Podcast Summary
The Fluidity of Income and Taxes: 76% of US income tax payers have passed through top income quintile, UK data shows income levels are not static.
Income earning and tax burdens are more fluid than people realize, particularly in economies like the US and the UK. Solea Mohsen and Sarah Holder, hosts of The Big Take DC and The Big Take from Bloomberg News, have discussed this topic for years. They've noted how the Japanese equity market has been undervalued for a long time, but more recently, it's broken through a significant barrier, indicating potential growth. However, they're more passionate about the misconception that income tax paying workers in the UK are statically placed in income brackets. A study from the New York Times revealed that 76% of income tax paying workers in the US have passed through the top income quintile at some point in their careers. While this may not be the exact case in the UK, recent data from the Office for National Statistics indicates that there is indeed fluidity in income levels in the UK. Income Dynamics, a report by the ONS, shows that individuals move around income brackets and even quintiles throughout their lifetimes. Therefore, the idea that 20% of income tax paying workers in the UK will end up in the 40% tax bracket is not as alarming as it may seem at first glance. Instead, it's a testament to the dynamic nature of income earning and taxation in the UK.
Income mobility challenges income tax assumptions: Over half of individuals in the top income bracket dropped out within a decade, while over half in the bottom bracket moved up, making income tax policies based on income stability questionable
Income mobility is significant, even over a 10-year period. The study found that while some individuals remained in the same income bracket, more than half of those in the top quintile had dropped out by the decade's end. Conversely, over half of those in the bottom quintile had moved up. The middle income groups saw a lot of movement as well. This income fluidity challenges the assumption that 20% of income taxpayers will always pay 40% tax. In fact, it's likely that more than half of workers will pay this rate at some point in their careers. This has implications for pension tax relief, which is often discussed in terms of flattening the system. However, the years when people pay the highest taxes are often the same years they want to save the most for retirement. Thus, a one-size-fits-all approach may not be fair or effective. Politicians, who often set policies based on their own income stability, may need to reconsider this assumption. While they may face income volatility due to political careers, they are an exception rather than the rule. Most people have more stable income trajectories, and policies should reflect this reality.
The fluidity of income levels over time: Focusing on economic growth and productivity, rather than just cutting or increasing taxes for specific groups, is important for long-term financial stability. Income levels can change significantly over the course of a career, making policies based on current income levels potentially misguided.
The focus on increasing taxes on the rich may not be as politically viable as some might think, due to the fluidity of income levels over time. According to Sharon Bell, managing director and senior European equity strategist at Goldman Sachs, as many as 60% of those in the bottom quartile at the beginning of a 10-year period were not there at the end, and nearly 50% of those in the top quartile had also changed positions. This means that a large number of people who are currently considered "poor" or "rich" may not remain so for their entire careers. Additionally, Bell emphasized the importance of focusing on economic growth and productivity rather than just cutting taxes or increasing them for specific groups. She also mentioned concerns about wealthy individuals and businesses leaving the UK due to unfavorable economic conditions.
Markets Show Resilience Amid Challenges, European Markets Perform Well: Markets have shown resilience despite challenges, European markets have strong returns, US markets perform well, but not cheap, unexpected low inflation, expectation of peaking interest rates, concerns about slow growth and recession risk, interest rates and inflation dynamic suggest rates have peaked, inflation to come down short term.
Global markets have shown resilience this year despite various challenges, including rising interest rates, slowing growth, and geopolitical tensions. European markets, in particular, have seen strong double-digit returns, with the US markets also performing well. However, markets are not cheap, with the US market trading at a PE ratio above its 20-year average. The unexpectedly low inflation and the expectation of peaking interest rates have been major boosts to equities. But, there are concerns about slow growth and the risk of recession, as well as the availability of attractive yields in other asset classes. The markets may be overly resilient, and it remains to be seen if they reflect the underlying risks. The interest rates and inflation dynamic suggest that rates have peaked and will stay at this level for a longer period, but inflation is expected to come down in the short to medium term.
Expected High Inflation Due to Strong Service Sector, Persistent Wage Growth, and Tight Labor Markets: Despite a potential decrease in inflation, strong service sector, persistent wage growth, and tight labor markets may keep inflation elevated, leading to increased wage demands and continued pressure on prices.
Inflation, although coming down from its peaks in many places, is expected to remain high due to the strong service sector, persistent wage growth, and tight labor markets. These factors are leading to increased wage demands from workers and unions, which could keep inflation elevated even if it settles around 4%. The tight labor market is a result of cyclical and structural factors, including a declining working-age population and rising wages in emerging economies where companies have historically moved production. These trends could continue to put pressure on inflation and lead to higher wage demands in the future.
Labor markets shifting, potential increase in wages and decrease in profit margins: High profit margins due to cost savings and lower taxes may no longer persist, leading to challenges for equities in the next economic cycle
Labor markets are shifting, with policy incentives and a shrinking workforce leading to a potential increase in wages and a decrease in profit margins. This trend, combined with slowing economic growth and competing asset classes, may make equities less resilient in the next economic cycle. Profit margins have been consistently high due to cost savings and lower taxes, but these factors may no longer persist. The tech sector, particularly in the US, is expected to continue performing well due to its role in the artificial intelligence technology wave. However, the peak of interest rates and the end of rate hikes may not be enough to offset the challenges facing equities.
European companies in healthcare, branded consumer goods, and tech to benefit from trends: European firms in healthcare, consumer goods, and tech sectors to gain from aging populations and AI. Commodities volatile, invest in related equities for exposure and yields. UK market offers opportunity for commodity exposure and attractive yields, but ESG vs commodity conflict arises.
Europe's largest companies in sectors like healthcare, branded consumer goods, and tech are poised to benefit from trends like aging populations and AI, while commodities, though a scarce resource, may not be a good idea for direct investment due to their volatile nature. Instead, investing in commodity-related equities, such as energy and mining companies, can provide exposure and attractive yields. However, there's a conflict between the need for commodities for an environmentally-friendly energy transition and the push towards ESG investing. The UK market, specifically its mining and energy companies, offers an opportunity for investors seeking exposure to commodities and attractive yields. Additionally, many UK companies are looking to list in the US for higher valuations.
Europe's lack of large domestic investors contributes to lower valuations: The decline of defined benefit pension schemes and regulatory changes have led to fewer domestic investors in UK stocks, causing lower valuations for European companies compared to US companies. Encouraging more domestic investment could potentially lead to higher valuations.
The lack of a large domestic investor base in Europe, particularly in the UK, contributes to lower valuations for European companies compared to US companies. This issue is due to the decline of defined benefit pension schemes and regulatory changes that have shifted the way these funds invest, leading to fewer domestic investors buying UK stocks. As a result, companies with a large American footprint or those looking to attract more US investment may consider moving their listing to the US for higher valuations. Encouraging more domestic investment in public equity in Europe and the UK could potentially lead to higher valuations for public companies and a more robust equity culture.
UK Equity Market's Low Valuation Attracting External Investors: The UK equity market's lower valuation compared to the US is attracting external investors, leading to potential fund flows, acquisitions, and buybacks, as global investors view the market as inexpensive. UK companies, particularly those in cyclical industries, are using cash reserves to buy back shares, improving EPS and closing the gap.
The UK equity market's relatively low valuation compared to the US market is attracting external investors, leading to potential fund flows, acquisitions, and buybacks. The discount between the two markets is significant, and despite the lack of growth and tech sectors in the UK, the gap is likely to continue closing. Global investors view the UK market as inexpensive, and we've seen evidence of this through fund flows, acquisitions, and buybacks. UK companies, particularly those in cyclical industries, are using their cash reserves to buy back shares, improving earnings per share and closing the gap. However, the incentives for management in the US to focus on growth rather than short-term gains may be a contributing factor to the difference in investment strategies between the two regions.
Exploring growth opportunities beyond share prices and executive remuneration: Invest in the UK market, financials, commodities, tech, luxury goods, healthcare, and gold for diversification and potential growth. Consider a barbell strategy of investing in both cheaper, undersupplied areas and growth sectors.
Even in markets with a focus on share prices and executive remuneration, like the US, companies are looking for growth opportunities. For retail investors, there are various interesting areas to invest in, including the UK market, which is less expensive than the US, and sectors like financials, commodities, and growth areas such as tech, luxury goods, and healthcare. Gold is also recommended as a hedge against economic downturns and potential inflation. Diversification is key, and a barbell strategy of investing in both cheaper, potentially undersupplied areas and growth sectors can be effective.
Understanding the disconnect between Washington and American voters: The Big Take DC podcast explores the intricacies of money, politics, and power in government and their impact on voters through real-life consequences.
Solea Mohsen, a seasoned economic policy reporter, recognized the disconnect between Washington and American voters during the 2016 election. In response, she created The Big Take DC podcast, which delves into the intricacies of how money, politics, and power shape government and the resulting impact on voters. With new episodes every Thursday, listeners can tune in on the Iheartradio app, Apple Podcasts, or any preferred podcast platform to gain a deeper understanding of these complex issues. By focusing on the real-life consequences of government decisions, The Big Take DC offers a unique perspective on the intersection of politics and everyday life.
