Progress 07/01/99 to 06/30/05
Outputs
Work was completed on the evaluation of comparative risks and returns associated with indexed annuity investments. As predicted, such investments resulted in lower returns with significantly lower risk than did pure equity investments over 10-, 20-, and 30-year holding periods. When compared to pure fixed income investments (i.e., long term Treasury bonds), the annuity investment offered significant risk reduction with comparable returns as long as the cap on the annuity return was high (i.e., 9%); when that cap was low (i.e., 5%) the annuity returns were significantly lower.
Impacts
The ability of farm-ranch owners to diversify asset holdings by investing in financial assets, especially through tax-deferred investing has been enhanced by the strategies developed by this research. Such diversification unequivocally can reduce risk with modest reduction in the expected rate of return, resulting in a more efficient portfolio of agricultural and financial assets. For example, using random 20-year low return holding periods, the mean annual return on the indexed annuity was 5.6% (with a standard deviation of 2.06%) compared to a mean return of 6.51% (standard deviation of 12.87%) on the pure equity investment. For all 20-year holding periods, the mean return on the indexed account was lower (6.49% compared to 12.95%) but risk was reduced by 84% by using the indexed annuity. The results have been disseminated through the annual USU Extension Income Tax Schools in Salt Lake City and in St. George.
Publications
- Lewis, W.C. 2005. A return risk evaluation of an indexed annuity investment. Journal of Wealth Management 7(3):43 51.
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Progress 01/01/04 to 12/31/04
Outputs
Initial work on the relative returns and risk associated with an indexed annuity investment showed that, based on historic returns on equity and fixed income investments, the annuity alternative achieved significantly lower returns than a pure equity investment for randomly solicited and concurrent 10-, 20-, and 30-year holding periods, although risk (i.e., variability in returns) was substantially lower for the annuity. When compared to a fixed income investment, the annuity generally recorded higher returns and consistently lower risk. Continued research portfolio diversification by farm owners/operators confirmed the after-tax wealth-maximizing strategy of investing part of the farm assets in tax-sheltered retirement accounts, such as IRAs and Keogh plans. It is proven that even if these assets are fully subject to estate taxes, the net estate unequivocally will be larger as long as the marginal income tax rate in the distribution period is no higher than that rate
in the accumulation period. In some situations, shifting from tax-sheltered to taxable investments is optimal as the date of retirement nears.
Impacts
This research increases the information base for farm owner-operators in making investment decisions. Further, the financial risk of farm asset holdings is reduced through the use of such strategies, especially by investment in nonfarm tax-deferred retirement assets.
Publications
- Lewis, W.C. and F.N. Caliendo. 2004. Strategies for maximizing estate wealth. Journal of Wealth Management--forthcoming.
- Caliendo, F.N. and W.C. Lewis. 2004. The effect of the current IRA program on federal debt. Public Fin. Rev. 32(3, May):331-351.
- Bowles, T.J. and W.C. Lewis. 2004. Valuing a small business: Implications of different income tax models. Journal of Leg. Econ.
- Bowles, T.J. and W.C. Lewis. 2004. Assessing economic damages in personal injury and wrongful death litigation: The state of Wyoming. Journal of Forensic Econ. 16(1, Winter 2003):87-99. (Published July 2004).
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Progress 01/01/03 to 12/31/03
Outputs
Research in 2003 continued to focus on the development of optimal strategies for nonfarm investment by farmowner-operators. Specifically, the work on the advantages of tax-sheltered (i.e., qualified) retirement plans was continued. A generalized two-period model was developed that confirms the earlier findings that if one is saving for retirement, the qualified plans offer the clear advantage of providing greater after-tax income in retirement than would saving in a nontax- sheltered arrangement. This is true regardless of the tax rate differentials on capital gains and dividend income compared to the taxation of income retirement plans that are all taxed as ordinary income. The advantages of the Roth plan compared to the traditional plan also were confirmed. Work also was completed on statistical estimation of the age earnings profile (i.e., the pattern of earnings over the period of one's life) and the implications for smoothing out the profile by saving during the
working years and then consuming out or the saving during the retirement years. One strategy for optimal investment is to do it in such a way that the time path of consumption is not significantly different at different points in the life span. Related to that, additional work was done on identifying sources of error in estimating the levels of personal consumption in retirement. This has implications for the timing and amount of investment in the working years necessary to generate adequate income for retirement again with the objective of maintaining a reasonable even level of personal consumption. Finally, an evaluation was made of the typical retirement plan for certain classes of workers. In general, it is shown that in some plans, significant increases in retirement asset wealth at the initial age of eligibility for receiving benefits and that the retirement wealth remains constant or declines if work is continued beyond that point. This has significant implications for the
retirement decision.
Impacts
The research under this project has increased the rationality of financial decisionmaking by farmowner-operators. Their strategies for saving and investment in nonfarm assets has been enhanced.
Publications
- Lewis, W.C., F.N. Caliendo, and T.J. Bowles. 2001. Measuring Public Safety Retirement Wealth. Journal of Legal Economics 11(2, Fall):61-80 (Published in June 2003).
- Lewis, W.C., F.N. Caliendo, and T.J. Bowles. 2003. Sources of Error in Estimating Personal Consumption in Retirement. Journal Forensic Economics 15(1, 2002):45-55 (Published August 2003).
- Lewis, W.C., F.N. Caliendo, and T.J. Bowles. 2003. Case Study: A Simplified Approach for Equitable Distribution of a Award. Litigation Economic Review 6(1):17-21.
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Progress 01/01/02 to 12/31/02
Outputs
Research work in 2002 extended the qualified retirement plan strategies for farm and nonfarm operators to specifically account for the simultaneity of the taxable and tax-deferred savings decisions by farm owner-operators. The existing literature considers such strategies independent of simultaneously investing in taxable assets, which are shown to be sub-optimal. This has been conclusively demonstrated and a set of principles for maximizing retirement wealth subject to a fixed contribution constraint have been developed. The microeconomic analysis is extended to estimate the impact of alternative retirement plan options (specifically the traditional and Roth IRA options) on both the short and long-term impacts on the federal budget. The economic modeling demonstrates that the traditional IRA option available to farm owners has a favorable long-term impact on the federal budget, but the Roth IRA alternative negatively impacts the federal budget in the sense of
increasing the present value of long-term government deficits. These conclusions are sensitive to the issue of how much of the investment represents a diversion of farm operator income from taxable investment accounts to tax-deferred plans. Preliminary work on the effects of changes in the capital gains tax demonstrates that change in the taxation of capital gains generate both personal and corporate income tax revenue effects. However, corporate income tax revenue effects are not accounted for in conventional modeling. Thus, it is essential that a more comprehensive modeling effort be developed.
Impacts
This work has significant impact both in terms of providing guidance for efficient investment of part of farm income in retirement plan assets as well as to measure the net effects of such qualified plan saving on the federal budget. The valuation issues also are important for optimal strategies regarding the sale of farm assets, some of which is done on a continuing basis such as with livestock. It is generally agreed that the portfolio of the average farm operator has little diversification; often, 100 percent of the owner-operator's assets are accounted for by the farm operation itself. Economic welfare can be enhanced by diversification, especially through investment of part of farm income in a qualified retirement plan (e.g., an IRA) that holds assets in the non-agricultural sector. This research provides guidance for increasing asset diversification for farm owners. Finally, the research on the capital gains tax issue will provide guidelines for optimal timing
of farm assets especially where such sales are made on a continuing basis with culled dairy cows that may have been depreciated sufficiently that capital gains tax liabilities will be incurred upon their sale.
Publications
- Caliendo, F.N., and W.C. Lewis. 2002. Myths and truths of IRA investing. Journal of Financial Planning, 15(10):86-94. October.
- Wrigley, W.N., and W.C. Lewis. 2002. Community economic development in Utah. Economic Development Quarterly, 16(3):273-279. August.
- Bowles, T.J., and W.C. Lewis. 2002. Time-series properties of capitalization rates. Litigation Economics Review, 5(2):27-31.
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Progress 01/01/01 to 12/31/01
Outputs
During 2001, research was focused on the effect of income taxes on farmer/operator decisions with regard to investment in qualified retirement plan assets. In particular, it was shown that failure to properly account for the income tax implications on qualified plan assets will result in a less than optimal portfolio. In particular, it was found that the average investor would take more risk than is necessary in his portfolio. Such risk can be mitigated by reducing the share of common stock held in such portfolios. This work was extended to determine the optimal strategies for investing in individual retirement accounts (IRAs). In particular it is shown that the usual decision rules for such investments may lead to a reduction in lifetime consumption. In particular, it is shown that if the individual invests in taxable assets as well as IRA assets (which would be typical of most farm/owner managers), then the usual rules on deciding between a Roth and a traditional
IRA are much more complicated. Additional work showed that in valuing nontaxable entities (subchapter S corporations and partnerships, which are common in the agricultural sector), that appropriate valuation for estate tax purposes or for valuation in litigation requires that the value be based on a pretax level of profit discounted by a pretax interest rate. This is contrary to the conventional thinking that the correct approach is to discount after tax income by a pretax discount rate. Given the level of federal and state income taxes, the difference in these two approaches implies significant differences in the value of farm and nonfarm business entities.
Impacts
This research is of considerable value to farm owner/operators, in that it provides a guidance on both the appropriate level and type of qualified investment plan to select as well as to provide guidance on the valuation of farm and nonfarm business entities.
Publications
- Lewis, W.C. and Bowles, T.J. 2001. The effect of income taxes on optimal portfolio selection. The Journal of Wealth Management 4(2):29-36. Fall.
- Lewis, W.C., Bowles, T.J., and Caliendo, F. 2001. Savings and investment options: Lifetime consumption and financial planning. Journal of Wealth Management 4(1):44-54. Summer.
- Caliendo, F., Lewis, W.C., and Bowles, T.J. 2001. New findings on strategic IRA investing. Journal of Wealth Management 3(4):49-53. Spring.
- Bowles, T.J. and Lewis, W.C. 2000. Tax considerations in valuing nontaxable entities. Journal of Business Valuation 19(4):175-85. December.
- Chakraborty, K., Biswas, B,., and Lewis, W.C. 2001. Measurement of technical efficiency in public education: A stochastic and non-stochastic production function approach. Southern Economic Journal 67(4):889-905. April.
- Bowles, T.J. and Lewis, W.C. 2000. A time-series analysis of the medical care price index: Implications for appraising economic losses. Journal of Forensic Economics 13(3):245-54. Fall.
- Bowles, T.J. and Lewis, W.C. 2000. Time-series properties of medical care net discount rates. Journal of Forensic Economics 13(3):245-254. Fall.
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Progress 01/01/00 to 12/31/00
Outputs
A theoretical model was developed to demonstrate the impact of unanticipated taxes on wealth accumulations. This research used basic finance principles, including the efficient frontier approach to document that the failure to account for such taxes will lead to a nonefficient portfolio of assets; in particular, the portfolio will have too much risk. This has implications for farm asset holdings, which tend to be nondiversified and probably do not maximize the expected rate of return given the level of risk that is taken. It is shown that if the future tax implications were considered, the optimal portfolio offers both less risk and a potentially higher rate of return, and, thus, is more efficient. Data from the Survey of Consumer Finance, the Survey of Income and Program Participation, and the Health and Retirement Survey have been collected. These data provide a detailed picture of the level, structure, and risk of asset holdings by farm households. Preliminary
analysis of these data indicate that farm families have above average levels of wealth, but assets largely are invested in nondiversified portfolios. Obviously, holdings of farm assets (including land, buildings, and equipment) comprise the largest share of assets; in fact, relatively few farmers hold significant assets in any kind of qualified retirement savings plan. Failure to take advantage of such plans is seen as a contributor to not only excessive risk but failure to optimize portfolio holdings. The work on stability of income taxes over time was continued, and a statistical analysis of the federal income tax indicated that that structure is not stable over time and that producers may have difficulty predicting future tax regimes. It appears that the best approach to take for predicting future tax structure is simply to use the current tax structure rather than any kind of historic average or statistical estimation of historic tax structures. Finally, additional work was done
on measurement of profit, including alternative ways for accounting for taxes. A derivative of this work was an analysis of the tax implications of alternative ownership structures of farms and other businesses. It is shown that the tax advantages of an S-corporation (which is not subject to double taxation) implies that there would be a premium paid for a regular corporation that could be converted to an S-corporation over and above the value of the regular corporation itself.
Impacts
This research has significant implications for Utah farmers and nonagricultural enterprises. The measurement of profit and the organizational structure of the business can be significantly impacted by both state and federal income taxes. Careful tax planning and identification of the appropriate corporate structure can result in significant tax saving and enhanced valuation of Utah farms and nonfarm property.
Publications
- Bowles, T.J., and Lewis, W.C. 2000. Unsettled issues in measuring lost profits. Journal of Legal Economics. 9(3):19-32. December.
- Lewis, W.C., and Bowles, T.J. 2000. A statistical analysis of federal income tax rate stability over time and implications for valuing lifetime earnings. Journal of Forensic Econnomics. 12(3):201-214. May.
- Chakraborty, K., Biswas, B., and Lewis, W.C. 2000. Economies of scale in public education. Contemporary Economic Policy. 15(2):238-247. April.
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Progress 01/01/99 to 12/31/99
Outputs
In the first six months of this project, detailed data on income tax rate for each of a number of income classes were collected for the six intermountain states that levy an income tax (i.e., Arizona, Colorado, Idaho, Montana, New Mexico, and Utah). These tax data were used to estimate alternative functional forms of an income tax function relating tax rate to adjusted gross income. The function where tax rate was regressed on the natural logarithm of adjusted gross income resulted in the best statistical results. Tests of stability indicated significant increases at the $25,000 level of income in five of eight states and there were significant increases in the tax function in six of eight states at the $50,000 and $75,000 levels. A similar analysis was made of federal income tax data over the period 1948-1995. It is interesting, that at the federal level there have been significant decreases in the tax function at the same time that state income tax functions have
been increasing. In addition, initial work was begun on evaluating the effect of state and federal income taxes on the optimal portfolio in a qualified retirement plan being held by an agricultural producer. It is found that failure to consider the potential tax implications can result in a sub-optimal portfolio; specifically, there is an incentive to over invest in risky assets such as common stock.
Impacts
This research documents increasing state income tax burdens in the intermountain states. The ability to compete for population and industry is influenced by such tax burdens. Policymakers must be aware of these effects in designing appropriate tax revenue programs.
Publications
- No publications reported this period
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