Tax expert Alan Viard has some advice on tax reform that probably won’t be good news to much of his audience. Here are his main points:
- We’ll probably have higher taxes in the future than we do now.
- Taxing investment income at the same rate as labor income is a really bad idea.
- The “Fair Tax”, a national sales tax with a prebate to introduce some progressivity into the system, won’t work.
- A flat tax won’t work.
- Taxes in the U. S. probably won’t come to resemble those in Europe any time soon.
IMO increasing our taxes from 17% of GDP to 21% of GDP is much, much more easily said than done and it’s not even easily said. I’d like to see the proposals from those who want to increase taxes to 21% of GDP on how they plan to do it. Raising nominal rates is not enough.
Our tax policy remains mired in the past as does so much of our federal policy. When personal income tax rates were north of 90% a maximum tax on capital gains tax of 25% was a real incentive. When the top personal income tax rate is 39%, a capital gains tax of 23.8%? Meh. A little incentive but not much.
I agree with Mr. Viard that a progressive consumption tax, presumably administered as a value-added tax, makes a lot of sense. I just don’t see how we get from where we are to there.
Yes, taxes must rise because government desperately needs to claw back the fiat currency it issued.
We should re-evaluate how we tax investments. The more I read the more I think we do it all wrong. We tend to treat all “investment ” income the same way. Doesnt make much sense. We should get rid of the hedge fund nonsense and tax their earnings as income. Short term cap gains from stock and bond investments should be treated as ordinary income. Long term gains should be taxed at a slightly lower rate. Earnings from investments in new businesses or in expansion of old ones should be tax exempt in years 2 through 5. If the money used to invest is borrowed, it should be tax free in years 5 through 10. In other years it should be taxed at same cap gains rate as long term stocks and bonds. Exempt all earnings from new small businesses (revenues less than $1 million) with at least 5 employees for the first year or two on a one time basis for the owner and his/her family.
Steve
“When the top personal income tax rate is 39%, a capital gains tax of 23.8%? Meh. A little incentive but not much.”
Spoken like someone not putting the money up, or expecting the return. Watching the Bears get whooped, and will read the article…..but right now:
A prototypical LBO investment (for firms like us) would be to put up $50MM and hope to achieve in 5 years a 2.75x gross cash on cash return. That’s an $88MM gain and a gross IRR of 23%. That, my friends, is prototypical; right down the middle of the fairway. Fun with numbers:
Let’s suppose that gain is taxed at 39% and reduced to $54MM. The government (for all their hard work and risk taking – guffaw)gets $34MM, the investors $54MM. Now $50MM grows to $104MM, an IRR of 16%.
Let’s suppose that gain is taxed at 24% and reduced to $76MM. The government (for all their hard work and risk taking – guffaw) gets $21MM, and the investors $67MM. Now $50MM grows to $117MM, an IRR of 19%.
Investment professionals kill over those extra 3pts. In fact, the difference between equity investments and subordinated debt investments is sometimes only 4-5 points, and you would really, really rather be in the mezz piece of the cap structure.
And on the original $50MM investment, the extra $13MM is 26% of the original $50MM bet. This is huge. The practically bankrupt IL public pension system projects an 8% return on their portfolio. Its a bogus assumption, but here’s some perspective. Those 3 points I just cited? It 38% of their assumption, and probably 60% of their gap. And take away the taxes? The difference between a 23% IRR and 16% IRR is almost the whole damned thing. Think taxes don’t matter?? (Endowments are tax exempt, not sure about Chicago and IL.)
People, we ain’t in Kansas anymore. These policy decisions have real implications for real people.
These policy decisions have real implications for real people.
Zzzzzzzzz….
Any call for for a tax rise is a call for a financially poorer non-government, as is a call for less spending. So many who claim to revere the private sector can’t wait to enact policies for kicking it in the nuts; when things inevitably get worse they’ll be stunned, geniuses that they are.
What logic does a consumption tax make other than to reduce consumption? “We have a serious lack of effective demand now, so let’s make it worse because a balance sheet will be all lined up and we’re obsessive-compulsive.” And then we get the pleasure of watching said people freak out when the sheet doesn’t balance as revenues fall.
Excellent analysis, ice, you little financial analyst, you.
steve
I think I know where you are trying to go, although there are some clumsy parts.
“We tend to treat all “investment †income the same way.”
As you are about to write, time and intent (expansion or innovation vs replenishment of capital stock) does have implications.
“We should get rid of the hedge fund nonsense and tax their earnings as income.”
Not sure you really understand what you say here. If a business owner invests for capital gain, they get capgains treatment. If a “hedge fund,” whatever that really means, invests for capital gain they should get same. If they are simply trading in securities, I understand. To wit:
“Short term cap gains from stock and bond investments should be treated as ordinary income. Long term gains should be taxed at a slightly lower rate.”
This is certainly seductive, and I understand the temptation to put obstacles in the way of speculation. But what if growth capex had a 1 year payback And what is slightly??
“Earnings from investments in new businesses or in expansion of old ones should be tax exempt in years 2 through 5.”
How do you square this with the hedge fund comment? You do realize that a venture firm does the former and an LBO fund does the latter.
“If the money used to invest is borrowed, it should be tax free in years 5 through 10.”
??? What should be tax free? The debt financed gains? And how do you apportion the debt vs equity financed gains? And since equity capital is more dear than debt, why would you tax advantage debt?
“Exempt all earnings from new small businesses (revenues less than $1 million) with at least 5 employees for the first year or two on a one time basis for the owner and his/her family.”
A nice gesture. And I’m all for it. I think you would find profits for said businesses miniscule.
A little factoid. Estimates have job creation for the 5 employee and under businesses at about 60% of all. Those with 5-100 about 30%. That’s us.
Yes, a bit clutzy writing it at work when things are slow. I dont have strong feelings about the specifics, but I think the fact that we treat gains from ordinary securities purchases the same as investing in a new venture a bit odd. We want more of the latter.
Steve
“Yes, a bit clutzy writing it at work when things are slow.”
I know the feeling. You are the only left leaning commenter here who seems to understand the ultra-importance of investment. I’d like to pursue this. Right now watching Patriots – Denver.
Drew, all your posts ultimately say one of two things. Either,
“Hey, I’m the biggest asshole in the room!”
as when you go off about such things as being intentionally rude to strangers at the golf course
-OR-
“You guys need to do more to make me richer, because THINK OF THE LITTLE PEOPLE!”
I’m sure it’s tough always being the ONLY person who is ever right about anything (“I told you people but no one would listen!”) and being the only hero us little people have.
And for the record, I’m nothing but a stay-at-home dad these days. All you Heroes on the Left and the Right have been too busy raping the economy for us little people to do anything other than hang on.
I’m sorry you are a failure, ice. Take it out on someone else.