🎙️ Financial Time Bomb

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— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the three biggest stories in markets:

• The Supreme Court ponders the meaning of ‘income’

• Why Moody’s cut China’s credit outlook to negative

• Who got a lot richer and who didn’t during the pandemic

All this, and more, in just 5 minutes to read.

CHART OF THE DAY

IN THE NEWS

🤔 SCOTUS Hears Case on What Income Means

Taxes are boring, but what if we told you about a Supreme Court case that could “effectively eliminate a third of the tax code?” That quote is from former Speaker of the House Paul Ryan, and he’s actually not exaggerating.

The Supreme Court is hearing arguments in Moore v. U.S., a tax dispute over roughly $15,000, with billion-dollar and even trillion-dollar implications.

Say what? See, Charles and Kathleen Moore were asked to pay a one-time tax on profits held overseas in 2018 after they invested about $40,000 in a friend’s business in India in the early 2000s.

• That one-time tax was part of a larger $340 billion tax revenue initiative passed in 2017.
  

• While companies could previously defer U.S. taxes on foreign income until they brought those earnings stateside, Congress opted to implement a minimum U.S. tax on foreign profits each year, with a one-time repatriation tax to be paid on companies’ profits from the past 30 years.
  

• Much of that $340 billion in one-time taxes was paid by familiar names like Apple, Alphabet, and Microsoft, but individuals like the Moores paid some of it.

Why it matters:

At the core of this case is taxation on unrealized gains. While the Moores were part owners of their friend’s business in India, they received no dividend payouts from the investment, nor did they sell their stake for a capital gain.

• Yet, they were asked to pay $15,000 in taxes on $135,000 of the company's historical foreign earnings.
  

• Although paying thousands in taxes for income earned by a company in India, of which they never saw a penny, doesn’t seem fair, the case’s precedent, particularly a ruling in their favor, could have major implications.

One implication is the constitutionality of the popular “billionaire tax” pitched by some politicians, where billionaires would pay minimum taxes based on increases in the value of their assets, even if they didn’t sell them or receive any cash payouts.

Tax talk: The other, bigger implication is, as Matt Levine argues, if the Supreme Court rules the taxes imposed on the Moores were unconstitutional, “then most of the regime of U.S. business taxation is unconstitutional.”

That’s because, among other reasons, pass-through taxation for LLCs can be similar to taxes on unrealized gains.

• Unlike corporate tax structures, where companies can retain earnings, many law firms, small businesses, and even hedge funds cannot.
  

• In other words, owners of these businesses with pass-through taxation must count business income as their personal income for tax purposes, proportional to their ownership stake, regardless of whether that income is paid out to them.

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🔻 Moody’s Cuts China’s Credit Outlook to Negative

Move aside, America, you’re not the only country whose credit status is hitting road bumps.

On Tuesday, the credit rating agency Moody’s cut its outlook on China’s “sovereign” credit rating to negative, raising the chances that it will receive a full downgrade if the country’s financial picture continues to worsen.

The causes for concern? Moody’s cited the mounting risk of a lasting economic slowdown in China amid headwinds from an ongoing real estate slump and debt crises across vulnerable local governments nationwide.

• As the WSJ puts it, “China’s colossal hidden debt problem is coming to a head” after “years of unchecked borrowing and spending” by Chinese cities and provinces.
  

• Adding, “China is trying to defuse a financial time bomb that could severely damage its banking system.”

Spend, spend, spend: These debt problems at the local government level go hand in hand with the property market downturn, as local governments routinely funded themselves with land sales, which demand for has dropped off.

• Yet, spending surged in recent years as cities implemented strict, costly-to-enforce Covid measures.
  

• To cope, local governments have relied on “off-balance-sheet government debt” where instead of raising money directly, so-called “local-government financing vehicles” issue debt on their behalf.
  

• It’s estimated that this “hidden” debt totals between $7 trillion to $11 trillion.

Why it matters:

Of the local government debt hidden off balance sheet, analysts worry that between $400 billion and $800 billion, or more, is at a high risk of default. This raises the prospect that China’s central government will have to financially support cities and provinces, hence Moody’s concerns about China’s sovereign borrower rating.

If defaults pile up before the central government can effectively intervene, that “could quickly snowball into a nationwide financial crisis.”

• While China’s property market bust has been a years-long affair, it hasn’t spilled into the country’s banks since many property developers raised funds from international investors.
  

• But Chinese banks are at much greater risk from municipality defaults — UBS estimates that 13% of the banking sector’s total assets are connected to local-government financing vehicles.

The CSI 300 index fell over 1.6% on Tuesday, marking a 12% decline since January for the index, which represents the top 300 stocks traded on the Shanghai and Shenzhen stock exchanges.

Read more

MORE HEADLINES

🥚 Major egg producers to pay $17.7 million fine after price-fixing court case

🇬🇧 The UK unveils new rules for cutting down immigration

💪 The 10 best-performing ETFs of 2023

📉 U.S. job openings fall to lowest level since March 2021

💼 How setbacks can boost your career forward

✏️ U.S. students’ math scores plunge in global education assessment

💰 Who Got Much Richer During the Pandemic?

Now that we’ve had some distance from the pandemic, the results are in: Who got a lot richer, and who didn’t?

The pandemic helped many Americans across every racial, ethnic and income group get wealthier. But not equally.

• Home values rose, the stock market soared after the March 2020 lows, and extra stimulus helped many people pay down debts or boost savings. 

• Per the Pew Research Center, the median household’s net worth jumped 30% to $166,900 between 2019 and 2021. 

Getting richer: Wealth for Asian and white households increased the most in total dollars. Black and Hispanic families got a lift, but not nearly as much: One in four Black households and one in seven Hispanic households had no wealth at the end of 2021, although many were able to reduce their debt. 

• Many of those families likely have felt financial pressures this year, long after the stimulus ended and inflation spiked in 2021 and 2022.
  

• Even though many Americans made out well financially from the pandemic, high inflation has offset rapid wealth increases for some people.

• “More recent trends suggest that the increase in household wealth is probably not something that sustained itself through 2022,” noted a senior researcher at Pew.

By the numbers:

• Asian households’ net worth grew 43% to $320,900 in 2021, which is by far the most wealth overall.

• White households posted a 23% jump to $250,400. 

• Conversely, Hispanic households had a net worth of $48,700 and Black households held $27,100. 

Why it matters:

The numbers provide a snapshot into the financial well-being of the country. They also show that a home is most households’ primary asset: Homeownership accounts for roughly two-thirds of the median household’s net worth. 

Part of why there’s such a stark difference in household wealth among the groups is that lower-income households are less likely to own homes and have assets invested in retirement accounts. 

A few other takeaways:

• Debt is still common among poorer households but not as high as pre-pandemic.
  

• The pandemic itself helped Americans boost their savings because of the closure of restaurants and other businesses.

• The rise in asset values moderated in 2022 as home prices increased from 5.7% from December 2021 to December 2022, only a fraction of the 18.9% jump in 2021.
  

• Meanwhile, mortgage rates doubled from 3.1% in late 2021 to 6.4% in late 2022, and stock prices fell about 20%. 

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QUICK POLL

Yesterday, we asked: How much gold do you own in your portfolio?

— Most of you aren’t gold bugs; over 54% responded with “None.”

— One reader commented, “Gold miners you meant, right? Not the physical...”

— Another added that, “If central banks are buying gold, then I want to be, too.”

See you next time!

That's it for today on We Study Markets!

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