I generally stay pretty deep in the weeds of taxation looking for little tidbits that might otherwise go unremarked like this case about how to deduct a covenant not to compete. I have fairly low expectations of taxes being fair or making sense. So my motto about taxes is “It is what it is. Deal with it.” I make it a rule not to comment on tax policy. I break the rule somewhat less often than Captain Kirk violated the Prime Directive.
I recently wrote a couple of posts about Warren Buffett’s comment that he thinks he should be paying more taxes. Here is a link to the second one. The point I was making was that Mr. Buffett gets more benefit from not realizingcapital gains than he does from paying a favorable rate on the gains that he does realize. I think some of the people who made comments inferred a policy recommendation in there somewhere and reacted accordingly. One guy thought that somebody who makes such obvious comments doesn’t deserve to be on Forbes. The Forbes E-book On Warren BuffettThe $59 Billion Philanthropist, chronicling 50 years of Buffett’s investment savvy and unprecedented giving, is available now for download. The problem with most comments on tax policy is that numerous issues get mixed up – fairness, efficiency, inequality to name a few. I’m going to try to explain here why I think making intelligent comments on tax policy is so hard. I picked Jennifer Aniston to represent a very high-income individual, who though wealthy is not near the same league as Mr. Buffett when it comes to net worth.
The religion I belong to doesn’t have a creed. We have principles. One of those is:
Respect for the interdependent web of all existence of which we are a part
There is no question that taxation is part of that web. The thing about a web is that when you go tugging on one of the strings, it’s a little hard to predict how your tug is going to change the web. The taxation string criss crosses all through the web. If you will forgive an analogy shift, pretend for a moment that our country is a family and we are facing a number of decisions:
1. How much should we consume currently?
2. How should the consumption be distributed?
3. How should we allocate our capital ?
There may be some people who think that the threat of starvation or lack of access to medical care is necessary to prevent slacking. I don’t agree with that. In the current situation of the world I don’t think we need to be that way. Enough people will want enough more than simple subsistence that the wheels of the world will keep turning even if we charitably assume that slackers might be suffering from undiagnosed mental illness. I really think we can afford to guarantee a base line. We actually do but in a very messy complicated manner, because we don’t want to admit that we are doing that.
What about consumption above that ? We probably need to have the possibility of unequal consumption in order to discourage slacking. Beyond a certain point, though, it is really wasteful. I don’t want to be hypocritical here. I live a pretty extravagant lifestyle. I pay somebody $75 per week to clean my condo rather than clean it myself. Last year because of the all wheel drive I went from a Toyota Corolla to a Subaru Impreza . With the Subaru you have to get electronic locks and windows. I saved two grand on the Corolla by sticking with mechanical locks and windows. Then there are those trips to Barnes and NobleNE-0.12% with the kids – don’t get me started. Regardless, my point is that the only justification for extra consumption, however you might measure it, is to encourage people to do their jobs.
Here is where it gets really interesting. What is the job of wealthy people ? Well, of course, there are people who are wealthy who are doing all sorts of different jobs, but what is it that wealthy people, as wealthy people, are charged with doing. They allocate capital. That’s their job as wealthy people. Now they may do it very indirectly by hiring an advisor who allocates funds to many different money managers who invest in companies like CVS, where managers decide whether they should have a store every quarter mile or so or that maybe people can make it an extra mile or two to fill their prescription or buy a bottle of Mountain Dew. Still the wealthy person has to make the ultimate executive decision. What do they get paid for doing that ? If we look at it in terms of consumption they can take whatever they want. But if they take too much, they will have to get another job. My impression is that Warren Buffett has more or less fixed his lifestyle. So what does Warren Buffett get when he does a good job ? He gets more work to do. What happens if we tax Warren Buffett more ? There will be less capital. Warren Buffett will have less work to do.
Now Warren Buffet had income, I inferred, of $40,000,000 and a net worth of $50,000,000,000. Jennifer Aniston, on the other hand had income of $27,000,000 and a net worth of a mere $120,000,000. So it is conceivable taxing her more might mean less consumption on her part. Maybe it will discourage her from buying her own jet or a bigger one. According to Forbes contributor Kiri Blakeley, there are probably people who are wishing that Ms. Aniston would spend less on clothes, but that is probably immaterial.
Here is the other problem. We are all better off if our capital allocators, the wealthy people, do a good job on allocating the capital. Taxing capital gains biases them towards standing pat rather than taking new risks. That’s the argument for taxing capital gains at a preferred rate or not at all. We would probably get the most efficiency if we didn’t tax capital gains that were reinvested but then taxed them at a punitive rate if they were funding consumption. Of course that would be kind of like kicking somebody when they’re down.
Another really good example of the tension in tax policy is the current excitement about hedge fund managers getting capital gains treatment on their carried interest. Reading some of the commentary you would think that there is some special Code provision for hedge fund managers. The reality is that the favorable treatment arises from fundamental principles of partnership taxation. To fix this problem, assuming it is one, it is proposed that we add 3,000 words to the Internal Revenue Code and create a new category and some new concepts. Existing deals would not be grandfathered. So much for simplification. By the way, if you want to talk about hedge fund managers and their carried interests and 2/20 and don’t know anything about partnership taxation and don’t want to learn, just shut up.
The point of this piece is that it is very hard to say anything intelligent about tax policy that won’t also seem stupid when viewed through another lens. I think a lot of commentators just look through one lens. One looks through the lens of efficiency and another through the lens of fairness. So I think I will probably go back in the weeds.