MaineBusiness.com

A Message to Augusta: Tax Reform Shouldn’t Be a Gimmick

Even though TABOR was defeated in November, it sent a strong message that a large constituency of Mainers are fed up with our high tax system. And it doesn’t comfort anyone to see that we are considered one of the most tax unfriendly states in the country by the media every year; especially given the fact that most other high tax states are more urban and have higher populations. Even the Brookings Institution report released last year called for tax relief; it didn’t go far enough I felt, but it indicated that Maine could be doing a better job in terms of its cost to residents and in exporting its tax burden to non-residents who come to enjoy what this state has to offer. With that, there have been a lot of ideas floating around Augusta on how to pay for budgets and lower the burden; here are my thoughts on some of these:

-Cigarette Tax: How many times can you go to the well with this one? Sooner of later the well is going to run dry and the next thing you know, there is going to be some other vice they are going to have to find. What’s going to be next? Pork rinds? I know the health advocates love this and smoking is unhealthy and a nasty habit. But this isn’t about public health, this is about tax reform. This one at least seems to be dead in the water. But this is an “easy out” type of tax.

-Real Estate Valuation Cap: Freezing real estate values until the property is sold isn’t a universal solution. And the cost will outweigh the benefit. Think about it. If you create a disincentive to move, it’s going to adversely affect the real estate services industry in Maine; reducing revenue and taxes. And why add another layer of disincentive for retiree’s, business and the skilled workers to come here? This isn’t tax relief, it’s a tax shift because they money is going to be taken from somewhere.

-TABOR: Well intentioned, destined for failure. The problem with these voter referendums is that they are so complex and provision laden that by the time they get to vote, they end up full of loopholes or provide lack of flexibility elsewhere. Even if TABOR won, the lawyers would have been poking so many holes in it that it would be as effective as Swiss cheese.

The problem with all of these ideas is that they are all gimmicks. They don’t provide universal tax relief to all. It’s just a shell game. If our state government really wants to provide tax relief, it’s much more simplistic but forces them to make hard choices. Choices they rather not make:

First: Cut spending. If we are going to ever have true tax relief, it’s going to start with Augusta running the state government more like a business than a subsidy vendor. The problem with that is with legislatures, the power they wield is the money that they can spend. And that power is difficult to give up.

Next: Simplistic tax relief measures. Instead of all of these silly, complicated and uneven tax relief proposals, keep it simple. Lower the highest marginal income tax rate or sales tax by 1%, or increase the tax brackets itself by $10,000, or have a real estate circuit breaker with a simple formula. Do something in plain language that anyone can figure out that doesn’t have thousands of provisions, loopholes or exceptions embedded within it.

In the end, there is a ray of hope that this approach may be beginning. This is in the form of Governor Baldacci’s proposal to consolidate our school districts to a regional system. Several others have made varying proposals as well on this issue. If you haven’t read the Brookings report (and if you haven’t, I don’t totally agree with everything, but it is worth the read) it does make a strong case that one of biggest cost problems is our localized control of our school systems and the redundancies can be eliminated by regionalizing. I think it’s a step in the right direction. Whether all the special interests will spin it around enough to kill it remains to be seen.

Taxes are a necessity, but we could be doing better. In the end, tax relief isn’t that difficult if you really want to accomplish it. It’s just going to take some leadership in Augusta to get it done.

Quick Tip: Mortgage Insurance is Now Deductible, But There’s A Catch

The Tax Relief and Health Care Act of 2006 provides a little nugget that I suspect many people aren’t aware of: Mortgage insurance (either private, known as PMI or government provided) is now an itemized deduction. The deduction can only apply to premiums paid to a primary residence or designated second home. And it only applies to premiums on loans that are considered “acquisition indebtedness” (or in other words, a mortgage used to acquire, purchase or substantially improve the residence). The deduction begins phasing out when one’s adjusted gross income reaches $100,000 and completely phases out at $109,000 (whether single or married filing jointly, but begins at $50,000 if married filing separately). Also there are also some limitations towards pre-paying this insurance to amplify the deduction. Mortgage lenders will need to report the amount of mortgage insurance to the taxpayer in Form 1098 if it is over $600.

Now this sounds like great news for those who are subject to mortgage insurance, but here’s the rub: Unless extended, the deduction is only good for 2007. And only for mortgage interest contracts issued in 2007 (so those who have been paying mortgage insurance prior to this year are out of luck). Due to the limited time that this deduction is available, more often than not it would still make more sense to try a “piggyback” strategy of combining a first and second mortgage rather than have a first mortgage with insurance. The second mortgage most likely would have higher interest rate than the first mortgage, but most people would be financial better off with this than paying the insurance.

So in the end, if you end up retaining a mortgage and have no other choice but to pay the insurance, this will certainly help. But for those who have the option to use a “piggyback” strategy, beware. The mortgage industry is planning to heavily promote that mortgage insurance is now deductible and may sway some from trying the “piggyback” strategy. Make them well aware that you know that the limited scope of the benefit just makes the selling point a gimmick.

Quick Tip: Want an Easy $30-$60? Don’t Forget This Tax Credit

Earlier last year, the IRS conceded to several challenges in the courts concerning the federal excise tax charged on toll calls. These excise taxes were one of the “nickel and dime” fees that everyone saw on their phone bill. Since most phone companies have gone to flat rate services, the challengers asserted that this was unfair – and won. As of August 30th 2006, phone companies stopped assessing the tax. In addition, you are available for a one time credit for the amount paid from February 28th 2003 to July 31, 2006. This can be done by any type of 1040 Form and even for people who no longer file taxes (on Form 1040EZ-T).

The Hard Way: For those who are able to pull up all of their phone bills from the time period above, they would need to tally the tax and file Form 8913 with their tax return. This may be particularly advantageous if you made a lot of toll calls in the time period involved.

The Easy Way: For those who can’t access their past bills or feel that it is too much of a hassle, there is an easy method that still enables you to enjoy a credit. You wouldn’t need to file the Form 8913, it is a simple line item on the tax form (line 71 of the 1040). If you are single and claim no dependents, the credit allowed is $30. If you file single with a dependent, the credit is $40. If you file married with no children, the credit is $40. And if you file married with children, the credit is $60.

Although this credit isn’t going to make or break anybody, it certainly will help

Get Rich Quick Schemes: Why Do People Fall for These?

It’s scary. The amount of people that continue to fall for the allure of schemes that only end up putting people in financial ruin. These things come in many flavors:

The truly illegal scams: Many of us have seen them before. I think every one has received one of the Nigerian letters indicating that a fortune could be theirs. Or the e-mail stating a long lost relative has left you an inheritance overseas in some offshore tax haven. Just contact them with your bank account number and it is yours. And of course, provide them with this and kiss your bank balance goodbye. The PPH in late November had a great article featuring the person in charge of Maine's office of the U.S. Secret Service, indicating that people still continue to fall for these scams over and over.

But the “get rich quick” schemes don’t necessarily have to be illegal. Some are very legitimate such as:

Legalized gambling: It is one thing when you are hanging out with your buddies and playing poker with the money in your change jar. That’s entertainment. It’s another when you are playing against someone who’s in the business or with money you can’t afford to lose. Take for example lottery tickets; you probably have a better chance of getting hit by lightening before winning Megabucks. But this doesn’t stop people from trying to win. Imagine instead of paying $2 towards Megabucks every week, you invested it moderately, making 8% over thirty years. If inflation was 4%, this decision would be worth $4,000 in today’s dollars (this means NOW). And with casino’s, why go against the house, which always stacks the deck in their favor (and if you figure something out like counting cards, they ban you from playing anyway). I just see no plain reason why someone would enjoy something that systematically is going to beat you.

Seminar Circuit: You’ve heard of these before. A so-called “guru” promises that their method will “Make You Rich.” Usually these “guru’s” write a book that makes it sound way too easy and mysterious online reviews of the book from so-called readers claim life has been rainbows, puppies, and unicorns ever since they’ve followed the guru’s methods. And usually the guru frequents the cable news to support their ongoing national seminars with exciting destination spots such as Florida or Vegas, maybe showing one success story to promote their ways. In the end, the “guru’s” prescription ends up leveraging yourself to the hilt to invest in real estate or creating a business (without addressing the capability that you have the wherewithal to be capable of doing either). It’s a lovely deck of cards that will ultimately fall.

Investing: I’ve seen a lot flavors of this over the years, from buying penny stocks, takeover rumors, watching technical charts and day trading. Recently it has gone into real estate, energy or correlates well with what’s “hot” at the moment. I suspect the same people who panicked and ran out of the stock market last June are back, buying things at much higher prices. Investing by nature is a long-term process where you act upon your lifetime goals by implementing a strategy. Speculation is a short-term process where the investor reacts; entering a perceived opportunity or running away from a threat at a moments notice when the crisis du-jour has arrived. In the end, finding the next Microsoft is a lottery ticket within itself, a matter of luck than skill. What if you do get lucky? Roughly 80% of the people who gain their wealth by investing in one thing usually lose it. And it is because they fail to diversify or their overconfidence blinds them; thinking they have the “magic touch”, they chase for the next “hot” thing that will wipe them out at once or gently erode their wealth in a never ending process of small mistakes over time.

Why do people over time continue to fall for these? It can be summed up in one word: Greed. This is one of the eight great investing mistakes people make and it has always been around and always will be. How can you stop yourself from making a greed based decision? Here are some tips:

-If something is too good to be true, listen to your instincts

-If you feel anxious or excited about the opportunity, you better step back. Good investing isn’t emotional; it’s a disciplined boring process. When emotion gets in the way, you are going to get burned

-Take your time. Good investment decisions never have to be made immediately on the spot. And if you are getting pressure from someone else to decide on the spot, I’d question the motive.

If you find yourself always chasing the next get rich scheme, make yourself a promise for the New Year – don’t get caught up in it. It may not be as exciting, but it will save you a lot of time, money and emotional pain in the long run.