April 11, 2015 Newsletter

Stock Market Valuation

Investors often debate whether or not the stock market as a whole is over-valued. I recently updated my comprehensive reference article that analyses whether or not the U.S. stock market (the S&P 500) is over-valued. Click to see that article.

Thoughts on Income Taxes

This is the time of year when most Canadians “square up” our income taxes with the government. Most employees tend to receive a small refund because our system tends to deduct a little more taxes than needed to insure most people don’t end up with income taxes owed.

This is also the time of year when people look at their T4 and wonder why such a large amount of their gross pay is going for income taxes. Most Canadians recognize that income tax is a necessary thing, though they would, of course, like to pay less.

It’s certainly fair game to complain about wasteful government spending and to complain if government wages, pensions and other benefits seem too high. And it’s fair game to ask if others including high income earners and corporations are paying their fair share of taxes. Most Canadians would agree that there is room for improvement in all these areas.

But there is a lunatic fringe that believes that all taxes are evil. They believe that lowering taxes is always good in all cases. They believe that all wealth is created by the private sector and that government creates nothing. They believe that government workers don’t really pay any taxes because their wages come from private sector taxes. When taken to to this extreme, all of this is utter nonsense.

These government bashers fail to understand that our private sector companies could not exist without the government that creates and provides the rule of law, property rights, security, free health care, free roads, municipal water and sewer service and many other things. Yes, some (but not all) of these things could be provided by the private sector. But to suggest that ALL of these things are unnecessary, wasteful and unproductive, by definition simply because they are provided by government, is sheer nonsense.

Those government bashers who go so far as to resent paying even a dollar in taxes  conveniently forget that there is not a single person earning money that does not benefit from government services. Without some amount of government, society would be in chaos and private sector employers would not exist. Even those exceptionally few people who live off the grid growing their own food  and making their own cloths benefit from the government laws that prevent others from simply seizing their property and possessions by force.

We all owe our incomes largely to the broader economic system that very much includes government services in addition to private companies.

Again, that is not to say that we should not complain about government waste of any kind or about an unfair division of the tax burden.

But none of us should go so far as to resent paying any income tax at all. We should be thankful that we are in a position to have earned the money which is being taxed. We might wish to remember that one thing worse than having to pay a large amount of taxes, is not having to do so because of not having the kind of income or wealth that results in a large tax burden.

Flawed thinking about Gross Domestic Product (GDP)

Gross Domestic Product or GDP refers the total dollar value-added by recorded monetary-based economic activities within a country. GDP is often criticized because it does not include the value of unpaid work or of unreported economic activities such as the “underground economy”.

The criticism is valid in that far too many people seem to think that GDP is a precise measure of the total economy and of the well being of a country.  In fact, GDP never purported to measure the totality of all the goods and services produced in an economy. It has always been the case that economic activity and exchanges not based on financial transactions as well as financial transactions that take place but that are not officially recorded were not included in measures of GDP.

Economic activities certainly pre-dates the invention of the concept of GDP in 1934 (see Wikipedia). The related concept of Gross National Product was “invented” in the 1600s but economic activities also took place long before that.  If we define economic activity as the creation of and the value-added exchange of goods and services, that would also pre-date the use of money of any kind.

When we attempt to measure the economic activity within a country, it is difficult or impossible to include unrecorded financial exchanges and the production or exchange of goods and services that do not involve money. GDP,by its nature, should be thought of as a limited and imperfect measure of economic activity.

It is valid to criticize those who rely on GDP without remembering that it is only a limited and imperfect measure.

Policy makers err when they focus exclusively on increasing GDP.

Consider the service of caring for children. Let’s assume that 50% of mothers are stay-at home Moms. The work that they do goes unmeasured by GDP. Now, imagine that each of these mothers is encouraged to pair up with another Mother. Each Mother exchanges her kid(s) with those of another Mother each day. Each Mother incorporates as a mini-daycare operation. She hires herself and remits income taxes and payroll taxes. She deducts part of her food bill and utilities as a business expense. All these mothers pay each other $1000 per child per month. Voila, the workforce has been expanded greatly. The economy has been “expanded” because the work of looking after these children is now recorded in GDP.

If the goal was to increase GDP and increase the number of people in the labor force, it has been achieved. But the real economy has not been changed. The well being and living standards of the community have not increased. In fact, it’s pretty clear that the well being of most of the mothers and most of the children has been reduced.

This example illustrates that what really counts is the well being of people. The true economic activity within a country is usually increased when GDP rises. But not always. Policy makers need to be careful not to lose sight of the real goal which is certainly not to increase GDP for the sake of increasing GDP.

Another example is when people argue for the legalization of grow-ops to increase the size of the economy. I won’t get into that debate but to the extent that you simply make legal an activity that is already occurring, you have not increased the size of the economy but have rather just begun to measure what was already happening. It might increase income taxes but by itself starting to account for an activity that formerly existed but went unaccounted for, does not change the size of the economy.

Understanding Canada’s Economy

I have updated my article that shows how each sector contributes to Canada’s GDP. It also shows what Canada exports and imports and shows how various countries rank as Canada’s trading partners. This article reveals some things about Canada’s economy that will surprise most people.


Shawn C. Allen

President InvestorsFriend Inc.

April 11, 2015

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