of your political enemies.Some people in poverty are just idiots, and that forces us to ask the inconvenient question: do idiots, too, deserve healthy food, adequate shelter, comprehensive health care, public education, and even the joys of parenthood? If so, we need a welfare state that accommodates them, too. Because Stephanie Land is proof that they need all the help they can get.Become a Patron!

The SECURE Act and the defects of the centrist mind

Become a Patron!I've written previously about the SECURE Act, the House version of a measure designed to encourage employers to allow employees to gamble their retirement savings on the long-term financial stability of private insurance companies. The measure has since cleared the House but is currently being held up in the Senate for now by Ted Cruz who is trying to turn the 529 loophole into a piggy bank for the wealthiest Americans. With this terrible measure one step closer to passage, I want to use it to illustrate a particular problem raised by the cult of moderate centrism.

401(k) plans have enough bad investment options without adding annuities

Like many pieces of the American welfare state, 401(k) plans became a retirement savings tools for private sector workers more or less by accident. Consequently, they are governed by a mishmash of rules and regulations of different vintages. For example, while the investment options within a 401(k) plan have to be administered exclusively for the benefit of the contributing employee, the design of the plan and selection of investment options does not — employers can and do receive kickbacks from 401(k) custodians for filling their plans with high-cost investment options, for instance. Employee lawsuits typically revolve around this distinction: is the kickback an employer receives based on employees' investment choices or based on plan design?Every 401(k) plan I've seen has included 10-15 high-cost, actively managed mutual funds alongside 2-4 low-cost index funds. That's not the exception: that's the rule. When deciding on an asset allocation within a 401(k), there's simply no alternative but to look up the ticker for each available investment option, record its benchmark and expense ratio, and try to cobble together an appropriate low-cost asset allocation from the options available. This is not terribly difficult for someone who knows what they're doing and has the time and patience to do it, but it's naturally overwhelming for the vast majority of people who have neither aptitude not interest in making these kinds of investment decisions.

Insurance companies want to add their annuities to your 401(k)

That brings us to the core policy goal of the SECURE Act: give employers a "safe harbor" from employee lawsuits when they include annuities offered by insurance companies that meet a rudimentary test of financial stability.You might observe this is a very counter-intuitive way to frame the policy change, and you would be right. The SECURE Act is supposed to improve employee retirement security by preventing employees from suing when their employers offer them crappy retirement investment options? Surely it would make more sense to improve employee retirement security by increasing their legal recourse against employers who do not offer them appropriate and appropriately-priced retirement investment options!But of course the circle is easy to square when you remember that annuities are sold, not bought. The issue is not that employers, let alone employees, are demanding access to annuities in their 401(k) plans. The issue, rather, is that insurance companies are clamoring to have their annuities included in 401(k) plans but are being stymied by the unwillingness of employers to take on the legal risk of vetting them. With that barrier removed through the "safe harbor," insurance companies will be free to offer the same kickbacks investment companies do today to sell their confusing, expensive annuity contracts to 401(k) participants.

Annuities don't eliminate risk, they transform and hide it

In theory I don't have anything against single-premium immediate annuities as a method of converting a lump sum into a predictable stream of income upon retirement (or any other time), but it's important to understand what is and is not happening when you do so.When you hold an FDIC-insured bank deposit, or a SIPC-insured security in a brokerage account, you are roughly speaking entitled to some stream of income (interest, dividends, capital gains distributions), plus the value of the underlying asset. Both components of the asset will generally fluctuate: the interest you earn on your bonds will change as you reinvest coupons over time; dividends will rise and fall along with the profitability and capital allocation decisions of the underlying companies; the asset's resale value will change along with the winds of capitalism. Even cash grows more or less valuable as inflation rises and falls.When you exchange those real assets for an annuity contract, you receive a different kind of asset in exchange: the promise of an insurance company to pay you a fixed or variable sum described in the contract over some time period. You've now converted the variable stream of income and variable asset value of your stocks and bonds into a fixed income stream.But there's no sense in which you have eliminated your risk by doing so. Instead, you've simply transformed the risk you're taking. Instead of being subject to the whims of inflation, interest rates, and the stock market, your income now depends on your insurance company being able to pay the promised stream of income over the promised time horizon.To be clear: I'm not an insurance company analyst and I don't have the tools to perform a comprehensive assessment of the creditworthiness of American insurance companies over the next 70+ years (a 40-year career followed by a 30-year retirement, for instance). Of course, your employer probably isn't either, and that's why they don't offer annuities in your 401(k) plan. If passed, what the SECURE Act will do is relieve employers of that responsibility, so you won't have any recourse if the annuity you select flounders and your contributions are lost or deeply discounted in your insurer's bankruptcy.

Social Security has always been the answer

Social Security's old age benefit is the only source of income security for the overwhelming majority of older Americans. It's important to understand exactly what this means. Social Security is not the only source of income for older Americans. About 27% of Americans continue to participate in the labor force (i.e. work or look for work) between the ages of 65 and 74. Others receive passive income from rental real estate, farm, mineral, and gas leases, etc.What distinguishes those sources of income from Social Security is that Social Security old age benefits are paid by the federal government and subject to annual cost of living adjustments, and they're guaranteed to continue for as long as you live. Employment income in old age lasts as long as you're employed, rental income fluctuates over time (just ask Detroit if you don't believe me), and commodity prices go through long cycles of rise and decline. Social Security isn't like that.That means the first place you should look to improve income security is the only source of income security most people have, and the obvious place to start is allowing people to make additional, voluntary Social Security contributions. Since the only input into the Social Security benefit calculation is the average wage-inflation adjusted income reported in each year of a worker's earnings record, a natural approach is to treat voluntary contributions as "increased income" for the year the contribution is made.For example, a worker earning $50,000 in 2019 would ordinarily pay $3,100 in OASDI (the Social Security component of FICA), matched by their employer. An additional, voluntarily payment of $6,200 (conveniently close to the 2019 IRA contribution limit) could raise their recorded OASDI income for that year to $100,000. Note that this would not double their Social Security old age benefit, since each year of earnings only contributes 1/35 to a worker's average earnings, and old age benefits increase at a graduated rate.

Centrists say personal responsibility when they mean risk

I'm all for "personal responsibility," defined properly. I simply don't know how a person can take personal responsibility for the trajectory of interest rates, or the performance of the S&P 500, or the rise and fall of US auto manufacturing, or the financial stability of America's insurance companies. If you believe an important problem facing America is the problem of retirement security, by all means let us allow workers to reduce their present consumption in exchange for higher income in retirement.But having decided to do so, why on earth would we then subject them to the cost, complexity, and vulnerability of private insurance companies?Because when a centrist talks about personal responsibility, what they really mean is risk. Personal responsibility for the decision of whether to go to college, and what to study, means the risk of poverty. Personal responsibility for an unplanned pregnancy means the risk of homelessness. Personal responsibility for filing your SNAP application on time means the risk of hunger. Personal responsibility for your income in retirement means the risk of being taken advantage of by unscrupulous employers and insurers.But there's no way to take personal responsibility for what happens to us under a system that mechanically produces pain and trauma. Our personal responsibility is to fix the system.Become a Patron!

Roth 401(k)'s are different, but they're not special

Become a Patron!The other day I got into a very frustrating argument with a popular anonymous Finance Twitter account about the epistemology of 401(k) savings vehicles. The frustration arose from a very specific phrase he used to describe one of the benefits of a Roth 401(k) over a traditional 401(k): "you’re able to contribute more with a Roth 401k." This is such a strange claim I asked him to clarify his argument, but he was never really able to do so.That being the case, I want to see if I can try to make the strong form of the argument that he wasn't able to make.

It's legal to save money in taxable accounts

While most financial planners will readily tell you that most people, under most circumstances, should maximize their workplace retirement savings contributions before investing in a taxable brokerage account, it's important to remember that it's perfectly legal to invest in taxable accounts at any time for any reason. Not only that, there are some advantages to doing so:

• Funds can be contributed in unlimited amounts, at any time, for any reason. For example, the S&P 500 hit its financial crisis low in March, 2009. If you were somehow aware of this fact at the time, making contributions through a workplace 401(k) would leave your hands somewhat tied: first of all, two months of payroll contributions had already been made for 2009, leaving you just 83% of your maximum $16,500 contribution left. Deferrals are limited to the amount of your paycheck, and sometimes to just a fraction of your paycheck, so it might take months to max out your contributions for the year, dramatically reducing the value of your clairvoyance.
• Dividends and capital gains are taxed at preferential rates, as low as 0%. Moreover, over time reinvesting dividends and capital gains allows you to establish a range of different cost bases for different lots, allowing you to right-size your capital gains depending on your tax rate year-to-year.
• Capital losses can be used to offset gains and ordinary income. A diversified taxable portfolio will experience gains and losses in different positions over time, giving taxable investors additional tools to manage their tax liability.
• Assets can be withdrawn at any time for any reason. There are no restrictions, no holding requirements, no caps, and no repayment requirements when withdrawing assets from a taxable account. It's your money from the day you deposit it to the day you withdraw it.

Of course, there are disadvantages as well, first and foremost among them that taxable investments are made with after-tax money. Thus, the price you pay for all the advantages of taxable investments is the income taxes owed on the invested amount in the year it's earned. To be consistent throughout, let's use the 22% marginal tax rate on single filers making between $51,475 and $96,200 in earned income per year. In order to make $19,000 in taxable investments, this investor must first pay $5,359 in federal income tax on $24,359 in earned income.Splitting it up in this way allows us to think about the $19,000 deposit as a "bundle" of two different assets: $19,000 in investible funds, plus the combination of rights and privileges the investor paid $5,359 for. This doesn't mean preferential taxation and ease of access are worth $5,359, rather, it means they cost $5,359.Knowing these facts allows us to perform all sorts of fancy calculations. For example, at a 0% discount rate (you value a dollar today exactly the same as a dollar in the future), it would take a little over 9 years for the benefits of maximal tax-loss harvesting ($3,000 in losses per year at a 22% income tax rate saves the taxpayer $660 per year) to recoup the amount paid for the right to tax-loss harvest. At a discount rate of 6%, it takes over 11 years to break even.It also allows us to adjust the value of our asset in the face of changing circumstances. Raising the maximum amount of deductible losses from $3,000 to $3,500 raises the value of the asset by reducing the amount of time needed to break even. Lowering or eliminating deductible losses reduces the value of the asset by extending the breakeven period.This sounds straightforward, because it is, but it's also a useful tool to use when thinking about the difference between traditional and Roth 401(k) contributions.

Traditional 401(k)'s combine a discounted investment asset and a tax liability

Traditional 401(k) contributions are made from payroll and removed from your taxable earned income before it's reported to the IRS. The same $24,359 in earned income as above can be split into a $19,000 traditional 401(k) deferral and, after paying federal income taxes at 22% on the remainder, a $4,180 taxable investment.It's essential to understand that your current-year cash flow situation is identical whether you make the traditional 401(k) deferral or whether you direct the income entirely into a taxable account: in both cases you earned $24,359 in income, in both cases you spent $0 on current-year consumption. The fact that in the first case you paid $1,179 in taxes while in the second you paid $5,359 in federal income taxes is entirely irrelevant to your current-year cash flow, which in each case is $24,359-in and $24,359-out.The difference is that in the second case you have created, alongside $23,180 in total investible assets, a new bundle of liabilities. Just as a taxable account represents "investments plus rights," a traditional 401(k) represents "investments plus duties."But this is a very peculiar liability. Most importantly, it is:

• the duty to pay taxes at your ordinary income tax rate, plus a 10% penalty, on withdrawals made before age 59 1/2.
• the duty to pay taxes at your ordinary income tax rate on withdrawals made between ages 59 1/2 and 70 1/2.
• the duty to make withdrawals (and pay ordinary income tax) starting at age 70 1/2.

Moreover, we know precisely what the federal government is willing to pay our investor for this liability: $4,180, the taxes foregone on his income when he made the traditional 401(k) deferral. The terms of this deal have some obvious advantages to the investor:

• playing with the house's money. Traditional 401(k) deferrals offer a kind of heads-I-win-tails-you-lose dynamic, since only 78 cents of each dollar in the account was contributed by the investor. This might allow the investor to take on more risk: if they hit a home run, there will be plenty left over to pay back their liability with, while if the account goes to zero, they get to walk away from their liability with no consequences.
• control over timing. While the $4,180 liability was created at a 22% marginal tax rate, it's paid back at the investor's marginal tax rate at the time of retirement. Planning on an early retirement and taking advantage of the Social Security magic trick might allow the investor to repay their liability at a 12% tax rate or below.
• pre-retirement rollovers and conversions. During a break in service it may be possible to move assets from traditional 401(k)'s into Roth IRA's, exchanging a liability for an asset at a deep discount, depending on your marginal tax rate.

Just as we can adjust the value of our taxable rights up and down as the tax code changes, we can adjust the value of our traditional 401(k) liability up and down. With the end of the "marriage penalty" and cuts in personal tax rates at least through 2028, tax brackets are historically wide and marginal tax rates are historically low. If those brackets narrow, or are tied to a slower measure of inflation, then the value of the traditional 401(k) liability might even grow faster than the value of the assets in the account. If you work longer or earn more money than expected, the value of the liability will likewise grow.Meanwhile, if you retire earlier than expected, your income is lower than expected or tax-exempt for whatever reason, tax rates are cut further, inflation adjustments are made even larger, or the required minimum distribution age is increased to 72 or higher, then the value of the liability on your books will fall.

Roth 401(k)'s are just another bundle of investments and rights

All of this brings me back to Jake's bizarre claim that Roth 401(k)'s allow you to "save more money." As should be clear at this point, nothing could be further from the truth. With $24,359 in earned income, you can:

1. invest $19,000 in a taxable account;
2. invest $19,000 in a traditional 401(k) account and $4,180 in a taxable account;
3. or invest $19,000 in a Roth 401(k) account.

In each case you have "saved" the same $24,359, in the concrete material sense that you earned the money but did not spend it. In the first case you pay $5,359 in federal income taxes for the right to preferential dividend and capital gains taxation and the ability to offset ordinary income with capital losses. In the second case you receive $4,180 in investible assets in exchange for a liability to pay your marginal ordinary income tax rate, plus penalties under certain circumstances, on any amount withdrawn from the account. And in the third case, you receive $19,000 in investible assets that can be withdrawn tax- and penalty-free in retirement.All of these assets and liabilities can be analyzed, assigned a value, and recorded on your personal ledger based on a sober analysis of present and future conditions. Moreover, the value can be adjusted over time as the future becomes clearer. It can be worth incurring liabilities to invest more money (traditional IRA's) if the investment will yield a higher return than the liability, and it can be worth paying for an asset up front (taxable and Roth investments) if you believe the value of the asset will appreciate at a faster rate than the consideration paid.And, of course, you can diversify your investments, assets, and liabilities across all three, and change that allocation over time, as public policy and your life circumstances change.That's the argument I hoped Jake was making in his initial tweet, but since he wasn't able to make it, I figured I would instead.Become a Patron!

Over There: franking credits in Australia

Become a Patron!Welcome to the second entry in my occasional series, "Over There," about personal finance topics in countries besides the United States. These posts aren't meant as advice to people living in those countries, but rather as some kind of practical insight for American readers into how other countries deal with the the same issues we do: savings, insurance, education, retirement, taxes, and so on.In today's edition I want to cover the fascinating question of Australian "franking credits."

Every question in tax policy has been answered differently in different times and places

To the extent that any state wants to collect taxes in order to finance government programs, it has to answer some basic questions:

• what should be taxed?
• what should the tax rates be, and how should they be structured?
• who should pay the tax?
• and who is responsible for reconciling taxes paid with taxes owed?

These questions can be and have been answered in an almost unlimited number of ways. For example, you may have heard anecdotally about early-modern "window taxes," which levied a kind of wealth tax on homeowners based on the number of windows in their home.Once you've decided that window taxes are a good way to raise revenue, you still have to answer the rest of the questions. For example, should the window tax be a flat tax on each window, starting with the first, or a progressive window tax, with the first few windows tax-free and each additional window incurring a larger and larger tax assessment? According to Wikipedia, Britain used the latter model, "a flat-rate house tax of 2 shillings per house...and a variable tax for the number of windows above ten windows in the house. Properties with between ten and twenty windows paid an extra four shillings...and those above twenty windows paid an extra eight shillings."Once you've settled on a progressive window tax, you still have to decide who should pay the tax. Should a tax assessor be employed to travel town-to-town and count windows each year, or should the builder of a house be required to add the house's window tax assessment to the price?And of course, the number of windows in a structure can change over time. When a house is made smaller by demolishing a wing or boarding up a window, does the owner have any opportunity to claim a refund of the window tax they've already paid? When an extension is added, how and when will they be assessed on the home's increased window count?

Franking credits: an elegant solution to a universal problem

The taxation of private, for-profit companies has produced some of the most divergent answers to these fundamental questions. That's for the simple reason that one one seems exactly sure what a corporation is. Is it purely a legal fiction created for the benefit of its shareholders? In that case, why shouldn't shareholders have unlimited liability for the debts incurred and crimes committed by the corporation? Is it a distinct legal entity capable of committing crimes, exercising religion, and producing speech on its own behalf? In that case, shouldn't the company pay taxes on its own profits like any other individual taxpayer?In the United States, we've split all these differences by charging tax on corporate profits twice: once at the corporate level, and once at the individual level when those profits are returned to shareholders. That has the effect of creating a mildly progressive corporate income tax, with a floor: the corporation pays taxes on its profits at a more-or-less fixed rate of 21% on its corporate tax return, then distributions to shareholders are reported on each shareholder's individual tax return and are taxed at between 0% and 39.6% depending on the duration of ownership and other income sources.Australia solved the identical problem completely differently. When an Australian company decides to distribute dividends, it pays a flat 30% of the distribution in taxes to the government, which corresponds to the maximum individual dividend tax rate. That tax payment is then passed along to shareholders who receive dividends together with a co-called "franking credit," which is fully refundable. A high-income taxpayer who owes taxes on dividends at the 30% rate simply applies his or her franking credit against the taxes owed, while a taxpayer who pays taxes at a lower marginal rate is able to claim the difference as a refund.In effect, this means all shareholders pay taxes on corporate profits at their own marginal tax rates: when a low-income shareholder receives a $70 dividend they can claim a $30 franking credit refund, receiving the full $100 dividend at a 0% tax rate, while a high-income shareholder receiving the same $70 dividend will only be able to apply the $30 franking credit against their $30 in tax liability, paying an effective 30% tax.

Superannuation funds: a brief digression

Superannuation funds are Australia's equivalent of the defined benefit, 401(k), 403(b), and IRA retirement arrangements used in the United States. Employers are required to make contributions, and employees are encouraged to make additional contributions, either through "concessional" (preferentially-taxed), or "non-concessional" (after-tax) contributions, roughly analogous to the way our 401(k) and IRA accounts feature both traditional and Roth contribution options.From what I can tell, superannuation funds are an absolute wild west of high-fee, low-quality investment options, but since most contributions are made by employers ("free money"), Australians themselves don't seem to be very aware or concerned that they're being ripped off by their investment managers, and the funds contain a vast share of Australian retirement savings.

Superannuation funds and franking credits

The interaction of superannuation funds and franking credits recently became a moderately important political issue in Australia. The issue arises because it's not immediately obvious how franking credits should be treated for superannuation account holders in retirement.During the accumulation phase of an Australian worker's life, the shares held in his concessional superannuation account are taxed at a flat 15%. Since corporate dividends are withheld at a 30% tax rate, each year the superannuation fund can claim a refundable franking credit of 15%.But after so-called "preservation age" ("full retirement age" in the United States), income from the superannuation fund is tax-free, and under current Australian law, that entitles the account holder to a full refund of the corporation's 30% dividend withholding, unless they have other sources of taxable income.This creates the strange situation where corporations with a larger proportions of superannuation shareholders, and especially wealthy retiree shareholders without taxable income, pay lower taxes than corporations with larger proportions of taxable shareholders and retiree shareholders with other sources of taxable income.

Conclusion: should income in retirement be tax-free?

I'm struck by how often I see people making dramatic policy arguments anchored on sympathetic anecdotes without any underlying principle they're able to articulate. This was made especially obvious when the mortgage interest and state and local tax deductions were limited in the Smash-and-Grab Tax Act of 2017: I am unable to find anyone able to explain why mortgage interest should be tax deductible, or why state and local taxes should be tax deductible, but plenty of people insisting they were being personally attacked and individually wronged by the limitations on the deductions, which of course only affected the small number of very wealthy individuals who itemized their deductions each year.Similarly, when the Australian Labor (yes, that's how they spell it) Party proposed limiting the refundability of franking credits for retirees, there was a vicious backlash by the tiny minority of Australian retirees using franking credits to supplement their tax-free retirement income, without even attempting to make a principled argument that Australian corporations ought to be able to distribute dividends tax-free to the wealthiest Australian retirees.Ultimately, as their defeat in last week's elections shows, whether the ALP is right or wrong on the question of franking credits will end up being less important than the question of whether they are able to convince their compatriots that it's worth building a society that lasts more than one half-generation into the future. Needless to say, things are not looking good.Become a Patron!

The manufactured "kiddie tax" crisis, explained

Become a Patron!There's a simple rule I like to remind people of whenever a business or finance story emerges from the business section of the paper into the news section or into public consciousness: business journalists are the laziest people in the country. I would call business journalism "stenography," except for the serious injustice that would do the patient, skilled, and honorable work hard-working stenographers do every day.Business journalism is far worse than stenography: it's fiction. Today's entry in the genre is the manufactured "kiddie tax" crisis that snuck its way into the "Politics" section of the New York Times.

What is the "kiddie tax?"

Formally the "Tax for Certain Children Who Have Unearned Income," the kiddie tax is a section of the tax code that applies to unearned income received by certain children, specifically children:

• who do not file a joint return;
• who have a living parent;
• who are under the age of 18;
  • or who are between 18 and 24 and are full-time students and receive less than half their "support" through earned income.

The kiddie tax is reported on Form 8615, which only needs to be completed for a certain child if that child's unearned income exceeds $2,100.Note one thing here: the test above is not whether a child is claimed as a dependent, but the stricter standard of whether a child may be claimed as a dependent, so the kiddie tax can't be avoided simply by having a full-time student file their own tax return (unless they meet the 50%-earned-income support test).

How and why did Republicans change the kiddie tax?

Until the 2018 tax year, Form 8615 required a complicated calculation based on their parents' tax rates, with special rules for divorced and separated parents. Republicans changed that calculation so that all children subject to the kiddie tax pay trust-and-estate rates on their unearned income in excess of $2,100.This somewhat simplified the calculation by not requiring reference to the parents' income, although as the Journal of Accountancy helpfully explains, "While many complexities of the old kiddie tax were eliminated, new complexities were introduced."But obviously simplifying the tax code wasn't the point of the change, since the Republican law made the tax code vastly more complicated, introducing as it did 6 new schedules to replicate information that used to be provided on Form 1040. The reason the change was made is that the budget authorizing the law to be passed through the reconciliation process only permitted Republicans to raise the federal deficit by $1.5 trillion over 10 years. Since they wanted to cut a far bigger hole in the federal budget than that, they needed to find offsetting revenue anywhere they could, including the much more famous changes to the standard deduction and the cap on the state and local tax and mortgage interest deductions.And it turns out, now they want to call backsies.

Policymaking by anecdote: students-and-orphans edition

That brings us to today's news, that the Republican authors of the tax reform bill, with control of both chambers of Congress and the White House, "accidentally" raised taxes on certain sympathetic populations, and want "to correct drafting errors and other technical issues on a bipartisan basis." Let's take a look under the hood.Financial aid for post-secondary students is treated by the tax code in distinct ways based on a number of factors:

• grants (including merit-based, need-based, and discretionary awards) are completely tax-free up to the amount of mandatory tuition and fees charged by the institution, plus books, supplies, and equipment required for courses;
• student loan interest is deductible from income in the year it's paid, whether or not you otherwise itemize deductions;
• work-study income is taxable as earned income but exempt from FICA taxes during the school year (FICA taxes apply if you continue to work over the summer, for instance);
• grants in excess of mandatory tuition, fees, and expenses are taxed as unearned income.

This treatment of "excess grants" as taxable income is one reason virtually no institutions provide scholarships covering room and board: a dollar of tax-free scholarship spending goes further than a dollar of taxed scholarship spending, so institutions naturally prefer to "fill up" the bucket of untaxed scholarships before they start issuing taxable ones. Student loans, work-study awards, and family contributions are expected to make up the difference in the cost of attendance.I want to draw special attention to one piece of sleight of hand the Times' journalists dutifully copied down from whichever lobbyist fed them this story:

"In the past, a student from a household with a joint income of $50,000 who was awarded a scholarship that covered $11,500 in room and board would be taxed at their parents’ rate of 12 percent. Under the new law, that money would be taxed up to 35 percent."

Did you catch it? Reread the paragraph one more time, I'll wait here."In the past" there was no 12 percent income tax bracket!In 2017, a married couple with one dependent making $50,000 would have owed $2,840 in income tax on $25,150 in taxable income, and the $9,400 in unearned income in excess of $2,100 would have been taxed at the parent's marginal income tax rate of 15%, for a "kiddie tax" of $1,410, and a total tax bill of $4,250.In 2018, the same couple would owe $2,739 on $26,000 in taxable income and $1,927 in kiddie tax, for a total of $4,666. In other words, the catastrophic mistake Republicans are rushing back to fix cost this family a grand total of $416 per year, raising their average tax rate from 8.5% to 9.33% during the years their child is enrolled.But of course even this overstates the consequences for the family because they'll continue to enjoy the Republicans' lower income tax rates after their child leaves school (and increased child tax credit in the years prior to that, if applicable). Assuming their income remains the same for the 10 years the personal income tax cuts are in effect, the changes to the kiddie tax will cost them a total of $1,664 while the lower personal income tax rates will save them $1,001, meaning the total cost to this family over 10 years is $663 on $500,000 in income, or 0.13% of the total.The point is, Republicans needed to find additional sources of revenue in order to make the numbers work on their enormous deficit-financed tax cut. Complaining about the new sources of revenue in isolation without taking into account the enormous tax cut is always going to make it look like taxes went up, instead of down, because you're only looking at one half of the equation.

Conclusion: politics ain't beanbag

Making predictions is hard — especially about the future. If you ask me honestly what I think will happen to this provision, I'll tell you I think Democrats are going to get rolled on it, because Republicans are better at this than Democrats are. There's going to be a steady stream of these stories planted in the business press, where the laziest journalists in America take in press releases, process them, and uncritically pass them along to the public. Long lines of sobbing athletes, scholarship students, widows, and orphans will parade past television cameras until Democrats cave and shovel another billion dollars into the furnace.And look: I don't care one way or the other if room and board scholarships are taxed as unearned income, earned income, or are completely untaxed. My point is that in a world with a competent financial press, Democrats would be in a much better position to extract concessions from the people who single-handedly created this manufactured crisis before throwing them a lifeline to get out of it.Become a Patron!

The SECURE backdoor into 529 assets

Become a Patron!I've written extensively in the past about 529 College Savings Plans, an extremely tax-advantaged method of saving for higher education expenses. Contributions are made after federal and state taxes (although many states offer in-state tax deductions for contributions), compound internally tax-free, and are withdrawn tax-free for "qualified higher education expenses."In the Smash-and-Grab Tax Act of 2017, Republicans expanded those eligible tax-free withdrawals to $10,000 per year in elementary and secondary education expenses as well. Increasing the expenses that are eligible for tax-and-penalty-free withdrawals mechanically increases the value of the 529 tax shelter since it decreases the risk of saving "too much" in an account and being forced to pay taxes and penalties on any withdrawals.A bill is being rushed through Congress that will create a new, even more cavernous loophole to avoid taxes and penalties on 529 plan assets.

The SECURE Act Double Dip

H.R. 1994, hilariously titled the "Setting Every Community Up For Retirement Enhancement Act of 2019" (SECURE, get it?), passed the House Ways & Means Committee early last month with bipartisan support, and is being fast-tracked through the House alongside a companion measure in the Senate.The House bill makes an unprecedented change to what expenses are eligible for tax-and-penalty-free withdrawals of 529 assets.As a refresher, there are three kinds of withdrawals from 529 College Savings Plans:

• withdrawals for qualified higher education expenses paid out of pocket or with student loans are completely tax-free;
• withdrawals for qualified higher education expenses covered by grants and scholarships are penalty-free, but subject to income tax on the earnings portion of the withdrawal;
• and withdrawals for non-qualified higher education expenses are subject to income tax on the earnings portion of the withdrawal and a 10% penalty on the earnings portion of the withdrawal.

All withdrawals are made proportionately from contributions and earnings, so it's not possible to designate withdrawals as coming first from contributions or first from earnings.Section 302(c)(1) of the SECURE Act is simple: "Any reference in this subsection to the term ‘qualified higher education expense’ shall include a reference to amounts paid as principal or interest on any qualified education loan...of the designated beneficiary or a sibling of the designated beneficiary."The tax-and-penalty-free student loan withdrawals are capped at $10,000 per individual.Attentive readers have no doubt already noticed the problem: the SECURE act would allow tax-free withdrawals for higher education expenses financed with student loans and for the repayment of those student loans!

The double dip, illustrated

To see how this would work in practice, take the example of someone who contributes $10,500 to a 529 plan the day their child is born, which compounds at 6% annually for 18 years, reaching a final value of $30,000 on the child's 18th birthday, when the 529 plan account is reallocated to an FDIC-insured money market fund. On that date, the child also enrolls in a higher education institution with a total annual cost of attendance of $5,000, and receives a $2,500 annual scholarship. The student takes out $2,500 in federal Stafford loans to cover the remaining balance.Under current law, the 529 plan owner can make a $2,500 tax-free withdrawal (the amount of qualified higher education expenses paid for with student loans) and a $2,500 penalty-free withdrawal (the amount of qualified higher education expenses paid for with grants and scholarships). They would owe ordinary income taxes on the earnings portion of the second $2,500 (roughly 65% of it, or $1,625).After four years, the account owner would have withdrawn $20,000 of the $30,000 balance, with $10,000 in completely tax-free withdrawals and $6,500 taxed as ordinary income. The remaining balance in the account would be $10,000. To withdraw that balance, the account owner would have to pay ordinary income taxes plus a 10% penalty on the earnings portion, which comes to roughly $1,788. A high-income account owner in a high-income state might pay as much as 50% of that in income taxes, or $894.Under the SECURE Act, if that withdrawal is used to repay the student's $10,000 student loan balance, it is also completely tax-free.

Conclusion: the system is breaking down

There are a few foundational principles of American tax law. You can't deduct an expense incurred by someone else. You can't claim a deduction and a credit for the same expense. What we are seeing right now is that system breaking down in real time.When the second Bush administration eliminated the estate tax, they also eliminated the stepped-up basis rule, so that appreciated assets would be taxed as capital gains when sold instead. When the Trump administration all-but-eliminated the estate tax, they left the stepped-up basis rule intact, so that appreciated assets would never be taxed.Today, so many assets have been sheltered from taxation for so long, and appreciated by so much, that their value looms over the entire system, with the tiniest changes to tax law having enormous downstream effects on those sheltered assets.Pre-tax contributions to accounts like IRA's and 401(k)'s were justified with the promise that they would eventually be taxed when withdrawn in retirement. Now that the wealthiest generation in human history is in retirement and being forced to make those withdrawals and tax payments, it seems they've found that they would prefer not to. And unlike poor Bartleby, the Boomers vote.Become a Patron!

"Social cohesion" and the bigot's veto

Become a Patron!Last week I wrote about the way people use and abuse terms like "horizontal equity," "intersectionality," and "cultural Marxism," stripped of their original context and brandished as weapons for whatever the speaker's agenda happens to be:

• If you're embarrassed to say you think it's good that college graduates are forced to defer home purchases, retirement savings, and childbearing for years or decades in order to service their student loans, you can insist your concern is actually one of "horizontal equity."
• If you're embarrassed to say you think it's good that the black LGBTQ community is particularly vulnerable to state violence, then you can say your real problem is that "intersectionality" has gone too far.
• If you're embarrassed to say you believe in white supremacy, you can always say de-platforming white supremacists is a classic tactic of "cultural Marxists" on college campuses.

I find this method of distraction and dissembling incredibly tiresome. If you know anything about the subject and try to address its technical application, you're met with a dead-eyed stare because the terms are being invoked as cudgels, not arguments. But if you try to address the underlying issues of poverty, racism, and white supremacy, you're told that you're ignoring the actual argument, which has nothing to do with poverty, racism, or white supremacy, but is instead a rational stand based on the sophisticated application of philosophical principles.

Immigrants don't destroy "social cohesion," bigots do

The current fad on the anti-immigrant right is to set aside the thorny questions of economic benefit and cost which dominated the debate over levels and flows of immigrants since at least the 1980's. Those arguments, most will now concede, have been lost: immigration to the United States both increases the prosperity of the United States and greatly improves the economic fortunes of the immigrants themselves, serving as a kind of negative-cost foreign aid.Since anti-immigrant sentiments were never based on economic analysis to begin with, the consensus that high levels of immigration in fact benefit the American economy never stood a chance of changing any minds. All it did was force the opponents of immigration who want to be taken seriously to find new ground, and the ground they have settled on is euphemistically referred to as "social cohesion."It wouldn't be fair to exclusively cite the bigots at the National Review, so I'll instead give New York Times columnist Ross Douthat the opportunity to explain this argument:

"there are various reasonable grounds on which one might favor a reduction. The foreign-born share of the U.S. population is near a record high, and increased diversity and the distrust it sows have clearly put stresses on our politics. There are questions about how fast the recent wave of low-skilled immigrants is assimilating, evidence that constant new immigration makes it harder for earlier arrivals to advance, and reasons to think that a native working class gripped by social crisis might benefit from a little less wage competition for a while. California, the model for a high-immigration future, is prosperous and dynamic — but also increasingly stratified by race, with the same inequality-measuring Gini coefficient as Honduras."

Douthat continued the following week:

"First, as mass immigration increases diversity, it reduces social cohesion and civic trust. This is not a universal law, as the economics writer Noah Smith has pointed out; there are counter-examples and ways to resist the trend. However, it is a finding that strongly comports with the real-world experience of Europe and America, where as cultural diversity has increased so has social distrust, elite-populist conflict, and the racial, religious and generational polarization of political parties."

What I find particularly illuminating about these quotes is how Douthat bounces back and forth between the active and passive voices. First increased diversity sows distrust. Then there are questions (whose questions?) about assimilation. Then the working class is gripped. Then mass immigration reduces social cohesion and cultural diversity increases (compared to what?).

How much do you trust bigots with the veto?

Interestingly, what comes through loud and clear throughout Douthat's "moderate" views on immigration is that not even Douthat is vulgar enough to accuse immigrants themselves of being responsible for any of these supposed harms. This is actually a fairly common stance on the right: if you lived in a "shithole country" you'd want to immigrate to America too!The problem, in these terms, doesn't lie with immigrants, it lies with American politicians for refusing to protect our borders and enforce our immigration laws, thus inviting social dissolution and political polarization. Reducing levels of immigration, especially unskilled immigration, is thus the responsible way to reconstruct the "social cohesion" of American life.But here we come full circle to the original problem of debating people who aren't arguing in good faith. The premise of a "moderate" immigration-restriction agenda is that if total immigration flows are reduced and tilted in favor of higher-skilled immigrants, then objections to immigration will dissipate. But that is not an argument about immigration, that is argument about bigots. It is an argument that bigots can and will "turn off" their bigotry once they observe falling levels of low-skilled immigration, that bigots can be brought to the table, negotiated with, compromised with, and will then move on to other issues.But what evidence do we have that bigots are willing to move on once an immigration "compromise" has been reached? When have bigots ever laid down their arms after achieving victory? After the slaver states were "redeemed" did Southern bigots settle down and peacefully exercise political power, or did they lead a decades-long campaign of terrorist violence against the black population of the South? After Clinton implemented the "Don't Ask, Don't Tell" policy, were bigots satisfied, or did they continue to entrap and drum out gay servicemembers? Today, almost a decade after the repeal of DADT, the Republican president is seeking to discharge transgender servicemembers.

Conclusion: social cohesion is real, and it comes through defeating bigotry

Just like "horizontal equity," "intersectionality," and "cultural Marxism," social cohesion is a perfectly real phenomenon. But social cohesion isn't something that happens to us when politicians police the border effectively, or regulate immigration appropriately. Social cohesion is something we create when we participate in our communities, when we empathize with our neighbors, and when we fight for justice.If pressing "1" for English pisses you off in 2019, your problem isn't unskilled immigration. Your problem is that you're a bigot. So knock it off.Become a Patron!

"Horizontal equity" is a perfectly reasonable idea used exclusively to make bad arguments

Become a Patron!Every once in a while a term of art is plucked from the world of academic literature and spread around like manure by journalists and pundits until people who have no idea what it originally meant start using it in casual conversation. What percentage of conservatives griping about "intersectionality" have ever read Kimberle Crenshaw's original analysis of the ways black women are multiply-burdened? What talking head whining about "cultural Marxism" on college campuses has even glanced at one of the texts of the Frankfurt School?This is not to criticize people who don't care about philosophy, which is a perfectly reasonable position; it's to criticize people who pretend to care about philosophy in order to defend their pre-existing beliefs, but refuse to seriously engage with it.

"Horizontal equity" can't help you if you don't identify the relevant axis

In the wake of Elizabeth Warren's plan to forgive some student debt, Matts as diverse as Bruenig and Yglesias have agreed that the main concern with the plan is one of "horizontal equity."Horizontal equity is the banal idea of justice which holds that similarly-situated people should be treated similarly. This principle is embodied in the United States Constitution in a variety of ways, through the Due Process and Equal Protection clauses of the 14th Amendment, and through the prohibition of bills of attainder in Article I. In general, Congress can pass only general laws, not laws respecting individual persons.But this general principle of justice does nothing to answer the question of who belongs to the similarly-situated group:

• Is a non-college-attendee who never took out student loans "similarly-situated" to a college-attendee who did?
• Is a college-attendee who paid their tuition without the need for loans "similarly-situated" to one who took out loans?
• Is a college-attendee who has paid off their student loans "similarly-situated" to a college-attendee who has not paid off their student loans?

Different problems have different solutions

The problem student loan forgiveness sets out to solve is simple, easily defined, and well-documented: after making housing, health insurance, and student loan payments, borrowers do not have enough money left over to save for retirement, settle down, invest in their community, or have children.People who do not have student loans because they never enrolled in higher education do not have those problems, but they surely have other problems: lower incomes, high housing costs, and expensive health insurance.People who do not have student loans because they have already paid them off also have problems: they may have prioritized their student loan payments over savings, for instance, and face lower income in retirement or precarity in case of unemployment.Trying to combine these groups into a single "similarly-situated" mass makes no sense: one group needs student loan forgiveness, the second needs affordable housing and health insurance, and the third needs adequate income security in retirement.To say student loan forgiveness doesn't help people who never took out student loans, or those who have already paid them off, misses the point: different problems have different solutions. Each of these problems has a solution, but solving one doesn't need to come at the expense of solving the others.If student loans are causing a problem, student loan forgiveness is the solution to that problem. If high housing prices are causing a problem, affordable housing is the solution to that problem. If unaffordable health insurance is a problem, affordable health insurance is the solution to that problem. If low savings are a problem, beefing up Social Security old age benefits and unemployment insurance is the solution to that problem.Horizontal equity only demands that everyone with student loan debt, everyone who needs housing, everyone who needs health insurance, and everyone who needs income security be treated equally, not that everyone born in the same year receive an identical amount of government assistance and pay an identical amount in taxes every year.Become a Patron!

Three bad and one good way to think about public higher education and tuition

Become a Patron!Elizabeth Warren made a splash this week with her plan to both ensure public higher education is tuition-free and forgive up to $50,000 per student of the existing stock of federal student debt.I already offered my hottest takes on Twitter, but I think a lot of the disagreements surrounding public tuition and student debt revolve around fundamentally different conceptions of the nature and purpose of higher education. As often happens in politics, that means people who think they are disagreeing about one thing (the appropriate level of tuition at public universities), are actually disagreeing about something else (what is education, who owns it, and who benefits from it?).I think there are basically four ways to look at the issue, and it's these competing perspectives that lie at the heart of the disagreement.

Education as a Private Capital Good

In this view, education is literally treated as an investment, made by the student, in a combination of individual "capital" (knowledge, experience, and credentials) and social "capital" (meeting friends, spouses, and business partners). Like many investments, the upfront cost is large, but since it yields an even higher time-weighted and risk-weighted return, it's still an investment worth making.Since education is a purely private capital good, purely private commercial loans are an obvious way of financing that investment. In a rationalized educational system, students would simply be charged for the appropriate fraction of their instructors' time, controlled for salary, enrollment, and overhead, and then borrow the necessary amount semester-by-semester at a market rate of interest.While this perspective has been beaten into Americans by the Reagan-Clinton neoliberal revolution, it's important to understand how completely novel it is, and what its real-world implications would be.First, what is the cost of overhead? If we are to completely rationalize the charge on the student's side of the equation, it seems necessary to likewise rationalize the expenses on the university's side of the equation. If they are to charge the entire cost of providing education, then the federal government should also capitalize the cost incurred through the Morrill Land-Grant Acts. Profitable universities, of course, would be able to take out long-term loans to finance the one-time cost of reimbursing the federal government for their land, but some institutions would no doubt fall into default and the federal government would have to seize and auction them off.Second, what is the market rate for an unsecured debt by a 17-or-18-year-old borrower? If the payoff to higher education has a barbell distribution, with a high percentage of low-income dropouts and an above-average income to graduates, the market interest rate would have to be astronomical: low-income dropouts and graduates will declare bankruptcy, while high-income graduates will repay their loans early.If higher education is a purely private capital good, obviously there's no reason for the federal government to get involved with loan guarantees or financing, and without them, it's unfathomable that private sector financing will be available at all.

Education as Intergenerational Wealth Transfer

Until 2015, this was the unspoken premise of a lot of opposition to universal tuition-free public higher education. And then in 2015, the unspoken became spoken, when Hillary Clinton insisted that "I am not in favor of making college free for Donald Trump's kids" (Interestingly, she did not insist on means-tested co-payments at public libraries, swimming pools, parks, museums, or elementary and secondary schools, so I gather the Trump clan is free to visit them at will without furnishing their tax returns).The logic here is simple: since we refuse to appropriately tax high incomes, and we refuse to tax estate transfers, and we refuse to treat capital income the same as earned income, the only mechanism we have left to tax the wealthy is through our system of public higher education, where we charge them full tuition. If tuition were low or non-existent at our public universities, we would lose our last remaining option to share any part of the largest private fortunes in the world.Hillary Clinton is a savvy politician, and she made this argument for a reason: it has immediate, emotional appeal. The trouble is, it begs the question. If we taxed high incomes properly, why would we need to single out high-income parents for additional tuition charges? If we taxed estate transfers properly, why would we need to finance universities with levies on high-net-worth parents? If we taxed capital income properly, why would we need to single out high-capital-income parents for special tuition fees?

Education as Class War

If "stick it to the rich" is one version of the argument for public higher education tuition, "stick it to the poor" is its mirror image, helpfully illustrated on Twitter. In this version of the story, public higher education is not a public or private investment, it's an ordinary consumption good. The poor buy cheap public higher education for less money, and the rich buy expensive public higher education for more money; the poor go to technical colleges, the rich go to flagship universities.I appreciate the fact that this view has resurfaced precisely because it disputes the entire premise of American meritocracy. College graduates do not become more qualified because of anything that takes place during the course of their education; rather, they're more qualified because of their starting wealth.However, if anyone really believed this was true (and I think almost no one does), the consequences would be radical. Graduates of elite universities would not receive more consideration during job applications, they would receive less, since such a large percentage of their education is attributable to their starting wealth, rather than any accrued qualifications.Needless to say, almost no one explicitly professes this belief. Rather, you end up with just-so stories wherein the well-genetically-endowed accumulate their wealth through hard work and intelligence, their children inherit their hard work and intelligence genes, and so the people who "deserve" to attend elite universities (thanks to the genes) also happen to be able to afford it (thanks to the wealth). There's even a term for it in the eugenics literature: "mismatch theory," whereby it's downright dangerous to admit the poor to elite universities where they are destined to underperform.

Conclusion: Student Debt as Aggregate Demand Management

It would be unfair to conclude without sharing my own view of the student debt crisis, which is simple: the experiment has failed.Federal student loans (and other federal programs like Pell and FSEOG grants) were intended to address a particular problem: if Baumol's cost disease causes the cost of public education provision to accelerate faster than the increase in productivity in the higher education sector, then the states (which are constrained by balanced budget rules) will be forced to radically reduce the quality of education they offer or radically increase their taxes to finance it, and over time gradually but permanently reduce the education level of the American people.Instead, the federal government decided to print money in order to finance those public education services. But this decision created a different problem: if the federal government had simply assumed the cost of operating the nation's public universities, the entire cost of that operation would be brought "on-budget," creating an expense that would have to be matched with increased taxes or debt.Instead, we went a different route. Rather than simply operating, and paying for, a system of nationwide free public universities, we created a system of federally-backed student loans. This has the great technical advantage of creating an entry on the asset side of the federal ledger. Indeed, the federal student loan program is "profitable," in the specific, bizarre sense that the money it earns in principle and interest payments exceeds the amount it loses in loans discharged due to death, disability, or other reasons.President Obama made important changes to the system again with the introduction of Income-Based Repayment, which allows the remaining balance of federal student loans to be discharged after 20 years of payments.The question remains, however: why assign the cost of a publicly-financed system of colleges and universities to the people who happen to attend them? If graduates earn higher incomes, then we can easily impose a progressive income tax that captures a share of their increased income over that of non-graduates. If graduates accumulate more lifetime wealth, then we can easily impose an estate tax that reclaims far more than the cost of their attendance at a public university. If graduates earn an unusually high share of income from capital, we can easily equalize the tax treatment of income and capital gains (as we did it as recently as the 1980's).The experiment was simple: if college attendees really exerted a unique upward pressure on wages and prices by earning and spending much more money than non-attendees, then isolating them for specific surcharges might have made sense, in order to prevent overall price inflation. But the experiment failed. In the very worst cases, it turned into just another bullshit means-tested program that no one qualifies for.The fact is, we already operate a system of publicly-financed colleges and universities, because we know as a country we rely on the graduates of that system. All that's left is to admit it.Become a Patron!

What would total employer-employee collusion look like?

Become a Patron!I've lately been researching some employer-side tax benefits and binge-listening to an organized-crime-themed comedy podcast, which I'm not going to name because it's so vulgar that I strongly discourage anyone with a weak stomach or guilty conscience from listening to it (e-mail me if you're interested), and the two eventually crystalized in my mind the following question: how would you organize a business with the explicit goal of maximizing the total benefits made available to the collective pool of both owners and employees?This is an interesting question because the employer-employee relationship is traditionally treated as adversarial. Employees ask, beg, plead, and strike for higher compensation and benefits, and employers hire strikebreakers and scabs, enlist the National Guard, and sue, delay, and terrorize in order to pay as little as possible in compensation and benefits.But there are other models. In the FIRE blogging community, it's de rigueur to "employ" your kid as a "model" so you can start making Roth IRA contributions while they're still in the womb, or at least as soon as they have a Social Security number.And likewise, anyone who has watched the entire run of the Sopranos more than once knows that Tony needs his W-2 from Barone Sanitation. While it observes the forms of an employer-employee relationship, it's what Baudrillard might call a simulation or simulacrum of employment: an imitation or a replica of an original that has long since ceased to function as designed or imagined.That eventually made me ask the question: if many of our public programs are designed around an adversarial employer-employee relationship, what would complete employer-employee collusion look like? In other words, if the total pool of profits were shared between everyone at the company, how would you organize the company to maximize the amount of benefits the entire collective received?

Workplace benefits

This may seem obvious, but it's important: there is a wide range of methods to distribute profits to employees in ways that are not taxable to either the employer or the employee.

• Dependent Care Flexible Spending Accounts. While many people associate FSA's with health insurance, Health FSA's are not available to the employees of firms that don't offer health insurance. Fortunately, Dependent Care FSA's are, and have higher contribution limits ($2,500 if married filing separately, $5,000 otherwise). These accounts can only be used to pay for dependent care (not healthcare) expenses, but that includes a wide range of childcare costs for children up to the age of 13, and dependent adults. Anyone with either kind of dependent will no doubt find it easy to find $5,000 in eligible expenses per year, but note that like health care FSA's, dependent care funds expire at the end of each calendar year.
• Workplace retirement accounts. Our employer-based welfare state affords enormous advantages to employees whose employers happen to offer workplace retirement plans. Obviously, if you have complete collusion with your employer, you'll both want to maximize your contributions to those plans. Employer contributions unfortunately have to be made into pre-tax accounts, but employee contributions (up to $19,000 in 2019) can also be made into after-tax Roth accounts, semi-permanently shielding the income from taxes on interest, dividends, and capital gains.
• Paid family and medical leave credit. I wrote up this benefit in detail on Tuesday, but the short version is that if an employer adopts a written policy offering 100% wage replacement for up to 12 weeks to all employees making up to $72,000 per year for all Family and Medical Leave Act purposes, the federal government will provide a tax credit credit of 25% of that wage replacement. Without total collusion, this simply offsets the cost of having to accommodate an employee's absence. With total collusion, the collective can get a tax credit of up to $4,150 per year, per employee earning up to $72,000 (25% of 12 weeks at 100% wage replacement). There is no limit on the number of years or number of times the leave can be taken to be eligible for the credit (up to 12 weeks per year).

Tailor payroll to family size

Because of the way our benefits system privileges employment income, under conditions of total collusion it's essential to report the lowest possible wage eligible for the highest possible benefits. I've written about these "minimax" conditions before, but to review, the most important benefits are:

• Earned income credit. The federal EIC phases in based on both tax filing status and number of dependents, meaning the optimal amount of earned income for each employee is highly dependent on the exact composition of the employee's household, ranging from (in 2018) $6,800 in income and a $519 credit for a single adult with no dependents to $14,300 in income and a $6,431 credit for a filer with 3 children.
• Child tax credit. The new $2,000 child tax credit doesn't require as much careful calculation as the EIC, but it still phases in and out, so under conditions of total collusion you'd want to make sure each employee with children has at least enough income to trigger the entire $2,000 credit. The key thing to keep in mind is that $600 of the credit is only refundable against tax liability, so you need to make sure each employee with children has at least $600 in tax left over each year to claim the entire credit.
• Supplemental Nutritional Assistance Program. SNAP, the successor program to "food stamps," is phased in and out like the earned income credit, and is based on family size like the child tax credit, but has additional employment requirements. Under conditions of total collusion, you'd want to make sure each employee was recorded as working at least 20 hours per week in order to satisfy SNAP's work requirement.
• Medicaid / Affordable Care Act subsidies. This is one of the most important areas of collusion, because it interacts in such a complicated way with the others. In Medicaid expansion states, it's essential to keep each employee's income below 138% of the federal poverty line for that employee's family size, while in non-expansion states, it's essential to make sure their income is just above 138% of the poverty line, so they'll be eligible for the maximum ACA subsidy.

You need a patsy

There's one big problem you run into right away when developing a conspiracy to maximize the transfer benefits of the welfare state on behalf of a collective: you need an employer. This isn't the end of the world, but it's also not trivial: several of the benefits I described above aren't available to the owners of companies and so-called "highly-compensated employees." This has some odd knock-on effects under conditions of total collusion.The highly-compensated employee test is complicated, but a truly committed crime family could find workarounds. For example, if the collective distributed 4.9% ownership to 20 totally unrelated people, then none of those people would meet the 5% ownership test. But, until your collective expands to that many people, you have the problem of assigning ownership to someone who won't, for example, be able to benefit from Dependent Care FSA's or certain employer-side 401(k) contributions. That's fine, but ideally you'd want to rotate the role among people who would be eligible for the fewest work-related benefits. If an "owner" gave birth, for example, you'd want to shift ownership to someone who wasn't incurring present-year dependent care expenses.

What do you do with the money?

This is sometimes treated as the most complicated part of the conspiracy, but it's actually the simplest. After all, once the business has completed its payroll, and once the "owner" of the business has taken the distribution of profits, the owner is free to do with that money whatever they wish.Now, it would certainly be illegal, and I would never encourage or even suggest, that the "owner" of a business "distribute" the "profits" of a "collective enterprise" to its other members as compensation for their labor. Those would be wages, and would need to be reported to the appropriate authorities, with appropriate state, local, and federal payroll taxes deducted and withheld.But hypothetically, under conditions of total employer-employee collusion, whomst amongst us has not made periodic transfers to our friends, relatives, and co-workers? And whomstsoever amongst us has ever even pretended to pay taxes on those transfers? The fact is, once money has been flushed out of a business through payroll or the distributions of profits, we can do anything we want with it. Even give it to our friends.Become a Patron!

If you have employees, adopt a written paid family and medical leave policy right now

Become a Patron!While doing some research for another project, I was reminded that in the CPA Full Employment Act of 2017, Republicans included a tax credit for employers offering paid family leave. Since I have some W-2 income in addition to my Patreon income, I decided to look into it and see exactly how the tax credit works.The good news is, it is in many ways better than I expected. The bad news is, like all such publicly-subsidized private sector schemes, it's way, way more complicated than it needs to be.

What is the paid family and medical leave credit?

The paid family and medical leave credit is a business tax credit of between 12.5% and 25% of the wage replacement offered by employers to qualifying employees who take leave for the reasons spelled out in the Family and Medical Leave Act (FMLA).

How is the credit calculated?

To qualify for the credit, qualifying employees must be offered at least 50% of their wage for at least 2 weeks per year for qualifying FMLA events. The credit is phased in at replacement wages between 50% and 100%. At a 50% replacement wage the credit is 12.5%, and at a 100% replacement wage the credit is 25%.

Who are qualifying employees?

Qualifying employees are those who have worked at the company for a year or more, and earned less than roughly $72,000 per year (this amount should be adjusted upward over time, and is based on an inscrutable IRS calculation).

What are qualifying FMLA events?

Qualifying FMLA events are:

• The birth of a son or daughter of the employee and in order to care for the son or daughter.
• The placement of a son or daughter with the employee for adoption or foster care.
• Caring for the spouse, or a son, daughter, or parent, of the employee, if the spouse, son, daughter, or parent has a serious health condition.
• A serious health condition that makes the employee unable to perform the functions of the employee’s position.
• Any qualifying exigency (as the Secretary of Labor shall, by regulation, determine) arising out of the fact that the spouse, or a son, daughter, or parent of the employee is a member of the Armed Forces (including the National Guard and Reserves) who is on covered active duty (or has been notified of an impending call or order to covered active duty).
• Caring for a covered service member with a serious injury or illness if the employee is the spouse, son, daughter, parent, or next of kin of the service member. The FMLA purposes are the purposes for which an employee may take leave under the FMLA. The terms used in this Q&A-8 have the same meaning as defined in section 825.102 of the FMLA regulations, 29 CFR § 825.102.

How does an employer qualify for the credit?

This is the important part. To qualify for the paid family and medical leave credit, the employer must:

1. adopt a written policy;
2. providing at least 2 weeks of annual paid leave for all qualifying FMLA events;
3. with at least a 50% wage replacement rate for all qualifying FMLA events;
4. for all qualifying employees.

If any one of these four conditions is not met, you will not qualify for the credit for any of your employees!

What should a paid family and medical leave policy look like?

I'm not a lawyer (and I'm especially not your lawyer), but if you want to ensure your eligibility for the paid family and medical leave credit, you need to do the following:

• Put it in writing. The current IRS regulations do not require you to distribute your policy to employees, but you must adopt a written policy before any replacement wages are eligible for the credit. If you start offering paid leave and only later adopt a written policy, you will only be eligible for the credit for wage replacement offered after the adoption of the policy.
• Specify at least 2 weeks of paid leave for all qualifying FMLA events. You can offer different lengths of leave for different FMLA events, but your policy must include at least 2 weeks of paid leave for every FMLA event or you are ineligible for the credit.
• Specify at least 50% wage replacement for all qualifying FMLA events. You can offer different amounts of wage replacement for different FMLA events, but your policy must include at least 50% wage replacement for every FMLA event or you are ineligible for the credit.
• Specify all qualifying employees. To qualify for the credit, you must offer paid family and medical leave to all qualifying employees. You can extend the policy to other employees (those employed less than a year, and those making more than roughly $72,000 per year, although those employees' wage replacement won't be eligible for the credit) but you must offer the paid leave benefit to every qualifying employee or you are ineligible for the credit for any of your employees.

Include this text in your plan

This is so important I want to mention it separately. Your written paid family and medical leave policy must include the following language (or a lawyer-approved alternative):

[Employer] will not interfere with, restrain, or deny the exercise of, or the attempt to exercise, any right provided under this policy. [Employer] will not discharge, or in any other manner discriminate against, any individual for opposing any practice prohibited by this policy.

The technical reason for this is that the FMLA itself does not protect employees who work less than 1,250 hours per year, but in order to claim your paid family and medical leave tax credit you must extend identical protections to employees even if they work less than 1,250 hours per year, as long as they have worked for at least one year.

How to claim the credit

File form 8994 "Employer Credit for Paid Family and Medical Leave" and Form 3800 "General Business Credit."

How pure is your hate?

Sound simple enough? Not so fast. You didn't really think you'd get off that easy, did you?Wages and salaries are, naturally, deductible business expenses. But the amount of the paid family and medical leave credit you claim is first applied against your wage and salary deduction. That means a firm with a 10% marginal tax rate that offers a 100% wage replacement for qualifying employees for qualifying FMLA events does not receive the 25% tax credit they were promised by the Smash and Grab Tax Act of 2017.A simple illustration: a $1,000 wage bill would normally be 100% deductible, reducing the firm's taxes by $100. After a $250 credit is granted, the firm's taxes are only reduced by $75, turning the statutory "25%" tax credit into a 22.5% tax credit.

Conclusion

There is no earthly reason to do things this way. But while we continue to fight for universal, comprehensive family and medical leave, we still have to do what we can to protect each other. So if you have any employees, this is as good a time as any to get started on a written policy for your company.Become a Patron!