Advice Rejected

Earlier your humble scribe offered some advice on economic policy that would be useful and might pass.  The advice centered on reducing regulation, creating a territorial tax system, and not trying to pick winners.  POTUS spoke last night and added some meat to his proposals.  These proposals reject the MWG advice.

Sidebar: it is impressive how strident the POTUS is.  AP reports that, “He said “serious people” in both parties should accept his offer.”  Really, is that how to create a bipartisan solution?

The POTUS offered the opposite of a territorial tax system.  He wants to tax world-wide income even if it is not repatriated.  He wants to increase regulation by, among other things, raising the minimum wage.  He wants to pick winners as exemplified by taxing manufacturing at a lower rate.  There are additional proposals that don’t fit the MWG recommendations.  His proposals and method of presenting them suggests that he is not seriously interested in getting them passed.

Speaking of Markets

Mark Perry has posted a list of faculty salaries by disciplines.  He makes the argument that price differentials reflect opportunity cost.  But price provides information beyond the opportunity cost.

Sidebar: There are lots of constraints on the market for faculty including the fact that some schools are unionized.  Still an imperfect market provides lots of information to individuals and organizations.

For example, why do folks choose the lower paid faculty disciplines when, according to the University of Texas, they could make essentially the same salary with a bachelor’s of business administration with no additional tuition and no opportunity cost of income lost during graduate study?

A few are probably poor consumers of graduate education but many have a utility function that values a variety of things including income.  For example, the relative certainty of continued employment, the opportunity to shape young minds, or love of the discipline might be worth the trade-off in income.  

As a PhD. in Business with a minor in economics, price was one, but not the only, signal that led me to putting the major and minor in that order.  The ten mathematical ways to catch a lion (the site has updates), posted on an economics faculty member’s door, was a big influence.  I do think research can get too quantitative.

Well said

Sheldon Richman has a nice article on basic economics.  Other than a gratuitous comment on empire that seems strangely out of place, it reminds all of us, not just the current administration, that of the effectiveness of markets in driving the economy.  Government activities and government restrictions are not nearly as effective.  Government activities are not effective because they never (Detroit will still be a city after bankruptcy) die.  Some regulations are great but many are not.  It is the knowledge problem, the regulator cannot know everything, combined with the inability to adapt to change.

The administration has come to the opposite conclusion by attacking austerity and the sequester. It will be interesting to see how the administration defines austerity and the opposing idea they are supporting.

Dixon, Rita, and Ethics

Given my background and the interest of my students, when I discuss ethics I often come at it from an economic point of view.  Thus, when a Big Four accounting firm dismissed a partner for leaking information, it was clear that he had made a bad economic choice.  The partner’s loss in income, capital, and future income is not worth it.

Rita Crundwell embezzled $53 million from the city of Dixon Illinois.  She got caught after 20 plus years and earned a 19 year sentence.  If you knew that outcome with certainty would you take it only considering the economic aspects?  Just think for a minute of what you can buy with $53 million tax free.  You can use it from age 38 to age 58.  Effectively, you can have anything you want for 20 years during the prime of your life and give up your dotage.  As much as I dislike the New York Yankees, it is a better deal than Damn Yankees.

I’m not encouraging you to start an embezzlement scheme.  I’m reminding you and me that economic analysis is often useful but not the only solution to ethical problems.  Right and wrong are the real concerns.  For many choices economics support right and wrong but not always.  We need to be on the alert for when they diverge.

Dixon, Rita, and Taxes

Previously, I have discussed the extent and the ethics of the Rita Crundwell’s fraud on Dixon Illinois.  One interesting topic for accountants is that the accounting firm that compiled Dixon’s financial statements also did Rita’s taxes.

Now a tax preparer’s responsibility is far different than an auditor’s responsibility and both are different from a complier’s responsibility.  As a taxpayer, you don’t need to worry that your tax preparer is an agent of the IRS.  The tax preparer is expected to be your advocate just like your lawyer.  The tax preparer, however, is expected to exercise due diligence with respect to representations made by the taxpayer.  To oversimplify, that means if the taxpayer arrives in a new Lexus and claims the Earned Income Credit then the tax preparer has some additional responsibilities.

Rita had a lot of stuff including a $2 million motor home and a hobby horse breeding farm.  The hobby farm especially would seem to be an area to investigate for the tax preparer.   Interest of lack thereof might be an area where the tax preparer is looking to engage in tax planning.  It would seem that she would substantial real estate taxes that are deductible.

We don’t know what Rita’s salary was but we know that the total amount spent by Dixon for general government after charges for services and capital expenditures was about $2.2 million.  Rita’s salary might be nice but it can’t be exorbitant for a city of 16,000 people.  In short, there is a question if the tax accounting firm exercised due diligence in evaluating Rita’s assertions.  I’m not sure why the IRS and the state of Illinois have not charged her with tax evasion.

Dixon Fraud Extent

Rita Crunwell’s amazing fraud from Dixon, Illinois is old news but I would like to discuss the extent of the fraud in this post and ethics in and tax issues in additional posts.  Thoughts on Auditing has a nice review of the auditing issues.  He is on track when he says, “[It was a] betrayal by the auditors who had a duty to seek out the fraud, but failed to heed the red flags that were available to them.”  I might quibble with the exact wording but I don’t want to be the auditor’s defense attorneys.  

I want to discuss the extent of the fraud.  Rita, the comptroller of Dixon, entered a guilty plea for taking in excess of $53 million dollars from her employer over a 20 year period to fund her horse breeding hobby and an impressive set of motor vehicles.  Jim Peterson has some additional information on Rita

Dixon is a city of 16,000 people with a total expenditures of almost $18 million in 2011.  How did Rita steal upwards of $5 million in some years without anyone noticing?  She took over $3,000 for every person in Dixon.  In her “best” years, over a quarter of the city expenditures went to her.  Government accounting, much more than corporate accounting, emphasizes accountability.  As a government employee, I can tell you about the difficulties in spending funds for purposes other than for which they were budgeted.  Obviously, Rita’s position allowed her to move funds around but it should have left a trail.

Without absolving the auditors, there is a real issue about what the folks in Dixon were thinking.  I know that some folks like to snipe at government employee lifestyles but a $2 million motor coach does seem like a legitimate concern.

Pivot to Jobs

President Obama recent speech has been described as a pivot to jobs.  He put it in an unusual formulation, “I care about one thing and one thing only, and that’s how to use every minute of the 1,276 days remaining in my term to make this country work for working Americans again,”  It is an unusual way of putting his concern because it seems to leave out folks out of work by emphasizing working Americans.  It also shows time is running short because the president has focused on other activities during his 1400 plus days to date in office.  The Knox College speech only offered offered a few specifics like increasing the minimum wage or expanding public schools.  A serious question is what could the president propose that would take effect quickly and have a positive impact on the middle class?
Clearly, his two proposals don’t meet the criteria.  An increase in the minimum wage might pass but it doesn’t have an impact on the middle class.  The extent to which it harms the lower class is disputed.

An extra year of public school seems unlikely to pass and if it did it would only be a transfer from the private economy to the public economy.

Less restrictive regulation seems an obvious choice to help the economy and particularly the middle class.  The long delayed Keystone pipeline would be the poster child with a subheadline of stop Lac Megantic in the US.

Taxes are another great opportunity but getting an agreement is difficult.  Adopting a territorial tax system might be one possible area.  It was endorsed by the President’s commission (Bowles-Simpson) and has substantial supporters with a limited cost.  It has a limited cost because corporations can avoid the tax by keeping the earning overseas.  Investing those earnings in the US would be beneficial.

In short, these ideas are not exhaustive but the key is to find solutions like them that are possible and improve the incentive structure.  It can be done.  Do not try to pick winners or losers even if you invested in fracking ten years ago.

Detroit Irony

We have been stuck on Detroit but there is so much to investigate.  There are a couple of  pieces of irony gleaned from the 2012 Detroit financial statements (links are down – see previous posts).  First, there seem to be two mottos: ““We hope for better things.” and “It shall rise again from the ashes.””  They also seem to have an extra “.

The second is that Detroit received an award for their 2011 financial statements.  They received a Certificate of Achievement for Excellence in Financial Reporting presented by the Government Finance Officers Association of the United States and Canada to government units and public employee retirement systems whose comprehensive annual financial reports (CAFRs) achieve the highest standards in government accounting and financial reporting. 

Now you could have excellent reporting about an entity that has Detroit-level financial problems.  Perhaps Detroit did an excellent job of disclosing the myriad of problems they face.  Still the sponsoring organization can’t feel good about this.  

Detroit Again

Nicole Gelinas has an interesting opinion piece on Detroit and the risk for NYC.  In it she brings a new problem to light, post employment benefits (OPEB).  The acronym is OPEB because the term refers to benefits other than pensions.  Gelinas lists the unfunded liabilities as $3.5 billion for pensions and $5.7 billion for OPEB.  The latter number might be substantially understated because the 2012 management discussion and analysis (MD&A) in Detroit’s financial statements gives the $5.7 billion number as being measured on June 30, 2011.

Sidebar: MD&A is not audited so the numbers are not as solid as the financial statements but we would expect the liabilities to be no smaller than those numbers.

The reason the OPEB number might be substantially understated is that the same disclosure lists the unfunded pension amount at a measly $644 million as of June 30, 2011.  Gelinas uses the $3.5 billion that many have lifted from the bankruptcy petition.  The bankruptcy petition is updated data as it happened a few weeks ago.  So if the unfunded pension amount increased by a multiple of over five between 6/30/11 and the bankruptcy petition.  What happend to the much bigger OPEB liability during that same period?  We don’t have enough data to speculate but it will be interesting to see how big a problem the OPEB liability turns out to be in the coming weeks.

Detroit and Accounting

Megan McArdle discusses Detroit and its pension problem.  She recognizes that the order to withdraw the bankruptcy petition is not a big deal.  It only moves Detroit from bankrupt back to insolvent.  There are two problems with her discussion of pensions.

First, she says, “The 2008 financial crisis whacked Detroit’s pension assets, just as it did every other pension in the country. But the city was in a particularly bad position to recover, because it had no cash to make up the deficits, and no prospect of getting any in the future.” Properly funded pension funds make up for the bad years with good years.  Wisconsin’s pension fund is 99.9% funded as of June 30, 2012.  The bad year in 2008 hurt but the good years since haven’t been enough to make up for failures to fund.

The second problem is that, “The rest of the debt can be written down, but pension obligations will keep racking up every year unless something drastic is done.”  The racking up is misleading.  The pension liability as of today is the present value of future payments.  It will “rack up” some interest but future pensions are clearly open to negotiation (we’ll talk about the Michigan Constitution in a later post).  Transferring the risk from the city is a real option for current and future employees.  It seems better than firing everyone.

Detroit needs to negotiate a better deal on pensions with current and future employees.  It is a crucial step to economic life.  Better pension accounting is on the way for governmental entities.  It might make Detroit look worse but help it act rationally.