If Jobs Are Back, Where’s My Raise?

Empty pockets of businessman
Dude, where's my raise? Jeffrey Coolidge—Getty Images

Despite good jobs numbers, wages aren't growing much. The reason why is the biggest debate in economics right now

Today’s strong jobless claims data, which show that applications for unemployment benefits dropped again, is one reason to be cheerful heading into the Labor Day weekend.

Yet despite this, and the fact that the unemployment rate is now down to 6.2%, the economy still has this glaring weak spot: Workers aren’t getting serious raises.

Here’s how two important measures of wage growth have done since the recession. (The Brookings Institution keeps a running tab of these and other key economic indicators in the excellent interactive graphic here.)


Basically, what you are seeing is that pay to workers, whether measured as hourly wages or salaries plus benefits, has been running neck-and-neck with inflation of a bit under 2%. As Fed chair Janet Yellen pointed out in her recent speech at a Fed symposium in Jackson Hole, Wyo., wages are also growing less than workers’ productivity.

Why is this happening? Yellen, for one, likely thinks there’s some remaining “slack” in the economy. Employers are still wary about whether there’s growing demand for their stuff, and so they remain slow to hire. The low unemployment figures leave out a large number of workers who have become discouraged after a long time out of work. But if the slack explanation is right, as companies continue to hire, more of those labor-force dropouts will be drawn back into the employment pool. You won’t see companies under serious pressure to raise wages until that process has played out and companies start competing for a scarcer pool of job-seekers.

Yellen points to (though doesn’t endorse) another possible explanation. Many economists believe wages are downwardly “sticky”—even when companies want to cut costs, they’d rather lay people off than reduce the pay of the people they hang onto. That means that for people who kept working after the recession, wages were higher than they’d otherwise be. And now that the economy is (fitfully) coming back, maybe that means there’s also less room for wages to rise.

Another factor, of course, is that both corporate managers and workers are human, and people can take some time to adjust to new economic signals. Back in July, I sat down with a stock fund manager, who talked about what he was seeing going on at the companies he kept in touch with. More than five years after the financial crisis, he said, the corporate culture among top managers had changed. The people in the C-suite got their positions not by expanding their companies and finding great new hires, but by cutting costs. And they got used to a slack labor market. The manager used the specific example of truckers: You always know you can get a guy to drive a truck from your warehouse to your customer on a moment’s notice. So why worry about hiring more truckers?

As it happens, at the New York Times Upshot blog earlier this month, Neil Irwin wrote that this may be changing. A trucking company called Swift told investors it was having hard time finding enough drivers. The company says the problem is that there aren’t enough skilled people, but Irwin wonders if the problem is really that companies just aren’t paying enough. Trucker pay has fallen, in real terms, over the past decade. Irwin writes:

The most basic of economic theories would suggest that when supply isn’t enough to meet demand, it’s because the price—in this case, truckers’ wages—is too low. Raise wages, and an ample supply of workers should follow…. But corporate America has become so parsimonious about paying workers outside the executive suite that meaningful wage increases may seem an unacceptable affront.

The question now is, how strong does the economy have to get before employers are forced to change their thinking?

If You’re Looking for Work, the Outlook is Brightening
Why the Fed Won’t Care About Higher Prices Until You Get a Real Raise
What’s the Deal With America’s Declining Workforce?

MONEY Economy

Is Inflation Really Dead?

Joe Pugliese

We put the question to Pimco Chief Economist Paul McCulley, who explains why you don't have to worry about rising prices—and why Forrest Gump was a great economist.

Paul McCulley, 57, retired from Pimco in 2010 but returned as chief economist in May. Pimco runs almost $2 trillion, including Pimco Total Return, the world’s largest bond mutual fund. McCulley coined the term “shadow banks” in 2007 to explain how Wall Street could trigger a financial panic.

MONEY assistant managing editor Pat Regnier spoke to McCulley in late July; this edited interview appeared in the September 2014 issue of the magazine.

Q: Is inflation really dead?

A: Inflation, which is below 2% per year, may very well move above 2%. In fact, that is very much the Federal Reserve’s objective. So it will move up, but only from below 2% to just above 2%. But in terms of whether we will have an inflationary problem, I don’t think we have much to worry about. Back in my youth, in the days of Paul Volcker at the Fed in the early 1980s, inflation was considered the No. 1 problem. Now I’m not even sure it’s on the top 10 list, but it for darned sure ain’t No. 1.

Q: What’s holding inflation down?

A: First, we’ve had very low inflation for a long time, and there’s inertia to inflation. The best indicator of where inflation will be next year is to start from where it is this year. We won the war against inflation. It’s that simple.

Second, we still have slack in our economy, in both labor markets as well as in product markets. Companies have very little pricing power—as an aside, the Internet is a reinforcing factor because consumers can find the price of everything. And we have too many people unemployed or underemployed for workers to be running around demanding raises.

Finally, the Fed has credibility, so expectations of inflation are low. Unmoored expectations could foster higher inflation, as companies try to anticipate higher costs. Fed credibility is a bulwark against that. Unlike 30 years ago, the Fed has had demonstrable success in keeping prices stable by showing it is willing to raise short-term rates to slow growth and inflation.

Q: What about quantitative easing, in which the Fed buys bonds with money it creates? Doesn’t that create inflationary pressure?

A: I’ve been hearing that song for the last five years. And inflation has yet to show up on the dance floor. People say, “The Fed’s been printing money. It’s got to someday show up in higher inflation.” My answer, borrowing from the famous economist Forrest Gump, is that money is as money does. And it ain’t doin’ much.

Q: You mean money isn’t getting out of banks into the broader economy to drive up prices?

A: Yeah. I mean the Fed has created a lot of money, but it’s done so when the private sector is in deleveraging mode, meaning people are trying to get out of debt. There has been low demand for credit, so the inflationary effect of money creation has been very feeble.

Q: You’ve said that a low-inflation world also means low yields and low fixed-income returns. Why?

A: People my age—I’m 57—remember the days of double-digit interest rates and double-digit inflation. But as the Fed’s fought and won its multidecade war against inflation, interest rates have come down. And it has been a glorious ride for bond investors from a total-return perspective because when interest rates fall, bond prices go up, so you earn more than the stated interest rate.

But now inflation is actually below where the Fed says it should be. So there’s nowhere lower that we want to go on inflation to pull interest rates down further. Now what you see is what you get, which is low stated nominal yields. In fact, rates will drift up in the years ahead, which is actually negative for the prices of bonds.

Q: What does this mean for how I should be positioning myself as a bond investor?

A: First and foremost is to set realistic expectations that low single digits is all you’re going to get from your bond allocation.

New normal

Q: Is there anything I can do to get better yields?

A: For bond investors, what makes sense right now is to be in what Pimco Total Return Fund manager Bill Gross calls “safe spread” investments. These are shorter-duration bonds—meaning they are less sensitive to interest rate changes—that also pay out higher yields than Treasuries do. These could be corporate bonds or mortgage-related debt. They can also be global bonds.

Q: Pimco says investors should also hold some TIPS, or Treasury Inflation-Protected Securities. Why would I own an inflation-protected bond in a low-inflation world?

A: It’s a diversification bet in some respects. But also, the Fed’s objective is 2% inflation, higher than it is now. What’s more likely? That the Fed misses the mark by letting inflation fall to 1%, or by letting inflation hit 3%? I think 3% to 4% is more likely. TIPS protect you against the risk of 3% to 4% inflation. The Fed has made clear that if it’s going to make a mistake, it wants to tilt to the high side, not the low.

Q: Why wouldn’t the Fed just aim for the lowest possible inflation rate?

A: When the next recession hits, do you want a starting point of inflation in the 1% zone? No. A recession pulls down inflation, and then you are in the zero-inflation or deflation zone.

Q: And deflation is bad because … ?

A: Because then people with debt face a higher real burden of paying it off.

Q: How much time does Pimco spend guessing what the Fed will decide? Pimco Total Return lagged in 2013 when the Fed signaled an earlier-than-expected end to quantitative easing.

A: You’ve asked me a difficult question because I wasn’t here. But I was here for the entire first decade of the 2000s, and I know a lot about the firm. I can tell you the firm spends a huge amount of time and, more important, intellectual energy in macroeconomic analysis, including trying to reverse-engineer what the Fed’s game plan is. Fed anticipation is a key to what Pimco does. You don’t always get it right, but not for a lack of effort.

Q: You argued the 2008 crisis was the result of good times making investors complacent. With Fed chair Janet Yellen talking about high prices for things like biotech stocks, is complacency a danger again?

A: I don’t worry too much about irrational exuberance in things like biotech. It doesn’t involve the irrational creation of credit, as the property bubble did. Think of the Internet and tech bubble back in 1999. It created a nasty spell, but it didn’t lead to five years in purgatory for the economy either.


No, Warren Buffett Is Not a Tax Hypocrite on Burger King

Warren Buffett
Andrew Harrer—Bloomberg via Getty Images

The investor's Berkshire Hathaway is helping to finance a deal that would turn Burger King into a Canadian company for tax purposes.

Burger King and Tim Horton have made it official: They’re planning to merge, and when all is said and done the new headquarters will be in Canada, not the U.S. By using Ontario as the address for the combined company—the operational HQ for BK restaurant will remain in Miami, the company says—the company may stand to pay a lower tax rate. This has linked BK to the roiling political controversy over “inversions,” in which American companies merge with smaller firms located abroad to become foreign companies for tax purposes.

Part of the financing for the deal comes from Berkshire Hathaway, the company run by famed investor Warren Buffett. He’s long been a a critic of the way our tax code favors, in his view, super-wealthy people like him. Back during the 2012 campaign, President Obama, whom Buffett supported, loved to bring up Buffett’s observation that he actually paid a lower tax rate than his secretary. Obama even proposed a “Buffett rule” that anyone earning more than $1 million should pay at least a 30% effective federal rate.

So a critic of the tax code is taxing advantage of what looks like a loophole in the tax code. This has already prompted some to call Buffett a hypocrite. Neil Cavuto at Fox Business doesn’t go to the H-word but says of Buffett: “It sets him up essentially against himself – and his oft-repeated claim those who have more should pay more in taxes.”

No, not really. First, it’s hardly news that Buffett has always been very shrewd about investing with an eye toward keeping taxes low. A small example: As Bloomberg News pointed out in March, tax savings are one reason Buffett says he prefers to buy companies outright when he can, instead of simply holding stock.

Second, while this is a story that’s very much developing, it is not clear that the Burger King/Tim Horton’s deal is mainly about lowering taxes. As MONEY’s Paul Lim argued yesterday, it may have more to do with diversifying Burger King’s portfolio beyond the slow-growing hamburger business. (BK will still pay U.S. taxes on its U.S. earnings. Though, as Reuters explains, locating in Canada now could eventually become more valuable if the company expands abroad.)

But mainly, suggestions of hypocrisy ring false because Buffett has never, ever held himself out as person who pays more taxes than he has to. The whole point of his story about his tax rate vs. his secretary’s is that he was allowed to pay less than he thought he should. He never said he was writing a check to the Treasury to make up the difference. He just said the law didn’t make any sense, and then he actively he supported a change that would presumably cost him money.

Also, if we had a Buffett rule that captured more of the income of high earners, complex corporate deals that cut taxes would actually be a little less worrying. After all, the ultimate beneficiaries of inversions and the like are the shareholders of companies. And that means it’s wealthy households who get the biggest bang for the tax-saving buck when a U.S. company heads abroad.


A Billion Passwords Have Been Stolen. Here’s What to Do Now

Door that has been broken into
Stuart McClymont—Getty Images

This is potentially a much bigger deal than credit card theft. Change these passwords now to protect your most vulnerable points.

The New York Times is reporting that a computer security firm has found evidence that a Russian cybercrime gang has stolen some 1.2 billion Internet passwords and user names.

At this point, we don’t know which sites the passwords are connected to. But given the size of the possible theft, this is something you should take time to respond to as soon as you can, by updating your passwords and making sure they are secure.

It has gotten easy to be blasé about data theft stories. For one thing, there’s been a constant stream of them, such as the Target credit-card data hack, which likely affects millions of the retailer’s customers. And many of the most publicized thefts have targeted credit-card information. That’s scary, but consumers actually have considerable protection when card data is stolen. Your losses on charges to a stolen credit card are limited by law to $50, and they are capped on debit cards if you report a problem promptly. “I wouldn’t worry at all about credit cards,” says Paul Stephens, directory of policy and advocacy at Privacy Rights Clearinghouse

But the latest case may merit more caution because losing a password to a website that holds your personal data can be much harder to recover from. So here’s how to prioritize your response.

Protect your web identity and online data first.

This means Google, Yahoo, Facebook, Dropbox, Twitter, Apple iCloud, Twitter—any place where you communicate with people and leave valuable data. Consider, for example, how much of yourself can live in on a site like Google—not just your emails going back years, but family photos, music, and work documents. Read (if you can stomach it) this harrowing 2011 story by the Atlantic‘s James Fallows. Hackers cracked his wife’s Google password and used it to send out scam emails to her contacts — and when they were done, they wiped all her email. She was able to recover it with Google’s help, but it took a lot of footwork and quick response.

Stephens of Privacy Rights Clearinghouse adds that keeping online email accounts safe is especially urgent because your archive “paints a picture of your entire life” online, potentially giving a criminal clues about which accounts to try next. Your email address may also be the tool for resetting passwords on other accounts.

So go change your passwords on these sites now.

Use a smart password strategy.

Below is a simple way to create a harder-to-crack but still reasonably memorable password. This is a technique frequently recommended by computer security experts like Bruce Schneier. (We published this graphic with Susie Poppick’s interview with Schneier in the April 2014 issue of Money magazine.)

Screen Shot 2014-08-06 at 10.06.24 AM

Set up “two-factor” or “two-step” verification where you can.

Many sites, including Google, provide the option of an added layer of security beyond passwords, known as “two-factor” or “two-step” verification. In addition to your memorized password, you’ll have to enter another code when you sign in; these codes change every minute or so and get sent to your smartphone (via an app, text message, phone call) in real time.

This may sound like a pain, but on you can typically set it up so that you only have to do this once from each computer you use — which is plenty of protection because the guy halfway across the country who buys your password from one of these Russia hackers won’t also have access to your computer. I use it on several sites, and it’s mostly invisible after you get it started.

Now repeat these steps with any site that taps into your money.

You should probably start with your bank and brokerage accounts. Logic dictates that you want to go to the sites that actually have direct access to your money. With banks, you still have legal protections, similar to those for credit cards, if there are unauthorized electronic transfers out, says Stephens. But losing cash for a time may be trickier to deal with than an unauthorized charge. You also have to report a problem within 60 days, and in a worst case-scenario, Stephens says, a criminal with access to your account could change your address and contact info so you don’t notice right away. That’s one more reason to check in on your accounts regularly.

Many financial sites also have two-step verification now (some use tokens rather than smartphones). Don’t forget sites that you’ve linked to your bank, like ones you might use to pay bills or an old PayPal account.

Finally, lock up the credit cards.

Next, change your passwords at card company websites and any retailer or service provider where you’ve put your credit-card data, such as Even if you are protected financially if your card number is stolen, it’s a pain to deal with and you’ll want to avoid it.

MONEY Health Care

The Hidden Health Care Subsidy for the Rich

Waiter holding silver platter
AndyL—Getty Images

If a recent appeals court decision holds up, many middle-class families will lose federal subsidies to buy insurance. But high-income families can still get help.

A recent decision by a federal appeals court has put an essential feature of the Affordable Care Act, better known as Obamacare, in danger. That ruling may not stand up in the next round of appeal. But if the court’s decision survives, it will create a troubling—and, I would argue, outright perverse—inequality.

The quick backstory: Opponents of the new health care law argued in court that a strict reading of the law doesn’t allow the federal government to subsidize individual insurance premiums in states that have not set up their own “exchanges,” online marketplaces where people can go to buy coverage. The D.C. circuit court agreed, while another court the same day reached the opposite conclusion, setting up a likely showdown in the Supreme Court next year. If the ruling stands, millions of people in up to 36 states could lose federal tax credits that helped make insurance affordable.

What’s so perverse about this is that while many low-income and middle-income people would no longer get help from the federal government to buy insurance, loads of affluent people still will.

Here’s why: Even before Obamacare, the federal government played a big, but hidden, role in funding the private health insurance of most working-age people. When you get insurance at work, the money your employer pays for your premiums isn’t included in your taxable compensation. That’s a valuable tax benefit to you, but that lost revenue costs the government just as much as if was cutting a check.

This system has done a lot to encourage companies to offer health insurance, which is a good thing. But it also had a surprisingly backwards effect. Affluent people are more likely to have coverage (and costlier coverage, too). And because they face higher tax rates, they benefit more from tax breaks. As a result, you get more from this hidden subsidy the more you earn. The Tax Policy Center recently estimated that the average benefit of the health-insurance tax break is about $800 for a household in the middle 20% of earners. For people in the top 20%, it’s $3,400.

Prior to the Affordable Care Act, tax subsidies for health care you bought for yourself were much stingier. One of the points of the law was to address this gap. Families earning less than 400% of the poverty line—as high as about $95,000 for a family of four—currently get a tax credit when they buy coverage on a state exchange or the federal Now that particular subsidy is under threat in some states. But the tax break for employer insurance will still be around for those fortunate enough to have an employer who pays up for premiums.

Of course, if this happens—and I should stress if—it wouldn’t exactly be new. This is how health insurance worked everywhere in the country before the ACA. But people on both sides of the political spectrum knew that was a crazy system. And now, the difference would be all the more glaring, since some Americans buying their own insurance would still get help, and others wouldn’t—all based on the technicality of whether their state set up a website.


Where Are the Good Investments Now?

Man with binoculars
Topical Press Agency—Getty Images

We put the question to T. Rowe Price Chairman Brian Rogers, who offers investors some strategies for what to do when everything looks expensive.


In 2015, Brian Rogers will step down as manager of the $30 billion T. Rowe Price Equity income fund, which he has led since 1985. Over the past 15 years, Equity Income has outperformed 67% of other mutual funds investing in large companies that are out of favor with investors, according to Morningstar.

MONEY assistant managing editor Pat Regnier spoke to Rogers in early July; this edited interview appeared in the August 2014 issue of the magazine. The S&P 500’s level and valuation, as measured by the price-earnings ratio, are roughly the same today.

Q: Where are the good investments now?
A: Neither the stock nor the bond market is inexpensive right now. So it’s ­probably a time to be risk-sensitive and risk-aware. Equities are not overpriced the way they were in 1999, but in the context of history, the S&P 500 trading at 16 times this year’s earnings is an expensive multiple. And there are pockets within the equity ­market, whether it’s biotech or some of the ­social-networking-type companies, where investors ought to be concerned about high valuations.

On the bond side, the 10-year Treasury is yielding only 2.6%. [Note: Yields are 2.5% as of August 4.] It’s fair to say the bond market has surprised a lot of people. If I had been a fixed-income strategist on the first of January, I would probably be unemployed right now, because I was convinced rates would move up and prices would fall, but instead rates moved down. [Bond prices move in the opposite direction to that of interest rates.]

Q: What happened there?
A: The bond market has rallied because of concern about the durability of the economic recovery. At the same time, the equity market looked right past those weak growth numbers. So it feels like the two markets are at odds. I suspect that bonds are the more extended and overpriced.

The Fed seems to be getting more comfortable with the economy’s prospects; the debate over raising rates will intensify.

Q: What should a person do in this situation?
A: When everything is expensive, you have to be prepared to not make as much. That’s the issue for investors. If you earn 2.6% on bonds, and equities return 7% or 8% instead of the 10% of the past, that doesn’t feel great, but it’s really not all that bad.

Q: What do you mean by “be prepared to not make as much”? Is that just a psychological adjustment, or do I have to change my strategy?
A: There is a psychological adjustment, but also a lifestyle affordability adjustment. If you’re a retiree and the old game was getting a 4% to 6% fixed-income return on your nest egg, you’re in a different position today. If you maintain the same risk profile, you will be getting about 2.5%.

Q: So I might have to rethink how much I can safely draw from savings.
A: Absolutely, yes.

Brian Rogers
Joe Pugliese

Q: You manage your firm’s Equity Income Fund, and you’re a value investor, meaning you look for stocks that are cheap relative to earnings. What’s this high-priced market like for you?
A: It’s simply harder to find things to invest in. And it’s easier to find things to sell or to trim. Great companies like 3M and Norfolk Southern, which we’ve had investments in, now look relatively expensive, and we’ve been selling.

Q: So what stocks look attractive now?
A: We look for laggards and emphasize quality. In terms of laggards, a company that we have a pretty big investment in is Mattel. It’s out of favor because the Fisher-Price and ­Barbie lines have been challenged, but I’ve been through this so many times with ­Mattel over the years, and they always seem to be able to execute fairly well. You get almost a 4% dividend yield, good cash flow, and strong financials.

Another laggard is Staples. It’s been a very disappointing stock recently [see graphic]. But a 4.4% yield [4.3% as of August 4]. Staples has a strong commitment to the dividend, so it’s almost like a fixed-income security where something good might happen someday.


In terms of quality-oriented stocks, I think General Electric is cheap right now. You have a 3.3% dividend yield. They’ve raised the dividend probably four times in the last three years.

Q: Why do you focus so much on dividends?
A: Dividends are a way for us to assess the relative value of a stock. For example, with Norfolk Southern having gone from $70 to $100, its dividend yield compared to its normal yield has diminished dramatically. [All else being equal, when a stock’s price rises, its dividend yield falls.] So its yield appeal has diminished.

Investors have flocked to dividend stocks to replace low-yielding bonds. Won’t those stocks get hurt when rates and yields do rise?

Very-high-dividend stocks that are basically fixed-income surrogates—AT&T and Verizon in my fund—will probably suffer if rates rise appreciably. But other companies have both decent yields and dividend growth. It’s less clear to me that those would suffer.

Q: About 20% of your fund is in financial services. Are you worried about risk building up in banks?
A: Banks and the financial system are in pretty good shape. Credit quality is improving. Banks have raised a lot of capital. When they stop paying multibillion-dollar fines, they’ll be able to rebuild capital even more. What takes us down next time will probably not be what took us down in 2008. It’ll be something else.

Q: Lots of investors are shifting to index funds and ETFs. Why buy an actively managed fund?
A: We’re not religious on active vs. index. Indexing is low-cost. It will rarely disappoint you. On the active side, many people want to try a bit ­harder. Our fees are reasonable, so we look better than many active managers.

Q: The performance of Equity Income has been similar to that of an S&P 500 index fund. So what’s the appeal?
A: Our case is a strong investment organization, a dividend focus that might get you a little more income, and sensitivity to market risk.

Q: You’ll step down as fund manager in 2015. How are you preparing?
A: I’ve done this transition before with John Linehan, the new manager. I used to manage another fund he took over in 2003. I don’t have to teach John much. I think our investors will be happy. I hope not too happy to see me go. Just happy enough.

MONEY Obamacare

The Real Reason Obamacare Is Now In Trouble

Tangle of colored wires
PM Images—Getty Images

Here's why we're still arguing over how the health care law is supposed to work.

The legal struggles over health care reform have taken yet another odd turn.

Last week a decision by a federal appeals courts put into doubt a key feature of the Affordable Care Act, a.k.a. Obamacare. In particular it ruled that residents in the 36 states that have not set up their own insurance “exchanges” aren’t eligible for tax credits when they buy coverage. Those credits are crucial to making the law work because they make insurance plans affordable. (The ruling may not stand; another court the same day made the opposite call.)

I wrote at the time that the court’s reading of the intent of the law seemed implausible. Why would Congress have allowed states to so easily opt out of such a hard-fought law? And why did no one mention this at the time? The theory that Congress meant for the law to work this way seemed to be news to everyone until Obamacare opponents came up with it for the lawsuit.

However, late last week opponents of Obamacare found video of a prominent, well-connected Obamacare adviser, M.I.T. economist Jonathan Gruber, saying that states should really set up exchanges because otherwise their residents wouldn’t get the federal money. Those remarks (and these too) were in 2012, two years after the law passed but before the court case. Gruber says his remarks were a mistake.

What Gruber said in 2012 doesn’t really prove much about what Congress was thinking in 2010. (More here from’s Sarah Kliff on how none of this came up during the actual debate). But I have to admit, it’s somewhat harder to argue that the D.C. circuit’s reading is a craaaaazy idea because, well, one architect of the law apparently once understood it that way, too.

That said, let’s look beyond the controversy of the moment, and even beyond the ACA, at the real reason Democrats have found themselves in this tight spot: Congress tried to squeeze a big social program through the tax code. No wonder things got complicated.

Remember what people were talking about in 2010? It was mandatemandatemandate. Tax credits and subsidies weren’t much on the minds of anyone but real health care wonks. Yet they are essential to making the ACA what it really is: A social insurance program, not unlike Social Security or Medicare, that raises some taxes (chiefly Medicare taxes on higher earners) to pay for a safety net for low and middle-income people.

But the subsidies are indirect: Instead of having a public insurance program, we have money running through private insurance. Which runs through state-run exchanges. Or sometimes federal exchanges. Through which run tax credits via the IRS. With another chunk of money going through states via the the Medicaid system.

That complexity is why the roll-out was such a mess. It’s why the Supreme Court has already reduced the law’s reach by striking down part of its Medicaid provision, allowing some states to opt-out of coverage for many low-income people. And it’s why it now matters so much how a judge chooses to interpret the language of section 1311(d)(1) of the legislation.

But of course the ACA isn’t the only example of the government using indirect means to put money into people’s pockets to achieve a social goal. There’s the Earned Income Tax Credit, an important anti-poverty program. But there’s also lots for the middle-class (and above): Medicare drug plans administered by private companies, longstanding tax incentives for employers to offer health insurance, and the 529 tax break for college savings. And, for homeowners, of course, the mortgage interest deduction.

Political scientist Suzanne Mettler calls these partly hidden benefits the “submerged state.” The government is still spending money–it’s just not always obvious how. Such programs have become become the center of gravity in the Washington’s approach to domestic spending. Republicans frequently try to make direct spending programs less direct. (Think Mitt Romney’s plan to turn Medicare into something like a voucher to buy coverage.) And Democrats proposing new programs go the indirect route. (Obamacare is basically a voucher to buy coverage.)

This has political advantage for both sides. Conservatives like that it leaves people less attached to the idea that government can help them, because the programs are harder to see, even if the money going to constituents is real. Liberals like that indirect programs are a lot easier to get passed.

The cost, though, is that indirect programs are hard to design well. They create a lot of complexity for users—these programs are a big part of why doing your taxes is such a pain. And they sometimes fail to get dollars where they are most needed.

That doesn’t mean indirect programs aren’t worth doing—the Affordable Care Act has achieved one of its key goals by adding millions to the insurance rolls. But if the D.C. circuit decision prevails (I’m still guessing it won’t) supporters of health-care reform are going to need to do some rethinking. They might consider pushing something like Medicare, except for people under 65. That wouldn’t be an easy political argument to win, of course. But at least you wouldn’t have to be a wonk to understand how it works.


Mark Cuban to Investors: Get Out Of U.S. Companies That Run Overseas

Mark Cuban
Hey, you! Get back here! Mpu Dinani—Getty Images

Companies are merging with foreign competitors to get tax breaks. Here's what the notorious Mavs owner thinks of that.

Dallas Mavericks owner and investor Mark Cuban has taken to Twitter this morning with some big thoughts about the U.S. companies changing to foreign addresses to get tax breaks.

Such corporate relocations, known as inversions, have become a hot-button issue in recent days after several major corporations pulled the tax maneuver and President Obama began calling for Congress to block this virtual corporate exodus.

Cuban starts with what sounds like your basic economic patriotism argument:


And then things get more interesting.


By PE, Cuban means price-earnings ratio, the standard way investors value a stock. He means that if companies take the tax break, investors ultimately benefit because it raises earnings. (We recently discussed who really benefits here. Short answer: That’s true mostly for wealthy investors like Cuban.) And he says he’s wiling to live with lower earnings. But what does “risk doesn’t leave the system” mean?



Of course, he adds, if you sell to punish a company for cutting its taxes, make sure it doesn’t mean you pay a bunch of taxes.


Activism has its limits, amirite?


This Hedge Fund’s $6.8 Billion Tax Break Is Going to Enrage You

If it looks like a loophole... Jupiterimages—Getty Images

Short-term trades are usually taxed like regular income. But not if you are a hedge fund with a helpful banker.

If you invest or do any stock trading outside of a 401(k) or IRA account, you know that how long you hold your stocks can make a big difference at tax time.

If you buy and then hold an investment for at least a year, your profits will be taxed at the long-term capital gains rate — 15% for people in most tax brackets and 20% for those in the very top one. Fast in-and-out trades, on the other hand, face a much bigger tax bite because they are taxed as ordinary income. What’s more, you can be hit with those higher rates even if you aren’t a day trader: For example, if you own an aggressively managed mutual fund that does a lot of trading, you may get capital gains distributions you have to pay tax on.

Now it appears that some high-powered hedge funds found a clever way around those higher rates, basically by turning short-term trading gains—often really short-term, as in minutes—into long-term ones. According to a report issued this week by a the Senate subcommittee on investigations, that move might have netted one fund managed by Renaissance Technologies a tax saving of $6.8 billion over several years. That billion with a B.

By what magic does a trade of a minutes become a long-term, buy-and-hold investment eligible for lower taxes? Well, it appears you just had to find a bank that will wrap your trading into something called a ” basket option.”

Here’s how it worked: Instead of buying and selling the stocks directly, hedge funds would go to a bank—the Senate report singled out Barclays and Deutsche Bank—and buy an options contract linked to the value of a basket of securities. Think of the basket of securities as being like a stock fund; and just like a stock fund you might have in your 401(k), the composition of that basket is constantly changing. In the Renaissance case, the basket changed based on computer algorithms looking for tiny inefficiencies in asset prices, which meant constant buying and selling.

At some future date, the hedge fund could exercise the option and get back the amount it paid for the option plus or minus any returns on investments in the basket. And here’s where the tax break happened: If the hedge fund waited at least year to exercise the option, all those quick in-an-out trades inside the basket got wrapped up in one big long-term trade.

The really clever (or, some might say, devious) part is that the basket of securities was all along actually still managed by the hedge fund. Technically, the banks hired Renaissance managers to run the basket backing the options that they sold to Renaissance. Did you catch that?

In Senate testimony this week, execs from the banks and Renaissance offered their side. They say that while it’s true there were tax advantages to this set-up, it wasn’t only a tax shelter. For example, in addition to changing the tax treatment, using an options contract also gave Renaissance a lot of leverage, since they only put in part of the money to buy the basket. That amplified their wins as well as losses. (The Senate’s not too happy about that part, either, though. Since 2008, big investors using borrowed money looks more like a bug than a feature.) It also limited Renaissance’s exposure to catastrophic losses, since they couldn’t lose more than they paid for the option, giving the banks some skin in the game on the portfolios. In tax law, something that works like a tax shelter can still be okay if it has another economic purpose.

The Internal Revenue Service, though, indicated in 2010 that moves like this don’t pass the smell test.

Howard Gleckman of the Tax Policy Center explains here why it is that the IRS might not yet have clamped down on this particular maneuver. Short answer: It’s tough for the IRS to go after big hedge funds and their investors. They are outgunned. Gleckman wonders if we have a “two-tiered” tax system, one for the rich and another for the rest of us.

At the subcommittee hearing, there were really two arguments in play. One was whether the tax law technically allows quick trades to be turned into long-term investments in this way.

The other was whether it should. That doesn’t seem like a hard question.

MONEY Health Care

4 Really Weird Things About the Latest Obamacare Ruling

U.S. President Barack Obama (L) walks out next to Vice President Joseph Biden
Obama's signature health-care law faces a new court challenge. Larry Downing—Reuters

An appeals court says Congress must have meant to make the health care law even more complicated than we thought.

Today two separate appeals courts handed down decisions on challenges to the Affordable Care Act, known popularly as Obamacare. One of those courts, a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit, ruled that the federal government can’t provide insurance premium subsidies to people in states that haven’t set up their own insurance exchanges. The other court rejected that argument.

The D.C. circuit’s opinion, which would invalidate the subsidies paid to about 5 million people, will be a huge, huge deal if it holds up. Much of the early debate and legal wrangling over the ACA focused on the “individual mandate,” the part of law that fines you if you don’t have health coverage. But the subsidies are even more important because they make the required coverage affordable for moderate- to middle-income families. (The subsidies are available to a family of four earning up to $95,400.) The law says you don’t have to pay the fine if insurance isn’t affordable, so without the subsidies the mandate doesn’t apply to so many people.

The ruling could very well be overturned on appeal, and in the meantime the subsidies remain in place. (You can read more on what happens next in this report by Time’s Kate Pickert.) But as a reporter who has covered health care reform closely since the George W. Bush administration, I have to say this ruling just doesn’t make much sense to me. In particular, four very odd things stand out.

1. The court’s interpretation seems implausible.

Quick background: Obamacare subsidies are issued when you buy insurance on an online marketplace called an exchange. Some states set up their own exchanges, but 36 states didn’t, leaving the federal government to do the job instead. The D.C. Circuit ruled that the law authorizes the subsidies to be paid only through state-run exchanges.

This ruling hinges on a close reading of the law, a purported effort to figure out what Congress truly intended. The government, defending Obamacare, argued that because the law can’t work without the premium subsidies, Congress must have meant them to apply regardless of who ran the exchange.

But the court offered another theory: Maybe Congress meant the subsidies to be an incentive for states to set up their own exchanges.

That sounds like a implausibly flexible approach to what was meant to be a sweeping national health care law. After all, it essentially gives any state whose governor or legislature opposes the ACA a chance to opt out of some its biggest provisions—not just the subsidies, but the individual mandate, too.

Cast your mind back to the debate in 2009 and 2010. What I remember was conservatives denying the ACA a single Republican vote and arguing that Democrats would brook no compromise. Democrats, meanwhile, were pointing out that Obamacare looked a lot like the Massachusetts law signed by Republican governor Mitt Romney.

It seems to me that in a long argument over whether Obama and Nancy Pelosi and Max Baucus were tyrants, or just sweetly reasonable splitters-of-the-difference, someone might have said: “Hey, if Republican-led states don’t like the individual mandate, they can always opt out of the exchanges.”

That did not happen.

2. If the ruling stands, this messes up the insurance markets in 36 states.

If there are no subsidies, that doesn’t only mean that many people won’t get help from the government to buy coverage. Even those who didn’t get the subsidies in the first place could face higher prices.

That’s because the law requires the exchanges to sell insurance to everyone who applies, charge them the same rates (based on age) regardless of health, and offer a minimum package of benefits. The problem is that if you don’t have to buy insurance, many people will do so only when they know they need coverage—i.e., when they are sick. And if too few healthy people and too many sick people sign up, insurers have to raise prices to cover the costs. That then means you have to really sick to want to sign up, and that jacks up rates more, and so on. This is known in insurance as adverse selection, or a “death spiral.”

So the federal exchanges could stop working pretty quickly if this ruling stands. In fact, according to the briefs filed by the insurance industry and a group of economists who support the ACA, the adverse selection problem in the exchanges could spill over into the market for private individual plans outside the exchange too, since the law links the two markets in various way. How this would actually play out is unclear, but suffice it say, it’s a major rug-pulling.

Setting up federal exchanges that can’t work seems pretty dumb. Now, as Michael Cannon of the libertarian Cato Institute says, it’s not like lawmakers never make bad laws. States have tried to regulate insurance coverage the way the ACA does, without subsidies, and they’ve run into all these adverse selection problems. The thing is, people in Washington knew this when the ACA was being debated and written. It’s why the subsidies and the individual mandate—a wildly controversial, politically costly provision that many members of Congress wished would go away—were in the law in the first place.

3. This somehow involves the Northern Mariana Islands.

The D.C. Circuit panel notes that the ACA in fact did trigger the “death spiral” problem in this U.S. overseas territory in the Pacific. That’s because the Northern Mariana Islands were subject to the new rules about health coverage but left out of the subsidies. That, says the court, means that maybe Congress really could have meant to regulate the insurance market without subsidizing it too.

I can think of some other reasons why Congress might have klutzed up the part the law that applies to U.S. territories. Like the fact that people in those places have no voting representation in Congress.

4. Congress really isn’t very good at crafting laws

I don’t mean it’s not good at making laws (views may vary on that). I’m talking about the actual writing-it-down part. The court’s lead opinion is devastating in showing how badly written parts of the law are. If these were comments from the professor in a course titled “Lawmaking 101: Making a Bill a Law,” you’d expect to see a big fat red “D” at the bottom of Congress’ term paper. The bill was pushed through hastily after Republican Scott Brown unexpectedly won the late Ted Kennedy’s seat in the Senate, depriving the Democrats of a filibuster-proof majority. The craziness of the legislative process shows in the text.

But its not just a craft problem. The legal vulnerability of the ACA goes hand-in-hand with how politically vulnerable it is. The law makes sense in a basic way and seems to be helping more people get coverage. And polls say people like many of the provisions of the law. But it is also complicated, and hinges on many different players (states, employers, private insurers, Medicare, Medicaid, you and me…) interacting in predictable and not-so-predictable ways. From the beginning, many people have really struggled to get how the law fits together. Turns out that may have included some people in Congress.

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