Katrina: the end of tax breaks and the redistribution of your money

Tags: Hurricane Katrina, Katrina, taxes, personal finance.

Here are a few New Orleans questions:

• What will be the long term consequences of Hurricane Katrina for the entire nation?
• Will we build a new and better New Orleans (N.O.)?
• Will N.O. expatriates return?
• Will N.O. be rebuilt in a manner to withstand future storms and hurricanes?
• What will happen to the famously corrupt governments of New Orleans and Louisiana?
• Will regular maintenance of dikes and levies continue to be ignored?
• Will billions of federal $ continue to flow into N.O. for 10 - 20 more years?
• How will such famously corrupt governments spend our tax money?
• Will our tax money be spent on social services?
• Will it be spent on hand outs?
• Will new social welfare programs be implemented to address long standing poverty?
• Will these new programs succeed or follow the path of previous programs?
• Who will pay for all the tax money poured into N.O.?
• Will it raise our taxes?
• Will it eliminate tax breaks both current and planned?
• What will happen to tax measures designed to stimulate broad economic growth such as reduction or elimination of capital gains taxes and dividends?
• Will other important political issues, such as tax reform, be starved of political capital and ultimately be ignored?
• Will we take so long to address resolving N.O.'s needs that the issue will lose it's feeling of immediacy and wan?

These thoughts came to me while reading an interesting article in Worth Magazine (put out by the Robb Report). In general I find Worth Magazine far to busy pandering to an idyllic and pristine image of bewildered trust fund children having little to do other than accept moralistic pleadings about donating money to the right charity while at the same time it bends over backwards to sell various high expense luxuries aimed at the same market. Perhaps moralists need to sell out if they want advertising dollars, it just seems rather hypocritical, especially when you compare the ratio of pages to consumption and luxury over charity and public service.

However, Worth does have a good article every now and then. The Katrina article was certainly quite interesting. It picked up on a strain of thought that had peppered newspaper discussions of budgetary politics, but had seldom been discussed in an outright manner.
How will the costs of Katrina and the various solutions established to help it's victims impact the rest of our country in the long term?

Some fairly strong alternate views to Worth's article can be found at The Carpetbagger Report. You'll find a strong opinion there that government is controlled by an oligarchy intent on redistributing wealth from the poor to the wealthy. Quite the opposite of the fears in the Worth article. Then again, although there have been several scams facilitated by our government in the past, they happen fairly rarely and have much less effect on redistribution than most of our social welfare programs.

I'd rather expose my biases immediate. I believe that the less government taxes us, the more we can deploy our resources (money and capital) productively to grow society's wealth -- which all members of society, rich and poor, benefit from. There are those that disagree and feel society's most productive individuals do not deserve the wealth they've gained, they believe the government (a proxy for the people) can utilize it more equitably. I've traveled extensively through communist countries and met with communist leaders. I've even lived in formerly communist countries. It just doesn't work. But enough of that, let's focus on Katrina.
You might break things down into a few categories:

• Reconstruction of New Orleans
• Distribution of Aid and Social Services to Victims
• Long term payment and financing of hurricane related expenses
• Approaches to manage future catastrophe costs
• Budgetary consequences of the new expenditures
• Political and legislative consequences of new budgetary constraints

Reconstruction

I can envision a continual flood of money to New Orleans. For those needing it, it will never be enough or distributed quickly enough - as long as it flows through a government bureaucracy - especially one held more accountable due to criticisms of lax fiscal controls.
Undoubtedly local government institutions traditionally awash with corruption and political influence will redirect much of this money - so much in fact - that future criticism might call it a second tragedy.

But ultimately New Orleans will be rebuilt. Political pressure groups will force the public monies to be spent on protecting people intent on returning to high risk areas -- this should be a budgetary no no.

Better and stronger dikes and levies will be built. They may last even longer than the others. In 30-50 years a pattern of neglect will return and maintenace will wan until they collapse again in 20-30 years.

Some, but not all New Orleans residents will return. I think New Orleans may take a queue from Las Vegas's remodeling effort and build a cleaner more family friendly New Orleans, high in entertainment and culture, but less sin and filth. Think of it has family friendly sin.
I think few of the poor N.O. expatriates will be able to return. Instead, they'll continue their migration to the far away states they've already been relocated to. Some will integrate and find new homes and jobs. Others will return to the poverty which they left and join the local underclass.

Distribution of Aid and Social Services

I think aid will continue but ultimately a long term aid package composed most heavily of reconstruction financial guarantees will come out of Washington.

LA will plead for and possibly receive short term budgetary assistance to offset it's significant loss of tax revenues. Funding will end within three years, possibly replaced by federal guarantees on state bonds issued to help resolve outstanding expenses - more capital related with a limited amount of short term expenses.

N.O. expatriates, mostly the poor, will continue to draw on social services and there will probably be a national effort to provide long term relief for these people. It will be strongly endorsed by the states that have received the most refugees. The first relief plan pitched will take the form of enhanced federal subsidies for state social services targeted at refugees. There is a strong probability it will grow into a general call for Federal subsidy of social services and an even stronger call for a new New Deal type program. It's very possible this may be a strong issue in the Democratic political campaigns. Walter Williams calls this the rediscovery of poverty. He writes a very interesting article in Capitalism Magazine called Ammunition for Poverty Pimps.
His main point is the rediscovery of poverty as political rhetoric by the left in an opportunistic move to establish political initiative. Williams criticizes President Bush's assertion that the underclass in N.O. was the byproduct of racial discrimination by demonstrating that the poverty numbers amongst blacks are not too dissimilar to the poverty numbers amongst whites - he more strongly emphasizes that the causes of poverty are most directly linked to the incredible rise of single parent families among the black community. Williams examines the failures of Johnson's Great Society program, sees little their to cure the single family problem and asserts that social solutions for Katrina are most likely to provide no solution and reinforce existing problems.

Long Term Payment and Financing of Hurricane Related Expenses

There will be three sources for hurricane related recovery.

Immediate federal tax dollars. These will continue to handle immediate clean up costs, short term social services, local and state government subsidies, etc.... They will most likely be spent inefficiently and wastefully distracted by local political patrons. Those that receive the monies (what little they get) will be grateful and at their most dire moment of need. You and I will be paying this money to them through the federal government. It will probably continue for two more years.

The second source will be long term capital - bonds raised by local and state bodies, most likely with federal guarantees. These will be used to sponsor long term capital projects to rebuild levies and infrastructure. I imagine some of it will be spent on welfare projects and subsidized housing -- I wonder if N.O. will repeat Chicago's failed mistakes: concentrating the poorest citizens in an urban slum disconnected from the rest of the city - Cabrini Green was a dumping ground for people society gave up on. Federal guarantees will be needed due to the uncertainty of state and local tax receipts - who knows how long it will take for businesses to return and prosper? Also, Federal guarantees will lower default risk and consequently the interest rate the state of LA will pay. You and I will be on the hook for this for 30 years. It won't cost as much as immediate federal subsidies, but there will be a piece of every pay check we receive going to subsidize the money Louisiana (LA) needed to borrow.

The third source will be insurance payments to people and businesses. These monies will be used the most efficiently to rebuild homes, stores, offices and factories. The insurances companies know how to monitor and allocate reconstruction spending better than anyone else. It's their business. Admittedly, they are not perfect, but they are the best hope.

Approaches to managing future catastrophe costs

This is a very interesting topic and a fascinating opportunity to both save the country massive future costs as well as create new investment opportunities. In a time when Baby Boomers are just starting to enter their path to retirement and access to expensive government programs, such as Medicare, etc... and in many cases to leave the work force, we will have less Federal money to spend on unexpected natural catastrophes.

The Worth article mentioned interest in the creation of a federally sponsored market for catastrophe reinsurance. By facilitating catastrophe reinsurance (either through facilitating laws and legal constructs, tax incentives or federal entities like Fanny Mae), it will be cheaper and less expensive for private insurers to offer catastrophe coverage. Other possibilities would be the offering or extension of commodity market products that facilitate catastrophic coverage. I know there's been talk and I think several exchanges have actually begun trading weather futures. This is a first step in insuring against weather related damages. Retailers can by the futures to offset potential weather related reductions in sales. At the same time insurers can by weather futures to offset against weather related claims. The combination of catastrophe reinsurance and expansion of weather related commodities - perhaps even reinsurance commodities themselves - can form the financial nucleus of private catastrophe insurance. With this approach those most effected by catastrophic risk will buy their own insurance and pay for the luxury of living in risk zones. Reconstruction would be managed by private insurance companies.

I suppose this approach will handle most private individuals and businesses in catastrophe zones. It may hopefully expand coverage.

The big issue will be how to provide coverage for those who either refuse to buy insurance or cannot afford it. Perhaps, like mandatory auto insurance, state law might require residents returning to N.O. to buy catastrophe insurance? Or it may subsidize insurance further for the poor. This will be an interesting and particularly thorny issue to resolve. Philosophically, virtually every state has decided in the interest of public good, that those who are too poor to buy auto insurance should not be allowed to operate (maybe even own) a car. Can this philosophy be extended to residence in a catastrophic flood zone?

Budgetary consequences of the new expenditures

I think the consequences will be serious. Between our recent natural disasters, those bound to come and the continuing expense of the Iraq war, we simply have less federal dollars to spend. Government deficit spending is cyclical. In the next few years we're due for a contraction. Let's hope our crises are paid off by then.

Political and Legislative Consequences

This is the most dangerous consequence of the hurricane cleanup.

A new rhetoric of the poor and new New Deal will flood the left. Efforts will begin to enact new long term anti-poverty programs that are very likely to be similar to our failed programs of the past. Why? Many of the failed programs have been cleaned up over the last twenty or thirty years. There failures are less visible. We have fewer reminders of the mistakes we made.

Tax reduction and simplification will be drowned out. Any attempt to reduce taxes and increase national economic growth will be categorized as either fiscally irresponsible (we need that money to pay for N.O.) or selfish (you're redistributing money from the poor to the rich - let's create new social programs instead).

Unfortunately, my friends, many legislative issues important to investors and those interested in personal finance will suffer:

Dividend tax and capital gains tax rates - see the heritage article
Estate taxes - this is the most likely victim
Income tax rate reductions - unlikely for the next 30 years
Income tax simplification / reform - may be hijacked by advocates of increased income taxes

Now the future need not look so glum. It's possible that innovative market oriented solutions to these problems will come about. Of course they will have great trouble competing against Federal solutions, unless the Federal government cooperates and encourages them.

Now, more than ever, it is important to participate in the political process and challenge the pull of rhetoric. This means action. Are you ready to take action?

Have a great day,

Making Our Way