These Are the Breaks

The Daily Reckoning PRESENTS: Todd Shoenberger has a bone to pick with the U.S. government. It seems he’s found loophole that relieves members of the United States executive branch from paying taxes! Is this constitutional? Should we have to pay our taxes if they don’t have to? Let’s learn more about this from the Diligent Investor…

THESE ARE THE BREAKS…

Henry M. Paulson, Jr., who has been nominated for the secretary of the U.S. Treasury and a member of President George W. Bush’s cabinet, is selling the idea that he has given up a $38 million annual salary as the CEO and chairman of Goldman Sachs Group to take a $183,500 job as a humble public servant. This is pure claptrap. Paulson didn’t rise to the top of that shark tank that is arguably the finest Wall Street investment bank on the planet by being a dupe.

If the Senate approves Mr. Paulson’s nomination – as is expected – he will receive a job perk that is only given to the privileged few. He will have the opportunity to take advantage of a tax loophole that will save him roughly $100 million. And, when I say save $100 million, I don’t mean tax-deferred until a later date. I mean actually keep the $100 million in his pocket.

Allow me to explain…

Throughout history, U.S. presidents have courted over-achieving corporate executives to join their cabinets, only to be rejected time and time again. One notable example occurred in Ronald Reagan’s second term when he asked Lee Iacocca to leave his post as chairman of Chrysler.

At the time, Reagan had an already positive working relationship with Iacocca when he was appointed by Reagan to head the Statue of Liberty-Ellis Island Foundation. Iacocca politely turned Reagan down and cited his continued mission at Chrysler as his reason for not moving to Washington.

More than a half-dozen years ago, I had lunch with President Reagan’s former press secretary, Marlin Fitzwater, and he confirmed Iacocca’s rejection, but added that his reasons were more about economics than loyalty. Had Iacocca been nominated and approved by the Senate, he would’ve had to liquidate tens of millions in Chrysler stock in order to steer clear of any conflict-of-interest laws, thus resulting in a massive tax bill.

Reagan was disappointed with Iacocca’s decision, but it was understood. Going forward, though, this historical event would soon change policy as politicians realized the importance of having high-level executives fulfill roles in the executive branch.

So, in 1989, then-President George H.W. Bush signed a bill that would grant a tax-exemption to individuals required to liquidate all or part of their stock holdings in order to accept a position in the West Wing. The purpose of this tax loophole is to allow government officials to defer capital gains taxes on assets they have to sell to avoid a conflict of interest.

The proceeds, though, have to be reinvested in government securities, like U.S. Treasury bills and notes, or a broad array of mutual funds approved by the government. Once the proceeds are diversified within the approved investments, the capital gains taxes are deferred until the holder decides to sell the securities at a later date. Think of it like a temporary tax-deferred IRA with no penalty for early withdrawal.

To make the exemption official, a cabinet nominee would need to obtain a “certificate of divestiture” from the Office of Government Ethics within 60 days of the sale of the assets. This, however, is a piece of cake considering a long list of approved options is available for investment.

The tax exemption has been taken advantage of in recent memory by the current Bush and Clinton administrations. Outgoing U.S. Treasury Secretary John Snow, who was the former chairman of CSX Corporation, received the “certificate of divestiture” when he sold his $20 million worth of CSX stock. And Snow’s predecessor, Paul O’Neill, received the same treatment when he liquidated his $100 million position in Alcoa. O’Neill had served as chairman of Alcoa before joining the Bush cabinet.

But the loophole is bipartisan as even a Clinton appointee received this favorable treatment. Goldman Sachs alumnus, Robert Rubin, didn’t sell his stake of Goldman stock, but rather opted to place it in a blind trust. But, before you think Rubin was acting patriotic by choosing to be hit with the tax liability, he still made ample use of the tax break by diversifying other portions of his vast fortune.

So, you think this tax loophole should be abolished because it provides the fattest of the fat cats with an unfair advantage over the common American? Well, there’s no chance of it going away anytime soon.

But, I haven’t even mentioned the most outlandish part of this tax loophole.

If the government official receives the “certificate of divestiture” and allocates their holdings into a government approved list of securities, thus deferring any capital gains taxes, and then dies, the official will forever escape the tax. That’s right. If they hold the new securities until their demise, they never owe the IRS a single nickel. Wow. What a deal!

Now, let’s fast forward to 2006, and take a look at Mr. Henry Paulson. Paulson owns 3.23 million shares of Goldman Sachs stock, worth an estimated $484 million dollars. He also has a truckload more in restricted stock and options worth another $200 plus million dollars.

If he were to sell his Goldman holdings, he would be staring at a tax bill well over $100 million dollars, according to Robert Willens, the top tax and accounting analyst at Lehman Brothers.

Once his nomination is approved, Paulson will most likely take advantage of the tax break, but he’ll also be thinking of these holdings for the rest of his life. Paulson is only 60 years of age, and will have a rare opportunity to offer his heirs a tax break of colossal proportions.

One has to wonder how much this tax break played into Paulson’s decision into taking President Bush up on his offer for the U.S. Treasury job. After all, Paulson had originally turned the president down, only to change his mind a week later. One must wonder if his former colleague, Mr. Rubin, took him out to lunch and suggest he take advantage of this legal policy while he has the chance. Who knows?

Considering we are running the country on a deficit, spending billions on an unpopular war and paying more taxes than ever before, it doesn’t sit well with Americans to know that somebody, who has a treasure chest worthy enough of buying an NFL team, is going to be granted the opportunity to bypass a tax bill that somebody else is going to have to pay for. And, it’s going to be people like you and me who have to make up the difference.

I’m surprised this topic hasn’t grabbed more headlines, especially considering we’re coming upon election season and some politicians may want to play the “rich people don’t pay enough taxes” card. Perhaps it’s because these same politicians may want to take advantage of this tax loophole for themselves one day or the finance is too complicated for the packs of journalists who would rather report on celebrities having babies.

Everybody should have a beef with a government that continues to change the rules as we go along. It almost seems unconstitutional that a member of the United States executive branch could receive such an opportunistic gift of not paying taxes, while the rest of the American population continues to see its income erode more and more by the government.

With all of this, though, Mr. Paulson is sure to do a great job in the U.S. Treasury, because he’s smart enough to spot a great deal when it comes around. Of course, who wouldn’t take the job? You only have to work a couple of years, go to a handful of state dinners, shake some hands and you get a monster-size gift from the IRS.

Guess it’s nice work if you can get it.

Sincerely yours,

Todd M. Schoenberger
for The Daily Reckoning
June 14, 2006

Editor’s Note: Todd M. Schoenberger began his career in the financial services industry as a Broker with Merrill Lynch & Co. where he specialized in helping individual investors achieve financial independence. After Merrill, Todd joined Legg Mason Wood Walker as an Institutional Trader where he was responsible for managing over US$140 million of cash for several publicly traded technology companies, and then went on to become a Rydex Funds manager.

Todd’s new newsletter, the Diligent Investor, guides readers away from the hype of Wall Street, giving readers a blueprint for investment success. Readers gain a vision, with a mixture of very conservative stocks for the backbone of your portfolio, and a few juicy stocks to rack up consistent gains that turn into huge investment returns. By exploiting the technologies of tomorrow, readers can safely and effectively bank solid returns.

Learn more about Diligent Investor here…

Diligent Investor

[Ed. Note: Where in the world is Bill Bonner?

We aren’t quite sure…but if you see him wandering around your town, please alert the DR Headquarters.]

What’s up with the bright minds at Harvard? They can’t seem to get their acts together…

On top of their president, Larry Summers, stepping down from his post amid sighs of relief from most of the staff, we have two conflicting forecasts of the U.S. economy coming out of America’s oldest university.

Tuesday, Harvard’s Joint Center for Housing Studies released a report saying that although the housing market has entered a “down cycle,” the party is nowhere near over.

“There may be tough times ahead,” says Nicholas Retsinas, director of the Joint Center for Housing Studies at Harvard, “but housing will emerge stronger than ever.”

The report acknowledges that nearly one-third of U.S. homebuyers chose “risky” interest-only mortgages last year, and that the average mortgage payment in 2005 rose to 24% of the U.S. median income (after taxes) – the highest level seen since 1984. But those Ivy League brainiacs decided to shrug those facts off and declare the U.S. economy “sound,” and that any softening in the housing markets should clear up before long.

Phew. We feel so much better now that they’ve cleared that up…wait – what’s this? The latest NY Times Magazine is entirely dedicated to “America’s Scariest Addiction: Debt,” and in the issue is a very interesting article by Harvard’s Professor of History, Niall Ferguson.

Prof. Ferguson’s piece “Reasons to Worry” looks to explain “Why you should be excused for feeling a little uneasy about the collapse in household savings, the rise in home-mortgage debt, a large and growing trade deficit and the fact that Asian countries hold so many U.S. Treasuries.”

“For America’s giant, dinosaurlike economy,” he writes in the article’s conclusion, “with its small wealthy head; its big, fat middle; and its long low-income tail – there is a tried-and-tested response to a change in the weather. Dollar depreciation and inflation have saved the debtlodocus before. The assumption seems to be they will do the trick again.

“Yet this time may be different. For sinking like a velociraptor’s fangs into the tail of the debtlodocus are interest-rate hikes that may outpace and check any increase in inflation. And no one knows when and how violently the leviathan may react to this slowly discernible pain.

“It is too soon to speak of extinction, of course. But one obvious inference to be drawn from the British experience of an indebted empire and a sliding currency…is that eternal life is not on offer.”

Ooh la la…doesn’t really sound as if Prof. Ferguson is describing the same “sound” economy as his friends over at the Housing Studies center.

But what would we know? After all, as the Harvard Political Review so graciously pointed out in their review of Empire of Debt, we are “overly simplistic” untrained economists.

[Ed. Note: Haven’t had the chance to read Empire of Debt yet? No worries…it makes the perfect beach reading. Purchase your copy here:

The Most Feared Book in Washington!

For now, we’ll turn to the news from our team at The Rude Awakening:

————–

Eric Fry, reporting from Westchester County, New York…

“Recent market action has crushed the life out of many of us investor-ants…or at least crushed the optimism out of us. Perhaps, therefore, buying opportunities are drawing near.”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.

————–

Back to Short Fuse and the rest of the crew at the DR HQ in Baltimore…

*** We’ve been receiving a lot of reader mail asking what to make of the recent fluctuations in the price of our favorite yellow metal. To help answer this quandary, our friend Dennis Gartman goes on record saying that the low gold price shall be the low for this move.

These lows are not likely to be seen again – or at least not likely to last, he wrote in The Gartman Letter. “The water is now safe once again to enter; those not long of gold should be long of gold, and those long of it should be longer.”

*** As you well know, dear reader, we always trying to think of new ways to spread the word of Empire of Debt…from sending the book to our friends in Washington, to sending colleagues on a cross-country road trip, we’ll try anything once. One innovative reader sends in his idea:

“I bought your book: Empire of Debt. Actually I bought two. Each morning I read The Daily Reckoning,” he writes.

“I am in real estate agent in Australia. I have 2000 homes I ‘farm’ in a suburb in the nations capital Canberra. I send out a flyer/card to every household each month.

“After reading your book I thought of a real estate marketing option for my 2000 homes which was to send out a flyer with the heading: ‘As everyone’s situation is different, do you want to know which year of the next 10 years may be the best year for you to sell your home?’

“If so, e-mail me for a free e-book plus daily e-mail updates with a value of $27.95 U.S. to assess when may be the best time to sell your home and what it’s value might be accordingly.

“The book I refer to is your book – Empire of Debt plus they go on your The Daily Reckoning e-mail list; providing we can come to some financial arrangement.

“I have just started with this real estate and I am able to pay a small promotional amount for each e-book to get my name known. It might work as follows: I send out the above flyer to each household. Probably 10% will reply, say 200 homes. They in turn will e-mail me with a request for your book. I will on-forward their request to you and you can e-mail them your e-book and e-mail me a bill for the books ordered. You retain control, you make contact with new people you would otherwise never make contact with and I maintain contact with my farm area so that they might use me to sell their home.”

Very interesting idea…

*** And another reader comment…

“Congrats on what I believe has been your main example of penetration into the mainstream media on this important quest to wake up the American people from this dangerous sleep.

“I realize that you’ve had many of your colleagues featured in the media (Kevin Kerr, Addison Wiggin, Eric Fry, etc.), but a brief segment by Ron Insana on CNBC’s Closing Bell on Friday really made me believe that perhaps not only will the never-concerned business media wake up, but also that Agora will get the credit it deserves.

“Nothing delighted me more than to hear Ron Insana tell Maria Bartiromo about last week’s Mish commentary about the Nightmare Carry Trade Scenario with a point-by-point explanation of the situation while: ‘Source: The Daily Reckoning’ was printed at the bottom of the screen.

“As a 25 year-old avid junkie of The Daily Reckoning, Rude Awakening, and Whiskey and Gunpowder, I’ve obviously been aware of Agora’s thoughts on global financial issues, but as a friend of many people at major banks on Wall Street, I realize this view is often misunderstood (if understood at all).

“I have mobilized what I believe is a solid group of young businessmen to become fans of your great work and look forward to continuing to become more involved with all you have to offer (Agora Financial Reserve, yearly conference, etc.).

“P.S. I think this Ayn Rand quote says it all: ‘The truth is not for all men, but only for those who seek it.’

“Let’s hope more people seek it. Thanks to all of you, I hope that perhaps they will.”