Taxes, Expertise, And Information

Kevin Williamson in the NRO Corner is upset about part of the Senate tax bill.  The Senate GOP is planning to tax stock options at the at the date of vesting.  Stock options is shorthand for a variety of equity instruments that are used as compensation.  What is not clear is how exactly the employee’s income would be measured in the proposed bill.

Sidebar: We account (recognize the expense for financial reporting purposes) by recognizing the fair value as the employee earns compensation.  Earning might coincide with vesting.  We don’t think that the Senate intends to use fair value measurement but we are not entirely sure.  Because financial accounting and tax accounting have different goals they are often different.  End Sidebar.

Kevin says:

You can award the options at a lower price than the current price of the stock: If you give the employee the option to pay $90 a share for 1,000 shares of stock currently priced at $100 a share, then you have given that employee $10,000, notionally.

The relevant definition of notionally would seem to be: not real or actual; ideal or imaginary.  We see that you have really given the employee more that $10,000 unless the option expires immediately.  The employee may end up with more or less than $10,000 but the value of that option is almost surely more than $10,000 because the best possible final value can easily be $40,000 but the worst possible final value can only be zero.  That’s why folks are willing to take options where the current price of the security is below the strike price in the option.  The fair value of Kevin’s option is surely more than $10,000.  Even so, we think if the Senate went in that direction it would be the worst possible incentive.

The information problem is knowing what the bill actually says.  We haven’t found anyone who cites the bill so we don’t know what it says.  We agree with Kevin but we want to know how income is measured and what would happen to old options.  Kevin reports and comments that:

The Senate estimates that the measure would produce an extra $13.4 billion in revenue over ten years, but that’s either moving forward revenue that eventually would be collected by taxing the options when the options are exercised or, worse, by taxing people on gains that aren’t actually realized—most startups fail, after all, but they may fail after employees’ shares are vested.

We agree that the Senate proposal is moving the revenue forward.  It is probably creating less total revenue since the startups that succeed do so in a big way.  Even an aging star like Apple has gone from 107 to 174 in the last year.  That surely produced income for the Feds and the state of California this year.

We support Kevin’s position because it is consistent with most tax rules.  You pay taxes on what you were paid in 2017 rather than what you earned.  We need more data to make a stronger position.  How is income measured under the Senate proposal?  What would be the total take keeping the old rules?  What would be the total take if we relaxed the rules as the House suggests?  The tax bill is not going to be perfect but let’s try to limit the number of stupid things in the tax bill.  We think Kevin has identified one of the stupid things but we need a variety of expertise to make a really compelling case.



Theater Three-For-Three

We spent the weekend at various forms of the theater with the Lady deGloves and went three-for-three.  We went to Madison and saw the touring version of Beautiful- the Carol King Musical.  It is interesting because it is not just about Carol King.  It is about the music industry of the 50s, 60s, and early 70s.  They have great music (and The Loco-motion) to create a story around and they do it well.  The singing and dancing is the quality you expect from a national tour.

Sidebar: We sat near a number of young folks and there was laughing when The Drifters first came on.  We are not positive but we think they we reacting to the groups choreographed moves.  It was a generational thing.  End Sidebar.

Beautiful is a beautiful show.  It starts with interesting songs but adds characters, sets, and presentations to make it a quality show.  We completely enjoyed it.

Our second stop was at American Players Theatre for The Unexpected Man.  This visit had the challenge of high expectations as it was a two person play with Brian Mani and Sarah Day, two of our favorite actors.  The show still far exceeded our high expectations. It is a wonderful story about characters of roughly our age dealing with opportunities to connect as well as the experiences of death and disappointment that come with being past the midpoint of your life..  Brian and Sarah are perfect and the simple set becomes a bit more with lighting and sound.  It is worth the trip to Spring Green.

Our third stop was to see Wonder Woman at the local cinema.  It was worthy of its positive reviews.  It introduced characters worthy of a franchise.  We hope they get back to them.  It, almost surprisingly for a summer blockbuster, had an interesting story.  And it did have enough action to be an action flick.  For us, one of the most interesting parts is the training of Diana (Wonder Woman).  Often in movies characters become expert warriors in too short of a time.  Diana, on the other hand, wants to become a  warrior at a very early age and begins training then despite her mother’s disapproval.  It is not epiphany that leads to her lethal skills.  It is mostly hard work.  You need to see the movie to fill in the missing piece.

It was a great weekend.  Our next experience will suffer from comparison.

Envy And Altruism

Kevin Williamson has a fun article on the joy of stardom and the joy many see when stars like Tiger Woods and Allen Iverson fall from grace.  As a Patriot fan we would add Aaron Hernandez as the one who fell the lowest because just couldn’t stop killing people.  Kevin concludes:

And that may be why we love the ritual public denunciation of fallen idols. If we convince ourselves that they are monsters and moral outliers, then we do not have to face the much more terrifying possibility that they are schmucks like us — and that we are schmucks like them.

We have a different take on it.  We do agree that stars are often schmucks like us.  Failure to prepare for retirement hits all classes of folks.  Any individual’s expertise is limited to a very small area.  Being a great retirement planner is unlikely to make you a great basketball player and vice versa.  On the positive side, the failure of retirement planning provides us with a steady stream of live classic rock.  Yet we think our joy in failure of these stars is more about envy.  And envy connects to politics as the left largely practices the politics of envy although the right is not envy free.  Anytime you hear about press bias from the right there is an element of envy in it.  Envy sells.  We admit to envy about our opponents ability to kill the ball in handball.  We hope they envy some part of our game.

Sidebar: The local lawn care company sells envy too.  The truck says, in big, bright, and bold letters: Kick your neighbor’s … grass.  We understand and expect it is well received.  End Sidebar

First, let’s talk about altruism.  Kevin writes about Allen:

Some guardian angel at Reebok saved him from the very worst of it, persuading him to take a modest $800,000-a-year stipend and leave $32 million in a trust fund that he cannot access until he is 55 years old. So he just has to eke out a living on the better part of a million bucks per annum until he gets paid for real.

Without being privy to the transaction we are pretty sure that Allen wanted the money up front.  We also highly doubt that Allen outfoxed the Reebok folks in determining the discount rate for the annuity.  In fact, it looks like he is getting an unimpressive 2.5% ($800,000/$32,000,000) on his investment.  We also think it is safe to say that Allen is way better off with an assured return and not being able touch the trust fund.  So some folks, like the guy at Reebok, do good.

But most of have a combined awe and envy of folks like Tiger, Allen, Aaron and many others.  We saw Jason Day hit a 260 yard, uphill, three wood absolutely on the pin when he won the PGA.  It was awe inspiring and he didn’t look like he swung hard.  We have a strange combination of envy and worship of these amazing beings that when they fail many of us feel good about ourselves.  As we said previously, (you can look it up) the only time Jordan Speith understood our golf game was when he hit the second shot (third including the penalty) at the 12th at The Masters and had the passing hope that he had hit so bad that it wouldn’t make it to the water.  We have had that joy he missed.

So we envy their talent as much as we love it.  When they fail somehow we succeed and that’s why the stories of abuse and failure are so popular.  We enjoy their epic accomplishment and we might enjoy their epic failures even more.  It works in politics, advertising, and the media.  It doesn’t mean that everyone is consumed with envy as Reebok guy showed but betting against envy is like betting against the market.  It doesn’t work very often.


Ending Slavery

Richard Brookhiser has a history lesson for The Donald on avoiding the Civil War in the current (5/29/17) NRODT.  One part, ending slavery by buying them, fits into our expertise from almost 40 years ago.  We believe there was a financial opportunity to avoid the Civil Was that politics failed to find.  Here we only consider the financial cost but the human cost of the Civil War, like slavery, is huge.

Sidebar One: We wrote this paper for a grad class in economic history almost 40 years ago.  We don’t have the references or the exact details anymore so we are painting with a broad brush.  End Sidebar One.

It seems simple because the Civil War was extraordinarily expensive that the government could buy out the slaves and avoid the Civil War and everybody would be at least as well off.  For example, here is an estimate of the actual cost that comes in at over $6 billion.  So when Richard quotes estimates from $600 to $900 million it is easy to wonder why there was a war.

Sidebar Two: There is strong evidence of an efficient market in slaves.  Given the pertinent characteristics like age and gender, the value of a slave can be reasonably estimated based on prices of actual sales.  According to the census there were almost 4 million slaves in the US in 1860 so Richard is estimating an average cost of $150 to $225.  Of course, individual prices would depend on pertinent characteristics.  A 20 year-old male will be worth more than a 60 year-old female.  End Sidebar Two

The problem with this analysis is that it is after the fact or ex-post.  Nobody expected that the Civil War would be as long or costly as it was and both sides thought they would win.  The analysis needs to be ex-ante.  What did folks think the Civil War would cost before it started?  They, see Sidebar, expected it to last a few months and cost a small number of millions.  The financial solution, and this was discussed, was to free the slaves at birth and death (B&D).  The  B&D solution reduces the costs in two ways.  First, babies are cheap because they are not productive for several years.  Second, it reduces the present value of the expenditures because the amounts are paid later.  It also provides a plausible way out for both sides because it doesn’t end slavery immediately.  For the same reason, it will have negative reactions too.

The bottom line is that it would have worked.  The present value of B&D expenditures was less than the expected cost of the Civil War.  It was not easily avoidable but it was avoidable.    James Buchanan might have been worse that our Immediate Past President.

Wisdom In Sports Too

Heather Wilhelm (here she is at NRO) is the Happy Warrior in NRODT.  She quotes Thoreau approvingly, “It is a characteristic of wisdom not to do desperate things.”  We approve too.  It might be a characteristic of expertise in general and sports in particular.  For the sports we are most active in, golf, handball, bridge, it rings true.

Sidebar: OK, bridge might not be be classified as a sport:  “An activity involving physical exertion and skill in which an individual or team competes against another or others for entertainment.”  Of the five bold words or phrases it surely meets four but would have trouble with physical exertion.  On the other hand, playing 26 hands in three hours has some exertion.  End Sidebar.

Expertise lies in deciding that doing the same thing and expecting different results is crazy but finding something else that isn’t crazy or desperate.  It is a fine line between a calculated risk and desperation.  In golf, a low percentage shot over the water is likely to be desperation in stroke play but a calculated risk in match play.  In handball trying a shot as a return (the second shot of the point) might be desperation but on the 14th shot when both players are tired it could be a good risk.  Bridge with its long events almost always rewards avoiding desperation.  Wisdom is knowing that a bottom score is a bottom score.  We are on board with avoiding desperation.

Auditing Opportunity

Kevin Williamson shows that not every forensic scientist is Abby Scuito.  His article provides a great opportunity for audit firms.  Folks often think that auditing only applies to financial records but as recognizes, financial records are just the most common example:

an official examination and verification of accounts and records, especially of financial accounts.

Comparing compliance with expected standards and giving an opinion is what auditing firms do.  They commonly do it for financial statements and internal control.  Compliance with standards of criminal investigation would only be a small step for them.  It makes sense that if we need external audits of financial statements then external audits of matters of life and death are a reasonable step.  The audit firms understand risk assessment, e.g., let’s audit all the murder cases and fewer less serious charges, internal control, and sampling that would lead to an effective audit of criminal investigation processes.

Audited financial statements provide reliable information for investors.  Audited criminal investigation processes would provide reliable information for jurors and help ferret out the problems that Kevin reports quickly.  There are details to be worked out on the extent of the engagement but experience will provide the solutions.  Why not try it now?

Expertise And The Presidency

Joseph Epstein at WSJ is trying to write off The Donald:

When I hear Donald Trump talk, I think of how much at home he would have felt in those living rooms [where money talked]. The guy’s a multibillionaire, cleaned up in real estate, so why shouldn’t he know about health care, immigration, life in the inner cities? Or if he doesn’t know, no reason why with a bit of quick study he can’t find out enough to put everything in order.

Joe is right about one thing: expertise rarely transfers.  Kevin Williamson mentioned that Peter Thiel’s chess skills and entrepreneurial skills are related.  Perhaps they are.  As a bridge player, we were happy when Ike’s bridge playing was linked to his strategy skills.  The fact is that expertise is created by hard work.  It takes, at a minimum, time, interest, ability, and effort.  Movies like the Karate Kid do a great disservice to understanding expertise.  So do the James Bond series.  Hint: Expertise is not about IQ.  IQ does not hurt.  Do we take from the Obama failure that academic skills are unrelated to being a successful president?  Or does it mean that experience is the key to being a successful president?  To consider Peter, he meets those four criteria in chess and business.  He might not be interested in bridge and have a hard time being successful at that.

The Donald does not match Peter in business as he but he has some business accomplishments. He has had good and bad moments as president.  He seems to know lots of folks and, generally, be a good judge of character.  Obama, on the other hand, seemed to know a few senators.  We shall see how it works out.

The presidency is close to a unique position.  There is no way to be an expert president prior to becoming president.  It is difficult to prepare for.  Each president has some skills that will help them but it is a learning experience.  It is why we tend to support political executives, i.e., governors, for president.  A business executive is not an unreasonable compromise.  Obama didn’t learn much about being a president during his eight years.  We will see if the Donald does.