The recent theft of tax information on wealthy people, apparently by some IRS employee, and its delivery to ProPublica, certainly has caused a stir. The disclosure was a crime and should be punished, but the information is informative about our current tax structures and needed reforms.
Many issues beg for public discussion but reporting on these disclosures are muddled to say the least. Some stories may have amplified misunderstanding rather than removed it.
Confusion was evident in the second paragraph of a New York Times article: “The analysis showed that the nation’s richest executives paid just a fraction of their wealth in taxes — $13.6 billion in federal income taxes during a time period when their collective net worth increased by $401 billion, according to a tabulation by Forbes.”
The problem here is a disconnect between income and net worth. To the general public, “they have very high income,” is the same as “they are very wealthy.” But to economists and accountants, the two are quite distinct.
Income is a flow over time. It is the money value received in a given period. This may be pay for work or interest, dividends, rents and other returns on assets.
Wealth is a total, a stock of value at some point in time, the market price of all assets owned minus money owed to other people.
The two certainly are related. Wealth usually comes from income. High income allows people to amass wealth. Wealth generates income. But there are some distinctions and exceptions.
The thrifty retiree who amassed stock in their employer’s corporation for decades and who may have a nice car and house but who lives on Social Security is an example of high wealth and low income. The young NFL sensation paid $15 million a year who blew it all on Lambos, chartered airliners to take friends to tropical isles and cocaine purchases but put nothing away had great income — but little wealth.
But the bigger academic issue is the nature and purpose of taxes. In general, there are four categories that can be taxed: income, consumption, property and wealth.
Federal and state income taxes are familiar to many, as are sales and property taxes. But about the only U.S tax on wealth is that levied on a tiny minority of estates after the owners’ deaths.
The value-added taxes levied in most other countries, including Canada, are a tax on consumption. Here we have state and local sales taxes that hit a smaller fraction of consumption than most VATs.
Real estate taxes on our homes, farms and commercial property are a property tax. They only take into account some assessed value of these lands and buildings. They do not depend on how much debt the property is securing, the overall net worth of owners, nor their income. So young couples who have $25,000 equity in a $250,000 house pay the same as someone who owns one outright. A retiree living on Social Security pays as much on the value of their home as a dual-income couple earning five times as much but living similarly.
Most states had personal property taxes in the past, like the one levied on my grandparents’ two bedsteads, cookstove, three horses, six sows and so on, back in 1911. The administrative costs of these taxes were enormous relative to revenue. Most were ended 40 years ago. However, annual license fees on vehicles are a vestige of a property tax that is not on real estate.
Now consider taxing income and wealth. Accounting theory says “income” is “consumption plus accretion to wealth.” That last is a fancy way of saying change in net worth. But measuring either consumption or net worth changes is cumbersome. So we tax cash flows in from working and cash returns from interest, dividends, rents or other cash returns from property.
However, we only tax the income from increases in value of physical and financial assets when these are “realized.” Sell stock, bonds or land and you will have to report the amount by which the sale price exceeded what you paid years or decades before.
This difference or “capital gain” is not adjusted for inflation, but it is taxed at a lower federal income tax rate than other income. And yes, there is a notorious exception for real estate that allows much of that to avoid payment even though financial asset sales are hit.
Jeff Bezos, Elon Musk and Bill Gates may own billions of dollars of stock in the companies they started, but they don’t “realize” any income until some is sold.
Why not just tax them on the increase in value of their holdings whether sold or not? Or on the value itself? If we did this only to the very rich, it might be manageable. But at what threshold should such as wealth tax kick in? Understand that as you cruise a rural Minnesota highway, each square mile of farmland you see may easily be worth $6.5 million. But much of it is mortgaged. Some is owned by retirees who are property rich, but have low annual incomes.
Also consider a household that bought a house 15 years ago that has tripled in value. Should they have to pay capital gains on the increases just over the last two years?
Yes, one could set the threshold high and catch only a few thousand of the highest-net-worth households. Progressive senators Bernie Sanders and Elizabeth Warren probably would support that. But there are further complications.
How do you value assets and measure any changes each year? You can look at stock prices for corporations. But wealth taxes inevitably push some money into oil paintings, diamonds, Greek islands and so forth. Will the IRS have to raid the Antiques Road Show for qualified appraisers? Depend on Greek appraisals?
Moreover, the market price of Amazon or Microsoft depends on their major owners not selling out chunks of their large holdings. It is an inverse fallacy of composition. Thousands of small stockholders can sell 50 or 100 shares with little effect on the price. But if Elon Musk drops 5 percent of his Tesla shares into the market, panic would ensue, big institutional investors also would run for the door and the price would tank. Do we estimate his wealth before or after we force him to pay the proposed annual tax?
There are further issues, including changes to the existing system proposed by the Biden administration. But that is a topic for another day.
St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
Real World Economics: Tax data leak begs several questions - TwinCities.com-Pioneer Press
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