Insurance Advice and Assistance

Threat to home equity

The biggest threat to home equity is impulse buying and keeping up appearances in a consumer society. Have you taken out a second mortgage even though you consider home equity your retirement nest egg? Many people run up credit card debt and then refinance it at a lower rate with a second mortgage. At some point, though, the nest egg disappears. Impulse buying and keeping up appearances can turn savers into spendthrifts.

Still, there is some justification for using a home as a savings vehicle. We all need to have a residence. The purpose of saving is to create a sense of financial security in our lives. Renters are subject to rent increases and the whims of landlords. A long-term saver able to pay a mortgage and not take out second and third mortgages will not have rent increases. A longterm saver able to pay off the mortgage will dramatically increase the sense of financial security in his life. Investors and speculators will have little interest in this type of security.

Home ownership works best for long-term savers who are not interested in the value of their home, but the security of their lifestyle. They are able to ignore the ups and downs of home prices, interest rates, and the economy, and focus on paying down the mortgage one payment at a time.

Often, true savers double their mortgage payments to eliminate the mortgage at a faster, orderly pace, whereas investors would not dream of using their excess cash to increase a mortgage payment.

INSURANCE AND THE ADVANTAGES OF CDO EQUITY

CDOs provide access to a host of assets that investors cannot easily gain exposure to, either because of liquidity or rating constraints. As previously mentioned, these assets include leveraged loans, noninvestment-grade bonds, residential subprime mortgages, and commercial real estate loans.

By providing access to these assets, CDOs deliver diversification benefits that expand the efficient frontier. In cases where the pool of financial assets is not static, but rather managed by a portfolio manager, CDO equity gives investors access to a manager’s expertise.

CDO structures do not manufacture diversification. CDO equity returns are closely linked to the performance of the underlying assets. They will not be perfectly correlated with the underlying asset performance because of structural provisions that affect the way the collateral cash flows are distributed to equity.

CDO equity offers high dividend payments that are typically front-loaded. The investment typically competes for capital with private equity and hedge funds. CDO equity offers far greater transparency than either of these two asset classes. With CDOs, the funding costs and cash flow allocation rules are known. Moreover, there is a trustee and regular surveillance through which investors can know the contents of a manager’s portfolio. In addition, the rating agencies closely monitor the CDO market and publish regular reports.

Personal Income Taxes

Adoptions: The last adoption of a personal income tax in a state without one was Connecticut early in the 1990s. For the status of proposals for income taxes in states without them see the section on state-local fiscal relations.

Changes: By basing a successful 1993 campaign for governor of New Jersey on a promise to reduce the state income tax by 30% Christie Whitman made cutting income taxes a popular proposal for candidates in the  1994 gubernatorial races. Victories by some of the gubernatorial and legislative candidates using the theme and strong state finances made cutting income taxes popular in 1995, 1996, and to a lesser degree 1997. The interest in income tax cuts has probably about run its course. Polls in New Jersey suggest that Whitman got little credit from New Jersey voters for the 30% cuts. She has promised that her tax cutting priority in the new term will be property tax reductions.

Sales Taxes

Reflecting public opinion, which objects to sales taxes less than income or property taxes, little of the tax cutting over the past few years has affected sales taxes. The three largest examples of cuts — Georgia, Missouri, and North Carolina — have involved whole or partial elimination of the portion of the sales tax levied on food.

Even in the state tax cutting environment of the last three years, there have many serious proposals to raise sales taxes. For example, sales tax increases were a part of Governor Bush’s tax plan in Texas, which failed this year, and Governor Voinovich’s Ohio plan for school finance equalization, which also failed. Wyoming legislators will likely raise their sales tax if and when they decide they can’t fund compliance with a state supreme court decision on school finance without raising taxes.

Local option sales taxes have become quite popular, with the option being offered in more states each year. More local governments are adopting the tax for the first time, and many are raising rates.

Trends in State Tax Policy

The level or burden of state and local taxes has remained remarkably stable at about 11% of personal income for 30 years. So in broad terms, the changes in tax policy have consisted of increasing reliance on some tax sources while decreasing reliance on others.

Until about 1990, state tax policies were following general patterns that had lasted for several decades. Reliance on sales taxes was being increased slowly, primarily by increases in rates.

Reliance on personal income taxes was being increased fairly rapidly. Most of the increases were associated with: (1) the tendency of income tax revenues to rise faster than personal income with no increase in tax rates and (2) adoption of income taxes by additional states.

Reliance on property taxes was being reduced. These changes were interrelated with a gradual shift from reliance on local taxes, primarily the property tax, to finance schools to having a greater percentage of school costs paid by states.

Since 1990, there has been no overriding feature of tax policy changes equivalent to the earlier shift from local property taxes to state sales and income taxes. Both the percentage of state and local tax revenues raised by states and the mix of revenues raised by sales, property, and income taxes have remained relatively stable. There is no overwhelming trend in any direction, though there are some hints of trends shown by the generalizations below.

Border Tax Issues and Options

While there are constant calls for special treatment of border communities, these calls are usually rejected by state legislatures for two reasons. First, special tax concessions in border communities raise constitutional issues in many states because otherwise equal citizens and firms are being treated unequally in state policy. Second, there is no obvious place to draw the lines around such policies. For example, a border municipality might be losing 25% of possible business to another state, another municipality in the same county might be losing 10%, the whole county 12%, and a neighboring county 8%. There is a difficult issue of whether to use special border taxes just in municipalities on the border, in entire counties, etc. No matter where the line is drawn, it creates a border problem for the first county not given special treatment. If
taxes are dropped in Border County to match a neighboring state, then Near-Border County residents have a new incentive to do business in Border County.