Monday, April 20, 2015

Death and Taxes

After operating on a fiat system for 20+ years people are starting to realize that the only thing that backs a currency is the real productive efforts of their people. Yes, over time we always borrow more than our productive efforts can pay back and proceed to crash the money system.
But what else is new? (smile)

We call this a money's "timeline" and it's as new an idea as life, death and taxes! Time and debt age any money system until it dies. The world moves on. Only this time gold is going to play a different part in the drama. We will all watch it unfold.
-FOA "Foundation" (2/26/00)

In 1789, Benjamin Franklin wrote, "In this world nothing can be said to be certain, except death and taxes." But while death and taxes may be certain, the combination of the two certainly isn't.

Last Thursday, the day after Tax Day in the US, the Republican-led House of Representatives voted to repeal the estate tax or "death tax" with a bill that President Obama promises to veto. This is a hot-button issue (and it should be IMO) even though it only affects 0.18% of deaths that occur in the US at its current limit of estates valued at over $5.3M.

Why is it such a hot-button issue? Well, for the Democrats, it shows that the Republicans are working hard for the 1%, or even the top 0.1%, the very wealthiest of the elite. But for the Republicans and for the majority of average Americans (68% in one poll), it's about the instinctive feeling that one's accumulated (after-tax) wealth should be able to be passed on in total to whoever you want it to go to, regardless of size.

As you probably guessed, I have a rather nuanced view of this issue. The top argument from the Democrats is that this is a rational point of taxation, in support of the greater social good, with major benefits compared to other types of taxes such as income and consumption taxes in that it only comes from the very rich. For the other side, the argument is a little more difficult to make in today's $IMFS world of paper wealth.

In my opinion, the problem with the top argument against the "death tax" boils down to the difference between real physical wealth and not-so-real-but-highly-liquid paper wealth as wealth is currently defined by the $IMFS. In order to make this problematic argument, Republicans are forced to think of extremely uncommon examples whereby physical wealth that is passed on must be sold, or borrowed against, to pay the tax burden.

The best example they could come up with (that would at least draw a little sympathy) was the small family farm. And while it's actually a good example of the principle, it's quite weak as presented, as an empirical foundation for the need for a congressional vote changing the national tax law, a weakness that is easily exploited:

"And what about those family farms Republicans are always talking about, the ones that are constantly being sold off to pay the estate taxes? They’re a myth. When The Post’s fact-checker Glenn Kessler was doing his estate tax fact check, he asked the office of John Thune, the sponsor of the Senate version of repeal, about the farms we keep hearing about. “Thune’s staff conceded that they could not identify a single farm that had been sold because of the estate tax, but they said some farms had to sell acreage in order to pay the tax.” Nobody else seems to be able to find one, either. You’ll notice that when Republicans talk about this, they always posit a hypothetical family farm being sold off and not “My constituents the Millers had to sell off their farm,” because the Millers are the equivalent of a unicorn." -Washington Post 4/17/15

Speaking of unicorns, imagine one, perhaps yourself as a unicorn, who put all of his wealth—his foregone consumption during his productive life—into physical wealth items like a nice home with a little land, fine furnishings, a few antiques and works of art, and a prized classic car or three. Should such a basket of wealth accumulated over a lifetime of overproduction/underconsumption be halved for the greater good, just because you died and your son or nephew or whomever took over ownership?

How do you figure the value of such an estate anyway? It's full of unique physical items, from the home to the artworks, so all you can really do is estimate a price it would presumably bring if it all went to auction, and then force some of it into auction in order to obtain—for the federal government who can print its own currency—remuneration for public services that was already paid when the money that bought the items was earned in the first place.

I have often said that savers pay inordinately through the "inflation tax" and currency devaluations when they save in currency-denominated paper assets, but does it really make sense to make them pay more for the greater good than anyone else regardless of what they're saving? I say absolutely not!

The Paris Hilton effect is certainly a factor. People are envious of people like her. Why should she live such a lavish lifestyle and not pay any taxes like the rest of us? Well, it's just a matter of scale. If you'd like to be able to leave your own children some wealth that will hopefully give them a head start on life, why does that principle stop at some point where envy kicks in?

The way I look at it is pragmatically. If she's earning income, she should pay income taxes just like everyone else, and she does! If she inherited an income-producing business, then she should pay taxes based on the income she earns. If she chooses not to work and to only consume conspicuously, she will surely run down her inheritance.

If we want to tax conspicuous consumption, we can easily tax all consumption and the conspicuous consumers will obviously pay the most. But we don't, because in reality that taxes the poor inordinately. So, instead, we tax income on a progressive scale where the more you earn, the higher the percentage you pay. Then, of course, there's the issue of investment income.

For that, we tax in a more favorable way because we want to encourage investment based on the notion that it leads to more jobs. And in some cases it does, but in the $IMFS paper world of stocks and bonds, this whole principle has become immeasurably distorted.

In the investment world, there is income and there's capital gains. Income is near zero today with ZIRP and global unprofitability due to asset overvaluation and lots of debt, so all that's really left is capital gains. And where I think we fail is in not distinguishing between capital gains in the paper and physical worlds.

Capital gains are generally only taxed when the item that gained value is sold. A capital gain is figured by subtracting a basis or starting value from the sales price, but the estate tax aims to take a slice based on a zero cost basis and an estimated selling price. It really is a wealth tax. It views the death as a transfer or transaction and the heir as receiving a gain or an income that can be taxed. But this obviously necessitates that slice being sold into the marketplace because the government has no use for physical wealth items like fine furnishings, antiques, works of art or classic cars.

In essence, the idea is that the value of those wealth items be transferred and redistributed to needy consumers. But let's think about that concept for a moment.

For the super wealthy, if you cut their wealth in half, it's not going to have an impact on the amount of basic necessities they consume over their (and even their heirs') lifetime. If anything, it may affect the quantity or quality of luxury items (wants) that they consume. An example the Washington Post article used is an heir buying a Porsche rather than a Ferrari. But here's the issue. How does that reduction from a Ferrari down to a Porsche free up (or create) more basic necessities for the needy consumers to consume. The answer is it doesn't.

Say Bill Gates decides to give away $10B to feed the poor in Africa. Does that create $10B worth of new basic necessities for them to consume? No, but it does redistribute the existing necessities to where he wants them to go. In fact, it does so by raising the price of necessities as the poor in Africa are able to bid some away from the rest of the world.

It's the same concept when we tax wealthy estates in an attempt to convert wealth into consumable necessities. In the arena of necessity consumption, it doesn't take any away from the rich and give it to the poor. What it does is eliminate the marginal saver, turning him into a net-consumer, to the benefit of the poor. This may not be a bad thing, but I think it's a concept worth understanding because it also has a few knock-on effects and unintended consequences.

As I said above, we could certainly tax consumption instead of the complicated system we have today. In fact, the "Fair Tax" proposal is basically a 30% sales tax that would replace all income, payroll and capital gains taxes. This may even be a good idea as it would certainly simplify the tax system, but it would have the same effect as above, that effect being that it would eliminate the marginal saver, turning him into a net-consumer, to the benefit of the poor.

A consumption tax like the "Fair Tax" is progressive on consumption (the more you consume, the more you shoulder the tax burden), but regressive on income and wealth (the more you earn or have, the lower consumption falls as a percentage of your income or wealth). A 30% sales tax would simply raise the price of everything, which will only turn the marginal saver into the marginal net-consumer, increasing the total number of net-consumers.

We certainly want to make sure that the poorest of the poor have the basic necessities and that our government has the income it needs to provide necessary services, but beyond that point we are only (and unnecessarily, IMO) increasing the total number of net-consumers while also increasing the total number of poor living on public aid by disincentivizing both work and saving. And this is true with any tax system, but especially true for something like the estate tax which pretends to transfer necessities from the rich to the poor, but only really transfers them from the marginal net-producer to the new marginal poor.

It feels good to the green envy monster in those who have one to take wealth items away from the super-rich, but let's take a quick look at some of the knock-on effects and unintended consequences.

The most obvious one is that the forced sale of wealth items will put downward pressure on the value of all such items. This only affects the rich, and has no benefit to the poor. The buyer of such items that were forced into the marketplace will get them at a lower price, but he too is rich. The forced seller of the items may have to reconsider his conspicuous consumption and downsize from a Ferrari to a Porsche, but that only affects the bottom line of Ferrari and Porsche, and they too are rich.

The wealthy man is taking nothing away from the poor by holding wealth. If that wasn't so, then it could be said that the more wealth any person has, the more he is withholding from the poor. This would make any savings immoral, which is simply not the case. The wealthy will always consume the same amount of basic necessity consumables, and only their consumption of luxury items (wants) will vary.

Some people truly believe that if only the super-duper-rich weren't allowed to be so rich, then the poorest of the poor starving in Africa would have food on their plates. But this is simply not the case. The super-duper-rich are not withholding food from Africa. If anything, they produced real value at some time and traded it for rather useless but expensive things (like Balloon Dogs and such). There is a problem if we have poor people starving in Africa, but the problem is not that the price of fine art at Christie’s is too high.

Like I said with the Bill Gates example above, the rich can choose to help the poor in one area or another, but all that does is force a redistribution of available necessities by adding money to bid on them in one locale over another, driving up the price of necessities just a little bit everywhere. I'm not saying that's a bad thing, but I am saying that if we try to do that systemically, and not by individual choice, it is a bad thing that will have unintended consequences.

Where those unintended consequences play out is at the margin of any group you choose to observe. The marginal net-producer will become the new marginal net-consumer. The marginal Ferrari driver will become the new marginal Porsche driver and so on. Overall, you will end up systemically increasing the number of people dependent upon the system, reducing the number of people who would otherwise be self-sufficient for their entire lives, and increasing the number of net-consumers and therefore elevating the debt level which has its own knock-on effects, like choking the global economy.

Now before you start railing against trickle-down economics, I'm not suggesting a trickle-down theory here. I'm not arguing for reducing the income tax or any other tax (other than eliminating the estate tax) on the rich. In fact, if the rich are deriving an income from their investments, then that should be taxed like any other income. And if they are trading in and out of liquid paper investments in order to churn an income through short term capital gains, those should be taxed as income as well, and today they are for the most part.

But if you followed my reasoning above on unintended consequences playing out at the margins, then I think it follows that if we systemically encourage and incentivize saving in real wealth items, the opposite will occur. The marginal net-consumer will become the marginal saver. Overall you will end up decreasing the number of people dependent upon the social safety net, increasing the number of people who will be self-sufficient over their entire lifetimes, increasing both the number of productive individuals and total productivity which will expand the arena of necessary consumables, and reduce both the total number of debtors as well as the total level of debt, which will be good for the global economy. And, of course, the marginal Porsche driver will become the marginal Ferrari driver (but who cares, other than that green envy monster?).

Again, tax income all you want, or at least all you can politically get away with, and feed the poor and make sure the government meets its budget, but beyond that, you are only creating more dependence on the social safety net and more dependence on government, less self-sufficiency and more debt. And within this concept, the estate tax makes a quantum leap to the far end of the bad side of the spectrum in going directly after wealth items at the very top in an attempt to convert them into consumables at the very bottom, which simply doesn't work and has knock-on effects that trickle—negatively—all the way down.

This is not supply side or trickle-down theory and there's no Laffer curve here, just a simple concept. But if you can't see the difference, you may want to check that green monster inside. The huge paper fortunes of today which will go poof one day soon would not even happen in the first place. I am on the same side as the critics of wealth disparity who point at investment bankers and Wall Street. That's all a gross aberration, not real capitalism, and an artifact of the end of the timeline of the $IMFS. Like I said at the top, where I think we fail is in not distinguishing between capital gains in the paper and physical worlds. Let's encourage saving in physical wealth items and tax the heck out of the jerks who save in paper choking the economy into global stagnation! :D And eliminating the estate tax is as good of a start as any, as far as I'm concerned!