The Quintessential Centrist believes in a progressive tax code. People who earn more should pay more. However, a progressive tax code must be applied with levelheadedness and proportionately. We agree with the position taken by many on the right side of the aisle who argue against excessively high marginal tax rates. A disproportionate number of people who would bear the burden of all in marginal tax rates over 50% and / or be subjected to “wealth taxes” proposed by politicians on the left, are responsible for creating a disproportionate number of jobs in America. We must be prudent so as not to impose a marginal tax so burdensome that it takes away job creators' economic incentive to offer employment opportunities for working Americans. That is suboptimal for all Americans. It is important to keep in mind: most higher earning individuals in the United States already do pay significantly more taxes, as they should.
We align ourselves with many on the left side of the aisle who argue that although marginal tax rates are higher on the wealthy, it is unjust that certain rich individuals can use the tax code to their advantage and lower their tax rate to a level lower than what working class Americans pay, in some cases to 0%. Hedge Fund managers, Family Office principals and Private Equity partners are typically wealthy individuals. By utilizing “carried interest,” they can reinvest profits back into their respective entities vs. paying ordinary income tax on short-term capital gains. Real estate investors often use 1031 exchanges to roll proceeds from property sales into new physical assets thereby shielding their gains from income tax. At TQC, we do not begrudge those individuals for utilizing the existing tax code to lower their tax bill; any rational person would do so.
It would be an understatement to assert that the United States Tax code is mired in complexity. Its sheer verbosity and length (4 million words across tens of thousands of pages) is testament to its convolution. The code is so granular, complex and cumbersome that it takes dedicated accounting and legal professionals years of diligent study to master the various opacities of it. After weeks of due diligence, TQC was at best able to skim the surface in assessing and appreciating all the nuances of a tax code so large, it is bigger than the Holy Bible. No such irony because perhaps only God himself can fully comprehend it.
When laws are overly cumbersome and complex, it typically means that those with money and influence, especially the political kind, can exploit them. Again, we find nothing nefarious in paying as minimal an amount of tax within the confines of the law. However, an individual who is compelled to pay an attorney over $1,000 an hour to study page 328, paragraph 3, line 5 of a tax code, is likely to have earned a significant enough income whereby they rely on complex legal maneuvers to shield those earnings from the Internal Revenue Service (IRS).
Here are but a few of the most egregious and regressive loopholes in the U.S. tax code that we feel are unfair to the vast majority of salaried, tax paying individuals across various tax brackets.
"Step-ups" allow those lucky enough to inherit stocks, bonds, real estate and certain closely held businesses to avoid paying tax on these securities or assets. Instead of paying taxes on any gains from the time the assets were originally purchased, the “step-up” (in cost basis) allows the beneficiary or heir to use the current market value of the given asset. Therefore, if the beneficiary sells any of these assets, they are taxed on the difference between the price at which they inherited them at and the value they received from selling them. Scratching your head? Here is a back of the envelope example of how this works. In 1982, the stock price of IBM traded between ~$5 and ~$10 per share. Let’s assume an Investor X purchased 10,000 shares of IBM for $7 or $70,000, tucked them away and held the shares until they died this week. The closing price of IBM on Friday, March 15th was $139.43. Beneficiary Y inherits the shares, and then sells the stock for the current market price of $139.43. He smiles when $1,394,300 dollars appears in his brokerage account. Instead of paying taxes on the difference between the price Investor X paid for IBM and the price Beneficairy Y sold IBM for, because of the “step-up,” the heir pays nothing and keeps the entire $1,394,300 for himself. Here is another simplified example, this time using real estate. Let’s assume Real Estate Investor X purchased a piece of property for $1,000,000 and held it for 15 years, until her death last month. During the tenure of her ownership, she leased the site to a tenant. Upon her death, the property passed onto her daughter. The property is now worth $1,750,000. The daughter decides she does not want to be a property owner and liquidates it for its current market value of $1,750,000. Instead of paying taxes on the difference between the price Investor X paid for the property and the price her daughter sold it for, because of the “step-up,” her daughter pays zero tax and retains the entire $1,750,000 herself.
A remarkable event took place in Washington last month; Congress passed a substantive piece of bipartisan legislation. In fact, prior to the passage of the SECURE (Setting Every Community Up for Retirement Enhancement) Act on May 23rd, by a margin of 417 to 3 in the U.S. House of Representatives, the only notable piece of recent legislation that was enacted with the blessing of both parties on the hill was the First Step Act, a sensible prison reform bill, signed into law by president Trump on December 21st, 2018. The SECURE Act still needs to be reconciled and voted on by the Senate; but the consensus is that some form of the bill will easily pass.
We commend Congress for passing a bi-partisan bill, an extraordinarily rare feat during this hyper-divisive time. Unfortunately, our lawmakers, the majority of whom have accomplished few things consistently but fail the American people by absolving their responsibility to work together, have failed their citizens yet again. This time, Congress let their constituents down by perversely doing exactly what they’ve been rightfully lambasted for not doing: working cohesively to pass meaningful legislation.
In its current form, the “SECURE Act” is disadvantageous to the tens of millions of working Americans and small business owners who contribute to Individual Retirement Accounts (IRAs). But before we delve into the reasons why, it would behoove us to frame why IRAs, while sometimes used by wealthy Americans, are often a preferred retirement vehicle for small business owners, the self-employed, and working Americans that do not have access to 401k's. For the sake of simplicity, we will focus on the two most commonly used IRAs: Traditional IRAs and ROTH IRAs, named after the deceased Delaware Senator and World War 2 Veteran William Roth, who spearheaded the effort to create the retirement product that has benefited millions of working American's and their heirs.
Each year, single individuals are allowed to contribute up to a fixed amount of money into IRAs. For the tax year 2019, IRS rules dictate that individuals can contribute up to $6,000 ($7,000 if you are over 50 years old). Although similar, there are two important differences between a Traditional IRA and a ROTH IRA. The money contributed to a Traditional IRA is tax deductible, whereas contributions to a ROTH IRA do not qualify for a tax deduction. However, while Traditional IRAs are tax deferred until redeemed and then taxed as ordinary income (the theory being, at retirement, the account holders' tax bracket will be lower than it was when they were working) ROTH IRAs grow and are cashed out tax free.
One of the costliest and, unfortunately, consistent mistakes many investors make is to purchase a stock and employ a “stop” price, where they will sell their stock if it declines by a predetermined amount, typically 5% or 10%. Arbitrary stop prices potentially preserve some capital in the short term, but often prevent investors from making multiples of the money they saved from using the “stop” price, in the long term. In fact, utilizing a “stop loss” will almost guarantee that an investor will grossly underperform an appropriate benchmark consisting of a basket of stocks. The reason for this is simple: almost every single publicly listed stock that doubles, triples, quadruples, quintuples or even sextuples over a one, two, five etc., year time horizon declines at least 20% in between doubling, tripling, quadrupling or quintupling, etc., at least once, and often, many times.
Absent a corporate takeover, the results of a late stage clinical trial for a small biotech company, or another atypical event, stock price gains (and losses) are almost never linear. Let’s use a few real-life examples to help frame our argument:
Over the last five years, the shares of Netflix (NFLX) have gained over 500%. However, in between quintupling during half a decade, NFLX suffered a 30% drawdown in March/April of 2014, a 38% sell-off in August of 2015, and plummeted 45% in 2018. Had an investor sold NFLX during anyone of those three corrections they would have missed out on a large percentage of NFLX’s price appreciation. Over the last five years, the shares of Amazon (AMZN) have risen over 550%! However, in between almost sextupling in those five years, AMZN lost 28% in January/February of 2016, 13% in August of 2017, 16% in March of 2018 and 33% in the 4th quarter of 2018. Had an investor dumped AMZN at any point during those four acute sell-offs, they would have forfeited a substantial sum of money.
Worth noting is that this phenomenon is not just limited to technology or biotech stocks. It applies to blue chip companies as well. For example, the shares of Bank of America (BAC) have doubled since 2014. But in between generating a 100% return over a five year period, BAC corrected 17% in April/May of 2014, 17% in August of 2015, 40% in January/February of 2016, 25% in June/July of 2016 and 33% in 2018. Had an investor panicked and sold BAC on a negative headline during any one of the examples listed above, they could very well be sitting on a realized loss, despite BAC doubling over the last five years. Even stodgy, safe and steady Johnson & Johnson (JNJ), one of the lowest volatility stocks in the S&P500, has grinded out a gain of 33% over the last 5 years (investors were also treated to dividends). However, in between rising 33%, JNJ traded down 10% in September/October of 2014, 10% in January of 2016, 10% in the last 6 months of 2016, 14% in January of in 2018 and 14% in December of 2018. If an investor sold JNJ during any one of these drawdowns, their investment portfolio might very well be in need of a JNJ band-aid.
Earlier this week in last-ditch attempt to salvage its original investment, the Japanese conglomerate SoftBank injected $10 billion dollars into WeWork. In exchange for the lifeline that currently values WeWork at $8 billion - less than the sum of Softbank’s total investment ($13 billion) - Softbank will get a controlling stake in the cash strapped startup. Before Softbank leader Masayoshi Son agreed to write a multibillion-dollar check, WeWork was approximately one month away from running out of cash.
Exasperatingly, under the, WeWork’s outlandish co-founder and former CEO Adam Neumann was effectively paid $1.7 billion to go away. Specifically, “Neumann is expected to sell nearly $1 billion worth of stock to SoftBank and receive $500 million in credit as well as a $185 million 'consulting fee'."
Under any circumstance, the size of this overly generous golden parachute would be heavily scrutinized. However, given Mr. Neumann’s history of arrogant, self-centered and tone-deaf behavior, brazen self-dealing and WeWork’s disastrous business performance metrics, it is downright disgraceful.
We (Did Not) Work
In early 2019, WeWork (officially known as “The We Company”) was preparing an initial public offering. Major Wall Street banks including Goldman Sachs and JP Morgan were busy pitching the deal to institutional investors. The bankers were apparently punch drunk from Mr. Neumann’s Kool-Aid spiked tales of what WeWork had to offer, which among other nonsensical things, included a “frictionless office-leasing experience.” In their pitch, bankers argued that WeWork was more akin to an upstart tech company. Somehow, they pegged WeWork’s valuation at $47 billion, despite that it had neither a unique nor remarkable business model, was a user of technology not a creator of it, and managed to hemorrhage investor cash since its inception, including ~$2 billion in the previous year alone.
Thankfully, markets tend to be effective at sniffing out odoriferous behavior. Soon after WeWork was pitched to the public, would be buyers of the shares began to question the firm’s nose bleed valuation and Mr. Neumann’s abhorrent judgement. Demand quickly dried up. On September 30th, WeWork scrapped its IPO.
Our Mission Is To Elevate The Worlds’ Consciousness.
Um, what? One of the more absurd claims made by Mr. Neumann was that his company’s mission was to “elevate the world’s consciousness.” At TQC, we have no idea what this even means. However, it appears that during his tenure at WeWork, Mr. Neumann seemingly lacked a conscience of his own. These are but a few examples of the fantastical claims and tone-deaf behavior that wreak of self-dealing, gross hypocrisy and blatant conflicts of interest which Mr. Neumann engaged in as CEO and whose cost was borne by WeWork’s investors:
• Sold hundreds of millions of dollars of WeWork stock ahead of its botched IPO when the firm was valued at $47 billion. (Those employees that were even authorized to unload shares had to do so at a lower price).
• Purchased a private plane for $60 million and used it for personal vacations.
• Authorized WeWork to purchase the “We” trademark from himself for almost $6 million dollars.
• Purchased real estate with funds partly derived from selling WeWork stock and subsequently leased the space back to WeWork.
• Allowed his wife, Rebekah, to terminate employees because she “did not like their energy.”
• Fired employees himself (perhaps his wife did not “like their energy”?) and moments later watched Run DMC perform their classic hit song “It’s Tricky.”
• Banned employees from expensing meat and serving it at company events then ate a lamb shank in the office.
• Hired the Red Hot Chili Peppers to perform at a company off-site event.
“…what’s transpiring in the retail foreign exchange market is indicative of oligopolistic practices, not capitalism…” - TQC
Billions of dollars are at stake. The targets: The uninformed general public traveling overseas. The perpetrators: The monopolistic foreign exchange (FX) booths situated throughout airports and tourist hotspots & retail banks. No informed person would ever use an FX changing firm (or bank) to source foreign currencies if they had any idea how badly they are being fleeced, especially when an ATM provides far superior rates. Let us provide a window into the world of foreign currency exchange.
First, we must put the foreign exchange market into context. It’s by far the largest and most liquid market in the world. In fact, it dwarfs stock and bond trading. All major currencies trade against one another globally. Two common markets are the "spot" or current market and the "futures" market. Both markets are very liquid and offer buyers and sellers instantaneous access to foreign currency. In Friday's market for the $U.S. Dollar / Euro ($USD/EUR): One Euro could be bought for $1.1319 U.S. Dollars. Hence, the market for the $USD/EUR looked like this: Bid $1.1319 Offer $1.1320. The Euro could be bought for $1.1319 and sold for $1.1320, a difference of less than a penny. Furthermore, the amount of currency bid for and offered at these prices, just fractions of a penny wide, amounts to millions of dollars. Far more than any retail customer would ever seek to exchange at an airport kiosk or retail bank.
FX booths and bank branches sometimes offer to exchange foreign currency for "no commission." Instead, their take amounts to far more than a reasonable standard commission. This is what typically transpires: A foreign exchange booth or retail bank branch offers $U.S. Dollar / Euro but widens the market - the difference between the bid and the offer - out. The “markup” they take amounts to well in excess of any commission any broker could ever expect to make on any foreign exchange trade. For example, vs Friday's quoted current market, they might post that they would buy Euros for $1.02 and sell Euros at say $1.24 when the inside market (see above) is $1.1319 bid and $1.1320 offer. This is absurd. FX booths and banks are in essence locking in a ~10% markup from unsuspecting customers, possibly more, on a trades that should cost less than 1 penny to execute.
Office Space, starring Jennifer Aniston and Ron Livingston released in 1999, is a comedy that portrays a group of disenchanted employees toiling at a software company at the dawn of the Internet age. The movie scored decent marks with critics but fared poorly on the big screen; it barely recouped its production cost. However, with the help of Comedy Central airing the film over 30 times, Office Space garnered a cult following, particularly with tech workers, and subsequently performed well on video and DVD, sold millions of copies and established itself as a classic film favorite among movie aficionados.
Office Space was a comedy. In contrast, the current state of the commercial office space market in America could be mistaken for a horror movie. Economic shutdowns enacted to stem the spread of Covid-19 have rendered office buildings across swaths of America eerily vacant. Many tenants are unwilling and / or unable to pay rent. In turn, landlords with existing mortgages are having difficulties servicing their debts and covering operating costs.
Pundits have chimed in, claiming the behavioral changes forced upon us by the coronavirus will permanently impair the market for office space. As companies quickly conclude that their employees can be equally as productive working remotely as they can “at work,” they will look to cut costs by reducing their office footprint.
Stocks of publicly traded real estate investment trusts (REITS) have been decimated. The shares of Vornado (VNO), which owns office towers in major metropolitan areas, have been halved. New York City stalwart SL Green’s (SLG) stock is down by almost two-thirds. Conversely, shares of Microsoft (MSFT), Zoom Video (ZM), Teladoc (TDOC), and other companies that benefit from the physical-to-digital shift have soared despite the recent stock market malaise.
"An investment in knowledge pays the best interest" - Benjamin Franklin
“Time” is a limited resource that has alternative uses. As such, it should be allocated to where the expected returns are highest. “Experts” opining as to why the stock market is moving in one direction or another on a day to day basis represent one of the biggest wastes of human capital. Few endeavors have consumed more energy and money, that’s been empirically proven to be impossible to prove: consistently predicting short term moves in the stock market and explaining why those moves happened.
People tend to feel vulnerable when they can’t draw definitive conclusions as to why something happened. Why did “X” cause “Y” to do this or that? How did “X” and “Y” affect “Z”? The market and its plethora of “experts” serve as a defense mechanism for the human mind. Because there is so much information and events continuously happening, an “expert” can easily "justify" the rationale behind these events. The truth is that absent a major binary event like a terrorist attack or a viral outbreak, nobody can ever have a high or even a reasonable degree of certainty as to the short-term directional movements in the stock market. Usually, “no idea” is the most specific and accurate answer one can offer regarding many market moves.