The Other Downside Of Social Justice Taxation

Dominic Pino at NRO has the story on Los Angeles trying out social justice taxation to try to fund various actions for the homeless. He starts out:

Los Angeles passed a tax on mansion sales to fund government programs for the homeless. Sounds simple, right? Take from the rich, who can afford the tax, and give to the poor, who need the assistance.

We put sales in bold because that is what makes it avoidable. The nefarious wealth taxes are going to evaluate your stuff and tax you on it but LA waits for a transaction. We’re not supporting wealth taxes and there are ways to avoid and evade those too but the wealth tax denizens have their plans too. Of course folks, especially folks with wealth, can find a method to avoid such transactions. Dominic tells us about the results. The tax went into effect on April 1. As you would expect there were lots of sales just before then:

The tax is raising less money than expected. The Post reports that from January through the end of March, 248 properties priced above $5 million were sold in Los Angeles. Since the tax went into effect on April 1, only 34 have been sold. Supporters of the tax hoped it would raise $900 million per year. But the city now estimates it will raise $670 million, and Mayor Karen Bass is only counting on $150 million in her homelessness plan, the Post reports. In its first two months in effect, the tax had only raised $15.5 million.

And, surprise!, not nearly as many after that. We don’t have the dates from the Washington Post post because that is a paywall we don’t pay but it looks like there are three months on either side of April 1. The problem that Dominic does not discuss

Sidebar: Dominic knows and he often tells us about the what is missed in economic transactions but in this short post he doesn’t get to the waste problem. End Sidebar.

is the wasted effort to avoid these onerous and often avoidable taxes. Dominic does tell us that the real estate industry in LA has something new to offer its wealthy clients. It is a bit of an overstatement but instead of Brad Pitt making a new movie he is deciding about how and when to sell his house. All of the tax avoidance work is a waste to society. And, of course, with onerous taxes there is an evasion problem where folks trying to evade (that’s illegal) the tax. That means that governments have to spend more money to enforce the tax law and that is another waste. Dominic is exactly right that we need taxes with broad bases and low rates. He is right because governments can know what to expect in revenue, they are cheaper to enforce, and taxpayers are less likely to spend time and money to avoid and evade them.

Modifiers Matter

Our president, The Frontrunner, wants to create a new tax. Well, he want to increase or create a number of taxes but we are talking about so called minimum tax on billionaires. In discussing it, the WSJ Opinion Editors ask a question and gives us an example as an answer. We’ve taken out a sentence to emphasize the problems of modifiers:

What is income, exactly? … Yet it’s relatively easier to say what income isn’t. If you own a house, or a stock, or a trendy and pricey modernist painting, it isn’t income simply when the market value rises.

Of course it is income when an asset you own goes up in value just as it is a loss when it goes down in value. When your house, 401 (k), or gold stash goes up in value then you are better off and you have income. It is a strong argument to say it is not income until it goes up in value in real terms but that is about the term value not income. The sentence we replaced with … is below:

That question can be trickier than it sounds, since the IRS says income includes fringe benefits, plus “the fair market value of property or services you receive in bartering.”

Income for taxes is very different than income for accounting. Of passing interest in that sentence is the statement that fringe benefits are taxable but they aren’t actually taxed. That is, the big fringe benefit, health care insurance, is not taxed. We wish it were but that is how it is.

Until now the federal government has show great wisdom in not taxing wealth or changes in wealth. The Frontrunner’s new budget proposal changes all that. The WSJ again:

One part of President Biden’s budget that deserves more attention is his stealth wealth tax, because it looks unconstitutional. He’s selling it as a 25% “minimum tax” on billionaire incomes, but see the fine print. The tax would apply to “those with wealth of more than $100 million,” while covering “all of their income, including appreciated assets.”

Why is it foolish to try and tax wealth or changes in wealth? The most important reason is that you don’t want to drive it out of the tax jurisdiction. There are lots of practical problems too. The value of many untraded assets like houses, paintings, and private companies are difficult to determine. The value of assets we can measure goes up and down. We see The Frontrunner’s plan for prices going up. What happens when they go down? Would have Jeff Bezos got a big refund in 2022 when Amazon stock price went down? A third problem with taxing wealth is liquidity. The federal government has until now wisely taxed realized (when you get the cash) gains and not unrealized gains. How would have Jeff paid his enormous unrealized gains in 2020? Perhaps you are not worried about Jeff? What happens to other Amazon stockholders when Jeff has to sell lots of shares?

We are pretty sure all The Frontrunner’s tax increases will be DOA in the GOP House and all but certain this one will be at the top of the chopping block. If this one passes they really isn’t much need for the GOP. It will just be two wolves and a sheep voting over what is for dinner. We are torn, however, about the possibility of passing them so they can be found unconstitutional by the Supreme Court. It is a high risk proposition but if wealth taxes were found unconstitutional it would make future debates more grounded in reality. And when you have them be sure to refer to gross income or taxable income and not just income to make it clear the discussion is about taxes.

The Misnamed Billionaire Tax

As we said yesterday we wanted to get to our president’s, The Frontrunner, tax proposal but we thought the investment charade in Chicago (see here and our last post) was more foolish than the tax proposal and we posted on that first. While we were doing that John Hinderaker at PowerLine addressed the billionaire tax with the post [The Frontrunner]’s Dumbest Idea Yet. It is a tough call because there is so much competition. Kevin D. Williamson is also on the case today at NRO with another read worth your time. Here is the the White House Fact Sheet if you can’t get behind the WSJ paywall. Do read John and Kevin’s posts but we want to start with the basic dishonesty. The fact sheet headline is

President’s Budget Rewards Work, Not Wealth with New Billionaire Minimum Income Tax [Emphasis added]

First of all that doesn’t make any sense about wealth but the text says they didn’t mean billionaire:

The tax will apply only to the top one-one hundredth of one percent (0.01%) of American households (those worth over $100 million). Over half of the revenue will come from households worth more than $1 billion.

So, almost half the revenue comes from taxpayers who are not billionaires. We get it. They want to target the wealthy but why not be honest about it? When you are the party of the wealthy and don’t want to admit it you put up a smokescreen like this that won’t become law.

John starts a good point that closely held corporations and other assets that are not publicly traded are difficult to value:

If your wealth consists in large part of closely held companies, real estate, fine arts and similar investments, this will be a matter of opinion and endless grist for litigation.

John is absolutely right but there is a bigger point that is the problem for any wealth tax and this proposal is really a wealth tax. The problem is that taxes must be paid in cash. It is hard to sell twenty percent of a closely held corporation. It is even harder to sell twenty percent of a Van Gogh. This is a particularly foolish tax because it will cause rich folks to spend their resources to avoid taxes rather than creating more income and wealth.

As Kevin says, there are plenty of taxes.

Sidebar: Remember that our proposal for a carbon tax includes eliminating the federal gas tax so the number of taxes would be unchanged. End Sidebar.

If that is what they want to do, The Frontrunner and the Democrats should pick one and propose to raise it so it has an impact on high income folks. They might want to check with the Tax Foundation data and see how much the top one percent already pay in individual income taxes. We still think Chicago was worse because it involved actual malpractice whereas this is just a political smokescreen to avoid Democrats being correctly identified as the party of the rich.

A Bad Tax But Not A Wealth Tax

The 11/15 National Review arrived while we were on vacation. Our favorite part, This Week by the NR editors, contained this convoluted anti-tax argument which we give you in full:

When is a wealth tax not a wealth tax? When, Treasury Secretary Janet Yellen doublespoke, it is “a tax on unrealized capital gains of exceptionally wealthy individuals.” The latest plan by the Democrats to help pay for what will be unaffordable is to tax what should be untaxable, namely gains that exist only on paper, and thus are in no sense income. Never mind the logistical obstacles that have caused even Nordic states to abandon wealth taxes. Even if any such tax would pass constitutional muster (debatable), it would remain undesirable, not least as a disincentive to long-term investing and an invitation to confiscation. And if anyone derives any comfort from the fact that this proposed tax would affect only “exceptionally wealthy individuals,” he or she should turn to the history books. Taxes that begin by being imposed on the rich do not end there. [Emphasis added]

An argument is only as strong as the weakest link and the editors’ argument has two links made of Cheerios. We are constantly amazed by the breadth and depth of the editors knowledge but you can’t be an expert about everything and accounting appears to be a knowledge hole for them. We agree entirely with their conclusion that this is a particularly bad tax but their paragraph is unconvincing for two accounting reasons.

First they argue it is wealth tax but Janet is exactly right that a tax on [current] unrealized income is not a wealth tax. Wealth is the stock or balance and income is the flow or change. This is a tax on the change or a tax on income.

Sidebar: Here we wander beyond our expertise and ask if folks should pursue the constitutional muster question that the editors find debatable. We think not. On the yea side there is the possibility that the tax on unrealized gains would be found unconstitutional by the Supremes as a bunch of constitutional lawyers might not know much about accounting and economics. It would be a great victory. But it seems more likely that the wealth tax gambit would fail with the Supremes because even lawyers should be able to see that it is not a wealth tax and that would embolden the tax and spend crowd. End Sidebar.

Then we have bolded the editors’ assertion that “gains that only exist on paper are in no sense income”. Gains on paper are income. We don’t think they should get the modifier taxable income but they are gains or income nonetheless. When your Roth IRA portfolio doubles you have income because you are better off financially but you don’t have any taxable income. Even financial accounting measures and reports changes in marketable securities as income with various modifiers. The problem is that taxes must be paid in cash and on time.

Let’s consider Microsoft and Bill Gates. Microsoft has gone up about 120 points in the last year (yes we know it is not the calendar tax year). Here it says Bill Gates owns 330 million shares (another former CEO owns a few million more) but Microsoft is just a small part of Bill’s portfolio. So in round figures Bill has an unrealized gain of about $40 billion on Microsoft alone in 2021. Nobody we’ve found identifies the tax rate so we are going to make a wild guess of 25 percent because that means Bill owes a nice round $10 billion just for Microsoft. That means he must sell about 30 million shares to pay his tax bill. We don’t know if that will move the market but it certainly is the wrong incentive to get folks to invest. It makes citizenship on some tropical tax haven island look pretty good.

If the proposal goes beyond marketable securities then the measurement problems become huge. According to this, the bill will tax all stock, bonds, real estate and art. That means enormous measurement problems and resulting litigation. It encourages an inefficient use of resources as folks are spending their time trying minimize taxes rather than create value. There are some very large privately owned companies and big investments in real estate and art. It sounds like they are coming for The Donald. It means that measurements will be contentious and taxpayers will have a real challenge trying to pay the resulting bill because it is really hard to sell 25 percent of a Van Gogh.

The recent cite also tells us that taxpayers can recoup their taxes if the assets fall in value. This would put tax collections on a roller-coaster. A year like 2021 would be great for tax collections but 2008 would be a disaster. Would we cut back spending when the next 2008 comes?

A wealth tax could be the worst possible tax. The proposed tax on unrealized capital gains is almost as bad. But it is a tax on income and it is not a wealth tax. Here is a good way to think about tax proposals. If your are creating a tax bill and you realize you need to include rules to stop people from leaving the country then you need to come up with a different idea.

When To Compromise?

Politics is, amongst other things, about getting wins, avoiding losses, and finding compromises. Success in politics requires a gambler’s instinct. Economics is a more intellectual pursuit. It is not that folks aren’t intellectual in politics and that they don’t try to win in economics but the nature of the two disciplines are different. We want to consider the economics and politics of the minimum wage, a carbon tax, and a wealth tax.

Mark J. Perry at Carpe Diem is exactly right about the economics when he says (it is the last item at the link):

The federal $7.25 an hour minimum wage is not a binding wage anymore and almost 100% of US workers already make more than that due to market forces and local minimum wages, so it really doesn’t matter. There’s no need for federal lawmakers to engage in “political wage-setting” at the national level.

We agree there is no need for federal political wage setting. But it is true that Congress is rife with proposals about such wage setting. It is also true that because the minimum wage has an impact on so few people that raising it will not be particularly onerous. That is why we support Mitt’s minimum wage proposal. It takes the minimum wage out of play (well, almost) and you get something useful like E-Verify. There is a good compromise to be made.

We think replacing the gas tax with a roughly equivalent carbon tax is another good compromise. It seems reasonable that less carbon is a good thing. When you tax something you get less of it. Because a carbon tax makes carbon based stuff more expensive and “alternative” sources more attractive the deal is some reduction in crony capitalism for “alternative” energy sources in return.

On the other hand, there is no room for compromise on a wealth tax. We don’t want less wealth. The average return on wealth is small, perhaps six to eight percent, and uncertain so there is no wealth tax that is not onerous. That is why there is a need for wealth tax proposals to include methods to stop rich people from leaving the US.

Compromise is a tricky thing. Matthew Yglesias has an interesting piece at Bloomberg about the challenges of minimum wage compromise for both sides. Other than he seems to think that increasing the minimum wage will help poor workers, it is worth a read.

The hardest part about compromise is that it is a gamble and like The Gambler you’ve got to “know when to walk away and know when to run.”

Wealth Versus Carbon Tax

Philip Cross at NRO Capital Matters explains why a wealth tax won’t reduce income inequality or raise much revenue for the government. Of course, even though it is over a week old, you should read the whole thing. We think Philip’s best argument against the tax is incentives:

A wealth tax also distorts economic incentives, encouraging consumption while penalizing the savings and investments that foster higher long-term growth. This is especially true when wealth taxes are layered on top of taxes on the capital income that wealth generates.

We are convinced we shouldn’t worry about income inequality at all. Economic growth, that Philip brings up above, is much more important. We want growth, because as JFK’s saying goes, a rising tide lifts all boats. Almost all of us are better off than our great-grandparents because of economic growth. It is a reasonable argument that all of you reading this are better off than the world’s richest man 100 year ago. JFK wasn’t exactly right. There are some leaky boats that sink deeper in a rising tide but generally we should be more focused on chasing the growth fairy than worrying about income inequality.

A carbon tax is an example of a policy that won’t help growth but is worth trying. Like most policies, it is hard to guess what impact it would have on income inequality. Some time ago at the university we had the rule: to build a program you had to burn a program. We like that rule applied to taxes. We don’t want to build a wealth tax because, as Philip says, it gets incentives wrong and has big costs for little revenue.

We would like to burn the federal gas tax to build a modest federal carbon tax. It is not that we think that climate change is a clear and present danger. It is not. But it doesn’t hurt to move the incentives in the right direction. Related to that, part of the carbon tax negotiation would be to eliminate subsidies of “alternative” energy production. If you think a modest carbon tax reflects half of the true cost of carbon that you eliminate half of the subsidies.

Sidebar: Why have a modest carbon tax rather that a “full” carbon tax? First, we don’t know the exact cost of carbon. Second, if you think it is a high cost then industries need time to adapt. Moving a step in the right direction is almost always a good idea. It is especially true when the range of potential correct answers is huge. End sidebar.

Don’t worry about income inequality. If you do, find something more useful than a wealth tax to attack it. It would be much more useful to worry about specific groups like folks that are homeless because they won’t take their meds. It is much more important to find ways to get the growth fairy to visit. While you are thinking about solving serious problems like that a modest carbon tax might be a useful thing to install. It would move incentives the the right direction and generate some revenues.