The Taxman Returns

The Taxman Returns

“The art of taxation consists in so plucking the goose as to obtain the largest
possible amount of feathers with the smallest possible amount of hissing.
– Jean-Baptiste Colbert, Louis XIV’s Finance Minister, 1665

The most recent $2 trillion tax and spend plan mooted for consideration is euphemistically titled, “The American Jobs Plan”, which is being discussed as an “infrastructure bill”, itself a euphemism for a cornucopia of benefits to be landed on a variety of constituencies ranging from hard-edged union bosses to misty-eyed green new dealers. The true infrastructure component is about 15%, slightly higher than the “shovel ready”, 12%, in the American Recovery and Reinvestment Act in 2009.

The best part about this plan is that these groups will garner lots of benefits but someone else will be taxed to pay for it. As Russell Long famously had it, “Don’t tax you, don’t tax me, tax that man behind the tree.”

Taxes are an emotional topic. Although there is lots of great economic analysis of assorted tax schemes, the politicians and media prefer to push that aside as it is a bit dull and does not generate great sound bites. Better to talk about “the greedy corporations” and “the selfish rich people” and “people not paying their fair share.” For the most part these hyperbolic phrases relate to myths that circulate in the marketplace of ideas. So today, I thought we would take out some nitro and explode a few myths.

Myth One: The greedy corporations. The “Jobs Act” will increase the tax rate for corporations from 21% to 28%, with an added Alternative Minimum Tax (AMT) of 15% on income reported on their public accounting (FASB) books. The naïve woke journalists seem astonished that corporations maintain two sets of books (ah ha!) but alas they have two sets of government regulators – the IRS and the SEC, each with their own specific demands. For the most part corporations are not “greedy” they are simply compliant with their regulatory masters.

The point of the AMT is to help politicians avoid the embarrassment of their 10 million-word tax code, which sometimes fails to produces any tax revenue from corporates that report significant accounting profits. As they did with individuals, rather than sort through and fix what they have created, better to just put an AMT patch on top of the mess. But then why shouldn’t these “greedy” companies join in the same nightmare individuals have been dancing with since 1970?

The core myth here is that corporate taxes are a big deal. In 2019, corporate taxes contributed only 6.6% of the $3.5 trillion in Federal tax revenue.

The major corporate tax function is to collect withholding and payroll taxes from employees on behalf of the government. Some may argue that they pay half of Social Security and Medicare taxes but it is just as easy to imagine if those taxes did not exist the labor market would push those sums into the hands of employees. So to be clear, the main impact of raising the corporate rate will be to drive more elaborate tax structuring behavior, not raising money. But then the political sound bite benefit is significant.

Myth Two: The rich have enough money to pay for everything. In some sense they already do pay for everything. For example, in 2018, the top 1% paid 37% of all income taxes and the top 18% paid 80%. The tax reform in 2017 actually made the distribution of tax payments more progressive, with the rich paying a greater percentage.

Payroll taxes are a different matter as these flat taxes are regressive in nature similar to the way consumption is taxed in Europe. The lower income groups pay a greater percentage of their income with FICA capped at $142,800. The new law removes the cap at $400,000, meaning this tax will become much more progressive. This change will affect about 2.6 million taxpayers

The wealth of the very rich cannot stack up to the politicians’ voracious appetite for money. The aggregate wealth of the 657 billionaires in the U.S. is estimated at $4.26 trillion – even taxed at 100% it is not enough to make much of a dent even in the extra COVID spending bills from last year not to mention the $4 trillion pending for this year. We could tax that wealth away as Senator Warren suggests, but many on the list are entrepreneurs. Take away that wealth incentive and we might miss out on iPhones, Google products, Nike shoes, Teslas, the convenience of Amazon and the “everyday low prices” at Walmart.

Myth Three: It is for the children. One of the least examined but most significant sources of revenue in this new tax regime is the loss of the step-up in basis for inherited assets. For example, suppose you bought a house in San Francisco in 1992 and paid $565,000. Today that house is worth about $2.2 million. You die (RIP) and leave that house to your kids who live in Chicago. Naturally they want to sell the house. Under the old rules the tax basis of the house would be $2.2 million so there would be no capital gains tax to pay. Under the new rules the tax basis would be $565,000 and at the new capital gain tax rate of 39.6%, $647,000 of the value would be transferred to the federal government.

Boomers have an aggregate net worth of about $54 trillion, much of it in appreciated assets that normally would go to their heirs. With this new law the most significant heir for that boomer wealth will be Uncle Sam. In effect, the Biden administration has written itself into your will. I wonder, if the Millennials understood that they are going to bear the cost of this $2 trillion effort, would they have a different view?

Myth Four: The government can create jobs. The great John Maynard Keynes argued that government deficit spending should be used to create jobs to smooth over recessions. (Note that the U.S. is not in a recession and is enjoying robust economic growth at the moment.) When asked what these additional workers should do he replied: “The government should pay people to dig holes and fill them up again.” The reason for that is almost any other activity by these new government employees will add to regulation or displace private sector employment distorting free markets.

To counter this myth, consider a survey that Gallup runs from time to time that shows Americans estimate that 51% of their tax dollars are wasted by the Federal government. The numbers vary a bit over the years and by demographic and political orientation but the range is consistently between 44% and 56%. Those are big numbers but it is unlikely that wasted part of the government activity is the same across all groups. One group may think the defense department is wasteful and another the education department. As they say, one person’s wasteful government program is another’s “investment in the middle class.” The high level of tax compliance in the U.S. is nothing short of remarkable given this perception of government incompetence and corruption.

Finally we would like to recommend Charles Adams great chronicle of taxes, “For Good and Evil – The Impact of Taxes on the Course of Civilization.” Adam’s points out that, “Once discriminatory taxes are assessed against a despised minority, it is only a matter of time before they become oppressive.”

Or as it was inscribed on an ancient Sumerian clay tablet, “You can have a Lord, you can have a King, but the man to fear is the tax collector.”