I highly recommend a recent Matt Yglesias post on taxes. This caught my eye:
My preferred framework for a progressive consumption tax is the one that Cornell University economist Robert Frank has outlined. It would work more or less exactly the same as today’s income tax, but with two major changes:
There would be no differentiation based on the source of income — whether it’s wages, capital gains, dividends, interest, rent, whatever — it all goes into the “income” bucket.
Instead of a little form where you list your 401(k) contributions and deduct them from your income, you’d deduct all contributions to any kind of savings vehicle (bank account, brokerage, whatever).
This is separate from optimal tax theory, but the way it ought to work is the IRS sends you a pre-filled form saying what they think you owe based on what’s been reported to them by employers and financial institutions. In 80-90 percent of cases, you could just check “yes, okay, that’s right” rather than needing to do your taxes.
This is similar to an idea that I often advocate—an unlimited 401k system. People can put as much of their income as they like into a 401k account, and then take the money out for consumption whenever they wish. That essentially converts an income tax into a consumption tax. I especially like the last part, which would save me from having to spend lots of time doing my taxes. But for many of us, that would require simplifying the tax system.
So how does Yglesias come down in the debate over capital gains taxes? Should they be taxed at the same rate as ordinary income, or at a lower rate (as in the current system)?
The phrase “no differentiation based on source of income” might suggest that Yglesias sides with the progressives that favor a higher capital gains tax rate. But things are not quite that simple, as when you reframe taxes as a function of consumption, everything looks very different.
In theory, a flat tax on wage income is identical to a flat tax on consumption. Yglesias prefers to tax consumption directly with the 401k approach, because he fears that wealthy business owners would evade a wage tax by claiming that income they earn working in their own company is actually capital income. This is a general problem with our tax system—the problem of tax avoidance.
Oddly, most people don’t see a wage income tax as being identical to a consumption tax. In a 401k type consumption tax setup, it looks like capital gains are taxed at exactly the same rate as is wage income, although the tax isn’t paid until the income is consumed. But this tax system is identical to a simple wage tax with no capital gains tax at all. How is that possible?
With a wage tax, you prepay taxes on your future investment income before the money is even invested. With a 401k approach, you pay the tax in the future when the money is withdrawn and spent on consumption. Consider a person determined to save 40% of their wage income, which is $100,000 before taxes. Also assume the invested money increases 5-fold over 40 years, before being spent.
A 50% wage tax: After-tax wage income is $50,000, of which $30,000 is spent on consumption and $20,000 is saved. After 40 years, the saving grows 5-fold to $100,000, when it is spent on consumption.
A 50% income tax with 401k privileges: The person saves $40,000 and pays a 50% tax on the other $60,000. That leaves $30,000 for current consumption. After 40 years the $40,000 grows to $200,000. When that $200,000 is withdrawn and spent, half is paid in tax. Future consumption is $100,000.
In both cases, current and future consumption is identical. The two tax systems are essentially the same. But one system looks like it taxes capital gains at the same rate as ordinary income, while the other looks like it doesn’t tax capital gains at all.
This confusion occurs because “income” is such an ambiguous concept. In economics, consumption has a clear meaning, while income does not. We can say that both systems apply the same 50% tax rate to current and future consumption, but as for the “income tax rate”, that’s a pretty meaningless concept. What do you mean by “income”? Thus one person might claim that Yglesias favors taxing capital gains at the same rate as ordinary income, while another might claim he favors abolishing the capital gains tax. Neither person is lying—those are two valid ways of looking at the same reality. He favors no taxation at the moment the gain is realized, but full taxation at the point it’s spent on consumption.
Readers might have noticed that the wage tax example is sort of like the Roth IRA approach to saving. You pay the full tax on the money before it is put into saving, but then don’t have to pay a further tax when the money (plus investment income) is withdrawn at a later date. Nonetheless, the two plans might differ in terms of ability to avoid taxes. Consider the following example from Bloomberg:
If Peter Thiel could use a special retirement account to accumulate $5 billion tax free, why can’t you? . . .
According to ProPublica, Thiel was able to put 1.7 million shares of then-private Paypal into a self-directed Roth IRA in 1999. There are contribution limits for Roth IRAs, but the total value of the Paypal shares was below the $2,000 threshold at the time. Those shares have since exploded in value, along with other investments Thiel has made, but since they’re in the Roth, they aren’t subject to tax.
For simplicity, assume the 1.7 million shares were worth exactly $2000. Also assume that Theil paid a 50% wage tax on his income. In that case, he needed to earn $4000 in wage income to accumulate the $2000 in after-tax income he put into the Roth IRA. If it were a 401k system, he could have put the entire $4,000 into a 401k, which would have grown to twice the level of his Roth balance. In other words, today he would have $10 billion in the 401k, instead of $5 billion in the Roth. So while it seems like he’s getting by without having to pay tax on this huge capital gain, he’s implicitly given up the extra $5 billion that he would have accumulated if he’d spent $4000 on 3.4 million shares of Paypal stock, instead of $2000 on 1.7 million shares of Paypal stock.
You might wonder if the $4000 option was ever actually on the table. After all, if $2000 could turn into $5 billion, then why not invest $200,000, which would later become worth $500 billion—making Theil the world’s richest man. Our intuition tells us that this investment was not scalable. And that intuition is probably linked in some way to our intuition that this investment option wasn’t available to average people. That is, in some sense Theil’s investment success reflected his skill as an entrepreneur. This would imply that the $5 billion gain was partly wage income being treated as capital income. While I don’t know anything about this particular case, I suspect that this is the general problem that Yglesias had in mind when he suggested that the 401k approach was superior to the Roth IRA approach.
Bloomberg points out that there is no evidence that Theil did anything illegal:
Don’t assume that because the IRS didn’t challenge Thiel, they won’t go after you. First, it’s unclear whether Thiel engaged in any prohibited transactions — and he has ample resources to hire lawyers to argue the point with the IRS. For almost everyone else, the resources spent are likely to outweigh any benefit.
Consider almost any highly successful entrepreneur that works hard and builds a very successful business. When they sell that business, some of the capital gain will be a return on the initial investment, and some will reflect the increase in the business value from the entrepreneur’s hard work. This is especially common in the high tech industry, where in some cases a clever idea combined with a relatively small capital investment can produce extraordinarily large returns. It makes an ongoing issue with our tax system much more noticeable. No one cares if a blue color worker purchases and fixes up a run down duplex, and then sells it for a profit that shows up as capital gains, not wage income. In contrast, the Theil case received major news coverage.
PS. I still favor supplementing a 401k-style consumption tax with a wage tax (and a VAT), as I believe that multiple approaches to taxation make tax evasion more difficult. But the focus should always be on taxing consumption. Income should not be taxed at all.
PPS. Yglesias also favors taxing land and negative externalities. I agree.
PPPS. Have you noticed how many people suddenly have an opinion on whether the IRS should get more money? I’d like to ask these people two questions:
1. What is the optimal IRS budget?
2. What is the current IRS budget?
Unless they can answer both questions, their opinion isn’t very valuable. I suspect that most people (on both sides of the debate) cannot answer both questions.
READER COMMENTS
robc
Aug 26 2022 at 2:01pm
Some might say $0 is the optimal IRS budget, in which case, they have no need to know the current one.
I don’t because I favor a Single Land Tax, and that would require some sort of IRS. I wouldn’t answer #1 or #2 other than 1 would be less than 2, I am pretty sure.
Scott Sumner
Aug 26 2022 at 4:08pm
The relevant question is what is the optimal budget for our current tax system, not what is the optimal budget for a tax system that we will not have in the foreseeable future.
robc
Aug 26 2022 at 5:53pm
Wasn’t the whole article about tax systems we will not have in the foreseeable future?
Scott Sumner
Aug 26 2022 at 10:06pm
“Wasn’t the whole article about tax systems we will not have in the foreseeable future?”
Of course not. The part about the IRS budget was not. I’m a bit surprised that you didn’t notice, given that you commented on that specific part of the post.
Frank Annecchini
Aug 26 2022 at 2:08pm
Answering #2: For 2021, IRS expenditures were $13.7B which supported $4.1T in collections and $1.1T in refunds for a net collection of $3T or an “overhead” rate of 0.5%. See here.
vince
Aug 27 2022 at 9:02pm
With “cusotmers” forced by law to pay, whether they want to or not, that overhead rate seems high. Almost all the work should be automated.
David Henderson
Aug 26 2022 at 2:10pm
Scott, I remember Murray Weidenbaum making the same proposal you make, sometime back in the 1990s. I think he called it an unlimited IRA.
Scott Sumner
Aug 26 2022 at 10:48pm
Yes, this idea has been around for a while.
John Hall
Aug 26 2022 at 2:11pm
I recall that Peter Thiel story, but not enough of the details of how he set it up. My recollection, which may not be correct, is that he had invested in shares before the stock went public. Presumably, the price of the shares should at least reflect the valuations for when the venture capitalists were investing the company, but I don’t really have a good sense of how it worked out since $2,000 for over a million shares puts the stock in penny stock territory.
He might have just known that the companies would go public soon and be worth a lot more, but I can’t help but think something shady was going on.
Nevertheless, it might be that being able to invest in private companies you control through a 401k or IRA allows too much opportunity for mischief. I don’t think it invalidates the whole idea of investing with Roth IRA, just that certain aspects of it might be prone to abuse. Fix those instead.
Regardless, we can keep both 401ks and roth IRAs, just raise the income and contribution limits. If you double or triple them and we will effectively have a consumption tax for everyone but the ultra rich (somewhat more complicated since there are restrictions on when you can take money out of them, but the roth IRA is a little more flexible)
Scott Sumner
Aug 26 2022 at 10:47pm
You also need to get rid of rules that force people to withdraw money before they wish to do so.
Thomas Lee Hutcheson
Aug 26 2022 at 5:14pm
Scott leaves out the problem of taxing unindexed capital gains the same as other income, but with “unlimited IRA’s” that would not matter. It would also remove the tax incentive for charitable contributions and somewhat facilitate multigenerational wealth accumulation. (Or maybe not if they were not classified as “consumption” i.e. unlimited IRA and charitable contribution. And since the top marginal rate of a consumption tax might need to be quite high if not >100%, the incentive would remain.)
Jose Pablo
Aug 26 2022 at 5:23pm
Your example shows that the actual system taxed twice capital income:
First thru wage taxes and, later on, thru capital gains taxes (both taxes exist under the current system). The person in your “50% wage tax” example will pay an additional $16,000 in taxes on capital gains (assuming a 20% capital gains tax rate and an $80,000 capital gain).
[And this is not taking into account that the corporate tax rate in place during the holding period affects the $100,000 final value. It would be bigger without that]
Jose Pablo
Aug 26 2022 at 5:51pm
a) A 50% wage tax: After-tax wage income is $50,000, of which $30,000 is spent on consumption and $20,000 is saved. After 40 years, the saving grows 5-fold to $100,000, when it is spent on consumption.
b) A 50% income tax with 401k privileges: The person saves $40,000 and pays a 50% tax on the other $60,000. That leaves $30,000 for current consumption. After 40 years the $40,000 grows to $200,000. When that $200,000 is withdrawn and spent, half is paid in tax. Future consumption is $100,000.
Something does not work in this example: in world “a” you can buy $100,000 of future “after-tax income from investment” for $20,000. But in world “b” you need $40,000 to “buy” the SAME future after-tax income from investment.
At the “price” of “after-tax income from investment” of world a (and “after-tax income from investment” is what you always value and buy) in world b with $40,000 you can buy $400,000 of pretax income ($200,000 of post tax income).
You are somehow assuming that in world b investments are twice more expensive (you pay double to get the same consumption).
It is true that you need to work the SAME in both worlds to get the same aftertax income from your investment. But I don’t think capital markets are valued in “Work” (or in your example in “pre-tax wage income”)
Jose Pablo
Aug 26 2022 at 6:17pm
I see now that because in world b “investors” (meaning “savers”) will have twice the money available to invest, you are assuming that this will result in a 100% increase in the price of assets (assuming the driver of asset prices in both worlds keeps being the after-tax cash flows the assets produce).
I understand you were trying to build a basic example to illustrate your point. Not sure if this is relevant at all with that purpose in mind.
Sorry if it is not.
Jose Pablo
Aug 26 2022 at 6:49pm
Another (maybe interesting) way of looking at this is that since “the money available for investing” will double in world b, investment and value creation will double (assuming there are enough opportunites so that capital returns does not follow the law of diminishing returns in this example).
World b would be much richer in this hypothesis
Another (lees interesting) way of looking at this is that since government in world b will need to finance an additional amount of $20,000 (compare with world a), half of the savings of the wage earner in world b will have to be used in buying government bonds.
World b would NOT be much richer in this hypothesis.
[I promise to stop now. Sorry Scott]
Scott Sumner
Aug 26 2022 at 10:42pm
It probably makes more sense to assume the recipients of the $50,000 in tax revenue spend $30,000 and save $20,000. In that case gross saving is the same either way.
Jose Pablo
Aug 27 2022 at 3:00pm
That would leave the “pricing discrepancy” between the two scenarios untouched:
People don’t pay double ($40,000 vs $20,000) to get an asset that produce the same after-tax return ($100,000).
Scott Sumner
Aug 27 2022 at 4:06pm
Jose, This is one of those ideas that’s hard to explain in words.
Dylan
Aug 26 2022 at 7:42pm
There’s a lot to digest in this post, and I’m feeling ill equipped on a Friday night to dive in, but I want to address at least one point that I see made often that I don’t think is a good assumption.
Why the assumption that the rate of return is equal between different types of saving vehicles? I have both traditional and Roth IRAs, and the Roth’s are worth far more than the traditional, even though I haven’t contributed nearly as much (since the traditional originally started life as a 401K). Part of this is the fact that I have had a wider variety of investment options in the Roth over the entire period of investment, but also I have different incentives. I put my riskiest investments in the Roth, knowing that the returns are all mine, while in the traditional I take a more balanced and diversified approach. I can see other people doing the opposite, the point is only that I don’t expect the tax regime to be neutral for investment returns.
Scott Sumner
Aug 26 2022 at 10:34pm
In the example I gave, the two tax systems were identical. If people invest differently, that’s their choice. But there is nothing in the two regimes that would logically cause people to invest differently .
Also, note that these two systems I discuss don’t correspond exactly to real world Roths and IRAs. In the real world the two systems are different, and people may choose to investment differently, as you suggest.
Thomas Lee Hutcheson
Aug 26 2022 at 8:47pm
The part I REALLY did not understand is what the consumption tax has to do with the prefilled form. IRS could do that today?
vince
Aug 26 2022 at 9:44pm
“What is the optimal IRS budget?”
How can anyone answer that question unless they can observe what the employees do in an 8 hour day? And that applies to any government employee. Many private sector employees have to turn in timesheets with such descriptions. Many professions summarize the information when they bill clients. Government should, especially.
vince
Aug 26 2022 at 9:46pm
Wouldn’t a national sales tax be much simpler than the 401k approach?
Michael Sandifer
Aug 26 2022 at 10:16pm
The problems with sales taxes are illustrated in various states. There are fights over loopholes, etc. For example, in Florida, food isn’t taxed, unless it’s cooked when purchased. Medication isn’t taxed, but should “medication” include herbal supplements? I remember controversy years ago over luxury sky box ticket sales not being taxed, due to a carve out for rich sports fans.
vince
Aug 26 2022 at 11:19pm
That’s true of any tax. I don’t hear Florida clamoring to replace its sales tax system with an income tax.
Matthias
Sep 2 2022 at 1:41am
Different taxes have different amounts of loophole trouble. Same for different tax systems.
My adopted home of Singapore has very simple taxes with much fewer loopholes than what I hear about the US (or Germany etc).
A land value tax could also be much simpler than most current taxes.
Scott Sumner
Aug 26 2022 at 10:38pm
Yes, there are advantages to a sales tax or VAT. Those who prefer the 401k approach often do so because it allows the tax system to be highly progressive. If you don’t care about progressivity, then just have a VAT. But a VAT by itself won’t raise enough revenue to fund a modern (big) government. At a minimum, you’d need a payroll tax too. And probably a property tax.
vince
Aug 26 2022 at 11:13pm
” If you don’t care about progressivity, then just have a VAT. But a VAT by itself won’t raise enough revenue to fund a modern (big) government. ”
There’s a simple solution to the regressivity of sales taxes: A prebate. Say the tax is 20% and poverty level is $20,000. Give everyone a handout of $4,000. Then collect the sales tax on everyone. This is just one example. Another is a very basic, simple, low rate tax on very high earners on their Adjusted Gross Income with no deductions.
As for raising enough money, any broad-based tax should be enough. Tax money is paid one way or another, and it’s a little devious and administratively inefficient to conceal it by spreading it around among various assets, excise taxes, income taxes, and inflation.
Another idea is to get rid of a modern (big) (screwed up) (tyrannical) government. What would our founding fathers say if they saw the monster it now is? They’d say way to go, you gave up your democracy.
Arqiduka
Aug 27 2022 at 7:30am
VAT and prebate is a great idea.
Jose Pablo
Aug 27 2022 at 8:52am
It is indeed. And has so many advantages:
tax counseling will no longer be needed. That means that a lot of very expensive professionals that now perform a task with no social value whatsoever, will have to find productive ways of making a living
And yes, the rate would have to be 40% of higher but that means that the size of the government(s) will be exposed and clear to see for everybody and not hidden behind totally artificial childish “euphemisms” like “types of income”, “employer’s share”, etc…
Politicians will be left with one “toy”less to fool around.
The idea is so good that you can be pretty sure that will never be implemented.
One improvement: let the VAT rate be decided by the voters. In the ballot you “vote” your preferred VAT rate. The final VAT rate will be the average of all the voter’s preferred rates. The government will have to adjust their expenses to the “elected” rate. You can even vote “rates” per area of spending (defense, education, health ….). Voters deciding the budget. That would be democracy at work!
Scott Sumner
Aug 27 2022 at 3:59pm
“Another idea is to get rid of a modern (big) (screwed up) (tyrannical) government. ”I certainly favor this, but as with ending the Fed it requires careful thought. Just to take one example, lots of old people currently rely on Social Security and Medicare. You could eventually transition to fully funded private accounts, but it’s not as easy as snapping your fingers.In the short run, I’d keep funding those programs with the current payroll tax (which doesn’t hassle individuals like the income tax does) and replace the income tax with a VAT plus rebate to the poor. But even replacing the income tax would require a pretty high VAT, especially if it were partially rebated. A land tax and a carbon tax are other possibilities.
Thomas Lee Hutcheson
Aug 27 2022 at 4:25pm
Why not replace the wage tax with a VAT, one mildly regressive tax with another slightly less regressive tax? Replacing the personal income tax (with or without the unlimited IRA) with a VAT is a much bigger structural change.
Jose Pablo
Aug 27 2022 at 8:22pm
You can keep the same entitlements actually in place (Social Security and Medicare included). No need to transition to any private scheme. That’s a completely different debate.
You just fund the existing entitlements tru a VAT. Afterall, the idea that you finance your own retirement thru your payroll contributions is pure “financial fiction”.
What’s the problem with the VAT rate being high? Actually, I think it is politically wonderful that the “thru size” of the government can be grasp just by looking at the VAT rate.
And can you imagine presidential and governor’s campaigns in which all the candidates have to “translate” their new proposed entitlements/political plans into an increase (or, most unlikely, a decrease) of the VAT rate? … wonderful, isn’t it? (With an independent technical body verifying their claims since, you know, politicians tend to lie)
And sure, you can keep Pigouvian taxes and a property tax financing local governments, without affecting the simplicity and beauty of the “only VAT + rebate” scheme.
Scott Sumner
Aug 28 2022 at 1:47pm
“Replacing the personal income tax (with or without the unlimited IRA) with a VAT is a much bigger structural change.”
The income tax is far worse than the wage tax.
Scott Sumner
Aug 28 2022 at 1:49pm
“What’s the problem with the VAT rate being high? ”
Laffer curve effects associated with high levels of tax evasion.
Thomas Lee Hutcheson
Aug 27 2022 at 8:27am
Why would a VAT need to be complimented with a wage tax instead of substituting for it?
vince
Aug 27 2022 at 10:14am
The very low rate, basic income tax on only high incomes is just a possibility for an even more progressive system.
Jose Pablo
Aug 27 2022 at 11:25am
The rebate makes the whole thing progressive enough and the simplicity of the “only-VAT” thing is a beauty. A one-page tax code!!!
Once you start enlarging the tax code parasites and rent seekers start creeping up.
Thomas Lee Hutcheson
Aug 27 2022 at 8:25am
The IRA approach permits the consumption tax to be progressive.
Arqiduka
Aug 27 2022 at 6:45am
Surely, given how very cheap the VAT is to collect, it would be best to rely on it alone to tax consumption and accept some evasion schemes that are peculiar to it, but gain on a much leaner admin. As for regressiveness, merge the VAT and UBI and there you go.
Agree on land et al.
Scott Sumner
Aug 27 2022 at 4:05pm
If you relied solely on the VAT then tax evasion would be rampant due to the very high tax rates (far higher than in Europe.) I may be wrong, but I seem to recall that VATs of say 20% raise about 7% or 8% of GDP. Our federal government spends well over 20% of GDP.
Arqiduka
Aug 27 2022 at 6:05pm
The relatively small portion of GDP collected is due to many, many items which are taxed at preferential rates, which practice runs counter to the point of VAT, but was done to assuage regressiveness fears.
Back when we used to apply very few such exceptions in my not fully developed country, we could get 15pc of GDP from a 20pc VAT, making it entirely feasible in my view to run a modern, bloated government on a universal 45pc VAT plus UBI\ prebate, and some land tax, an nothing else at all. For your alcohol, marijuana and such, bump the VAT up to 60 or so.
As to evasion, VAT is far and away the hardest to evade and easiest to enforce, as you only need to monitor final sales to consumers, not inter-business sales. Can’t see that it’d be harder than relying of 5 different taxes.
Arqiduka
Aug 28 2022 at 3:06am
Scratch that, I wa misremebering, we used to collect 10pc of GDP on a 20pc VAT, since fallen to 8pc from various exemptions.
Scott Sumner
Aug 28 2022 at 1:56pm
I certainly agree that if we didn’t have to worry about politics it would be much easier to devise a good tax system. But people need to know that a comprehensive VAT is nothing like real world VATs. After all, a big part of consumption is owner occupied rent. Another huge part is health care and K-12 education. You can tax all of these with a VAT, but that’s nothing like real world VAT systems.
Arqiduka
Aug 28 2022 at 5:58pm
To the degree that healthcare and K12 are govt funded, you cannot tax them under any system. The proposal you highlight (and simple income tax) “tax” those govt provided services by taxing the rest of the income stream more heavily. But to say that income or other systems tax govt-provided services is like saying that a bureaucrat is paid 1M, to which 900k of tax is withheld, and presto, they pay 90pc income tax. Its all a game of identities.
Agree on real estate though, tou need a stand-alone rax on that.
Scott Sumner
Aug 30 2022 at 2:56pm
My point is that the more types of consumption you exclude, the higher the tax rate must be. Health care alone is 18% of GDP, and a much higher percentage of total consumption.
Dan R
Aug 27 2022 at 12:01pm
The issue with Thiel, is on the initial valuation of stock. For 1.7 million shares to be under $2000, they would have to be about $0.001 each.
The media focuses on the result (gigantic IRA result) rather than the reason (nonpublic assets might not have accurate valuations, why does the IRS trust them?) as that makes a better headline.
I agree that Thiel would still have had a large increase, but doubt that the initial valuation was close to correct. (unless he really got that many shares by investing only $2000) That issue, valuation of nonpublic assets, seems like the right point to get upset about and address. Could anyone have invested at $0.001/share in 1999? If not then that’s not the valuation Thiel should have been allowed to use.
Scott Sumner
Aug 27 2022 at 4:02pm
Yes, that relates to my points that Theil’s investment was probably not available to ordinary people. And again, the 401K approach avoids that problem.
Rajat
Aug 27 2022 at 7:52pm
Scott, how would you treat home purchase costs under this model? To the extent these costs relate to land value, don’t they involve saving? One argument that would be raised if home purchases were treated as consumption is that while middle class people tend to save most via housing assets, rich people tend to save most via financial assets.
Scott Sumner
Aug 28 2022 at 1:58pm
That seems like consumption to me. After all, no capital is being created when you buy an existing home, right?
Rajat
Aug 28 2022 at 2:53pm
Isn’t the same true when one buys financial assets like equities or bonds through their 401k plans or Roth IRAs, etc? No new companies or new funding is being made available to companies. But in both cases, people are deferring consumption. As in, when people buy houses (or take a mortgage to buy them), they are out laying much more than if they were just renting the same property.
Scott Sumner
Aug 30 2022 at 2:49pm
“But in both cases, people are deferring consumption.”
Not in aggregate. If I buy a stock from you, then I save exactly as much as you dissave. There’s no extra net saving.
Aggregate saving equals aggregate investment in actual capital goods.
johnson85
Aug 29 2022 at 12:52pm
Is that the right test? So building a home would be investing but buying existing would not? That seems wrong?
Just first blush, it would seem like buying the home is investing, and then the return (which is consumed immediately) is the implicit rent. Not sure that’s workable in practice.
Maybe you just depreciate it and treat the depreciation as income and tax it? When people are building, unless they have under the table income, there is no incentive to undercount the costs because it will just increase their current tax bill. I guess the incentive would be to overstate it? But then they’d pay it on the back end in higher depreciation?
Scott Sumner
Aug 30 2022 at 2:52pm
“So building a home would be investing but buying existing would not? That seems wrong?”
Building a new home increases aggregate investment. Buying an existing home doesn’t increase aggregate investment, it merely moves an asset from one person to another. No new capital is created.
johnson85
Aug 31 2022 at 6:03pm
” No new capital is created.”
I guess I always viewed the investment/consumption distinction as a distinction, especially in the context of a consumption tax, between “using” something versus “setting it aside”. When I buy a house, I am “setting aside” future use of the house to consume (sort of like prepaying rent for later). When I buy a stock, I’m just parking money (and hoping it grows) for later.
I guess that’s maybe a distinction between savings and consumption rather than investing and consumption, but I sort of thought the difference was irrelevant for tax policy. If you save something by putting it in a bank, it’s still getting lent out to do something with it. If it’s just buying an existing house, that’s also presumably somewhere down the line providing someone money to build a new house.
Michael Rulle
Aug 29 2022 at 5:03pm
“Just to take one example, lots of old people currently rely on Social Security and Medicare. You could eventually transition to fully funded private accounts, but it’s not as easy as snapping your fingers.”
Agree of course.
This is because we live in a democratic political world—-(to paraphrase Churchill; it’s the worst world possible with the exception of all other worlds).
With that out of the way, my wish on Social Security (I don’t have as obvious a solution on Medicare as the medical world is harder for me to understand. I literally do not know how it works) would work something like the following.
First. We would no longer have to lie and pretend it’s not already a sunk cost. The present value losses have already happened (assuming we keep our obligations) BUT they continue to grow. What we want to do is stop increasing the losses and get rid of the system entirely. What to do?
No matter your age you get what you paid in using the current formula and methods. A 35 year old would then switch to any other savings plan —-one of Scott’s, 401ks, self created pension plans or whatever one can think of—-and eliminate all future payments into SS. Then what? We create an actual Social Security Trust Fund with real borrowed money from the public which gets paid out over time to the former SS contributors. (For those who are not aware of this, the current SS Trust Fund is just an accounting phantom—it has nothing in it but words and promises)
Obviously, this is not free money as the Treasuries need to be paid back. This is what I call the sunk cost (relative to never having done SS to begin with). Depending on what actuarial assumptions one makes this would likely take approx 50-75 years for the whole thing to disappear. Plus or minus a decade or two.
Now the hard part. The world will have to believe we will not change our mind. There should be a way (since we are dreaming, let’s make it a constitutional amendment).
Is it worth this hassle just to get rid of transfer payments? Yes, because we really do not have transfer payments—-we have future unlimited increasing borrowing. One can call them transfer payments but it’s absurdly misleading.
We would lock in our already achieved losses, which would become a true realized loss. But it is a fixed number with a known amount. And then we are done with it.
Yes, we might have to move to forced savings—-or we could go the Singapore path—-depending on political opinions.
But we get rid of this SS monstrosity and we can then move on to figuring out Medical insurance😂(Again, as long as we are fantasizing).
I am not joking but it is not a snapped finger concept as our author states. But if we could do it, it would be excellent.
(This is really close to what Ex-congressman Ryan had in mind —-and we saw where that got him)
Matthias
Sep 2 2022 at 1:45am
Talking about getting income tax vs consumption tax right seems like worrying about something that should be a rounding error.
Land value taxes should probably bring in the majority of government revenue. That would allow other taxes to be much lower (if they are needed at all).
Getting a 5% income tax exactly right is much less critical than getting a 37% income tax right. (Similar for consumption and capital gains.)
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