“It's a Wonderful Life,” and the “Fiscal Cliff.”

Addressing the fiscal cliff without politics.

Continuing with the theme of the last posting “It's a Wonderful Life’ and It's Good Financial Advice,” it's worth looking at the fiscal cliff from the perspective of the financial management wisdom of “It's a Wonderful Life.”

On November 3, 2012, the WALL STREET JOURNAL had a piece entitled “Tackling Investor Ignorance.”  It was an interesting effort to try to point out a major financial problem.  They deserve to be congratulated for addressing the issue.  As they stated: “The financial crisis exposed greed, reckless decisions and regulatory failures. Now we can add another shortcoming to the list: the ignorance of too many small investors.”  It's about time someone pointed that out.  

To me, it seems obvious from the start.  You can’t have a financial crisis like we had if only one side participates.  It took all players, which seems fairly obvious given that the problems uncovered were systemic.

There are many key pieces of information relevant to financial management that the fiscal cliff discussions indicate the public lacks; enough to justify a separate posting.  For now, however, let's focus on one not mentioned in the WALL STREET JOURNAL article.  It's one that's much in the news.  It has to do with tax rates, and in particular the Bush tax cuts.  For readers who just can't live without politics, I'd recommend a WALL STREET JOURNAL opinion piece entitled “Obama'sMiddle-Class Tax Flip: After a decade of bashing by Democrats, the Bush tax cutsget strange new respect.”

It points out the new orthodoxy being advanced by many analysts of the fiscal cliff.  Much of the fear of the fiscal cliff originates from the belief that the middle class benefits mightily from the Bush tax cuts and cannot afford to see them expire, thus, the insistence on preserving “middle-class tax breaks.”  This is a stark contrast to the original complaint that Mr. Bush's tax cuts favored the rich over the middle class.  That original complaint morphed into the orthodoxy we know today: Tax cuts for the rich came at the expense of the middle class.

What's clear is that a large number of people don't understand the tax rates they pay.  There are undoubtedly many people who know more about the rate paid by Warren Buffett than their own rate.  That ignorance may facilitate politicians’ demagoguing tax rates, but creating the opportunity to demagogue the issue is done at the expense of the public's ability to manage their own finances.

The WALL STREET JOURNAL article on financial ignorance lists budgeting as one of the areas where the public's financial management skills are weak.  Two years ago this blog pointed out the crucial role of budgeting in the movie “It's a Wonderful Life.”  Specifically, in a posting entitled “Investing Part 3: Setting the volume,” it noted that “…George avoids the clutches of the evil banker, Mr. Potter, due to the astute financial management of Miss Davis who only withdraws $17.50 rather than the $20 withdrawals of the customers before her….she knew she could get by for $2.50 less than the previous customers. That she leaves that $2.50 in the Bailey Building and Loan is crucial. George squeaks by with $2 left at the end of the day.”

Now, the logical question is: how can the public be expected to be able to project their cash flow and budget if they don't know how much of their cash flow will be taken for taxes?  One can't know what his or her taxes will be without knowing how taxes work. 

One can't just blame the public for their ignorance if there is a concerted effort to create misinformation on the part of many spokespeople on the topic of taxes.  Further, one can't blame the public if in late December the government still has not decided what income tax will be due in the current year.  That is exactly the situation many people in the middle class are facing. How the Alternative Minimum Tax (ATM) will be applied this year is undecided, and the ATM could apply to a substantial portion of the middle-class.  A public which understood how their taxes work wouldn't tolerate such deception and mismanagement.

Reaching a reasonable compromise about how revenue should be raised is impossible among people who don't know how revenue is currently being raised.  In a public which knows more about others’ taxes than how their own taxes work is in no position to address the issue.  Not knowing what your tax rate is or how your taxes work is a significant deficiency in the public's financial skills.  It's one that the public as portrayed in “It's a Wonderful Life” would find unacceptable.