Wednesday, December 6, 2023

The Income Tax Paradox

The Supreme Court is hearing a case with profound implications for the income tax. WSJ editorial here and good commentary from Ilya Shapiro here

This issue is naturally contorted into legalisms:  What the heck does "apportioned" mean? How is "income"  defined legally? I won't wade into that. What are the economic issues? What's the right thing to do here, leaving aside legalisms?

Three general principles underlie taxation. The most important is: The government taxes what it can get its hands on. The economists' analysis of incentives comes much later: The government tries to tax in such a way that does not set off a rush to avoidance, either legal (complex structures to avoid taxes) or economic (don't do the thing that gets taxed, like earn income). 

So why does the government tax income? Because, circa 1913, income was easier to measure than sales, value added, consumption, or other economically better concepts. When money changes hands, it's relatively for the government to see what's there and take a share.  Tariffs really start from the same concept. It's relatively easy to see what's going through the port and demand a share, Adam Smith, David Ricardo and free trade be damned.  But the government wanted more money than tariffs could provide. 

So, even if it were a good idea to tax wealth, the problem is that there is not neceassarily any cash around where there is wealth or unrealized capital gains. When you sell an asset, you get some cash, and it's easy for the government to demand it. When you do not sell an asset, you have no extra cash. It's a "paper profit." What are you going to pay the government with? 

This comes up in practical terms with estate taxes. Yes, we have a 40% top marginal rate wealth tax right now. (If wealth taxes are unconstitutional, why isn't the estate tax number one on the chopping block? OK, I promised not to delve in to law, but I wish someone would answer it.)  But private businesses, family farms, and the like don't have 40% of their value sitting around in cash. Unless you carve out a Swiss cheese of loopholes, and complex legal structures, you have to break up or sell the business to get the cash. That's why the estate tax has said Swiss cheese. 

It also has happened in the news lately with internet titans who got big stock grants at the top of the market. The market crashes. They still owe tax on the value of stock when granted. 

Property taxes are another case. Yes, we have wealth taxes, in the form of property taxes. (They are state and local, not federal, and the issue is federal wealth taxes.) People sometimes can own a house but not have the money to pay the tax. 

Wealth and unrealized capital gains are also troublesome because in many cases it's hard to know exactly how much there is. Just what is the value of a house, a building, or a privately held business? Accountants can differ, especially if taxes are at stake. The minute you tax it,  accountants also can get creative about corporate structure to game valuation rules -- voting vs. non voting shares, debt with embedded options, options to buy that are never exercised, interlocking trusts, and so forth. See above estate tax Swiss cheese.

Moreover, market values change. If I pay tax on unrealized appreciation this year, do I get my money back when the value goes down next year?

So you can see it makes sense: If one wants to include "investment income" as "income." then tax it when there is a definite value -- the market sale price -- and  tax it when there is some cash around to grab; when it is realized. 

But now trouble perks up. It's reasonably easy to turn actual income into an unrealized gain. Suppose you have some income stream, and you don't plan to spend it right away. You want to reinvest it. Rather than pay income tax on the income, then additional income tax on the interest or dividends over time, and then more income tax on the appreciation of the final sale, create a corporation or other entity; let the income flow into the corporation which reinvests it. The "corporation" could just be a shell to receive income and put it in a mutual fund. Yes, you'll still pay capital gains tax when you sell, but that's a lot less. And delay is always great. 

Now you know why we have a corporate income tax at all. There is no economic point to corporate taxes, and "corporations pay their fair share" is nonsense. Every cent of corporate income tax comes from higher prices, lower wages, or lower payouts to stock and bondholders. We should tax those people. And if you want redistribution, taxing the "right" people, that's a lot easier to do when you tax people. But if there is no corporate tax, lots of people will incorporate to avoid income taxes. So, we tax corporate income and then your payout. Thousands of pages of tax law and regulation follow to plug one hole after another.  After 100 years of patchwork, including some taxing of unrealized gains, it sort of kept a balance, but people keep inventing new ideas. The case before the court involves domestic owners of a foreign corporation and the treatment of the income received into that corporation abroad. 

So, as revealed by the pro-tax arguments before the court, we have already stepped over the grab-it-while-it's-hot line and taxed a good deal of unrealized income. There was some sort of equilibrium of not overdoing it. 

But not overdoing it, obeying norms and gentlepersons's agreements, is going out of style these days. From WSJ:

The Ninth Circuit’s opinion opened up a freeway to tax wealth and property. And wouldn’t you know, President Biden’s budget this year includes a 25% tax on the appreciation of assets of Americans with more than $100 million in wealth....

Justice Samuel Alito asked: “What about the appreciation of holdings in securities by millions and millions of Americans, holdings in mutual funds over a period of time without selling the shares in those mutual funds?” Ms. Prelogar replied: “I think if Congress actually enacted a tax like that, and it never has, that we would likely defend it as an income tax.”

Well, it's also called an estate tax, and we have it now!  

There you have it. The Biden Administration believes the Sixteenth Amendment lets Congress tax the unrealized appreciation of assets. As Justice Neil Gorsuch noted, when the Supreme Court opens a door, “Congress tends to walk through it.” The Justices should close the wealth-tax door. 

But it is also true that would upset the delicate balance above that allows the government to collect a lot of taxes. Someone has to pay taxes, so other rates would have to go up a lot. When one side overdoes it, the gentleperson's agreement explodes. 

Like corporate income, taxing investment income also makes no sense. You earn money, pay taxes on it, and invest it. If you choose to consume later rather than now, why pay additional tax on it? One of the main don't-distort-the-economy propositions is that we should give people the full incentive to save, by refraining from taxing investment income.

So why take investment income? Again, because once you tax income, many people can shift labor income to investment income. If you run a business, don't take a salary, but pay yourself a dividend. If you're a consultant, incorporate yourself and call it all business income. In the 1980s even cab drivers incorporated to get lower corporate tax rates. 

The income tax is the original sin. Taxing income made no sense on an economic basis. The government only did it because it was easy to measure and grab, at least before people started inventing a century's worth of clever schemes to redefine "income."  It leads inescapably to more sins, the corporate tax and the tax on investment income. And now the repatriation tax on accumulated foreign earnings. 

What's the solution? Well, duh. Tax consumption, not income or wealth. Get the rich down at the Porsche dealer. Leave alone any money reinvested in a company that is employing people and producing products. Now we can do it. And we can then throw out the income tax, corporate tax, and estate tax. 

Income is really meaningless. You earn a lot of income in your middle years, but little early and late. The year you sell a house, you're a millionaire, but then back to low income the rest of the time. Yet our government hands out more and more benefits based on income as if it were an immutable characteristic. It is not. Consumption is a lot more meaningful! 

The case brings up another uncomfortable question. The couple invested their money, and then the IRS changed the rules and told them to pay taxes now on decades worth of past earnings. While we're playing lawyer, laws generally cannot penalize past behavior. Surely if they knew this rule, the couple would have arranged their business differently. 

Here there is an uncomfortable principle of taxation. Unexpected, just this once and we'll never do it again wealth taxes are economically efficient. The problem of taxation is disincentives. If you announce a wealth tax in the future, people respond by not accumulating wealth. Go on round the world private jet tours instead. (I hear UAE is nice this time of year, and all the smart people are there.) But if you tax existing wealth, and nobody knew it was coming, there is no disincentive. 

This is, however, one of the most misused propositions in economics. That promise never to do it again isn't credible. If the government did it once, why not again? And it feels horribly unfair, doesn't it? Grabbing wealth willy nilly unpredictably is not something responsive rule-of-law democracies can or should do. (This  issue came up with the corporate tax cut. There was a lot of effort not to reward past investment. That's the same principle as trying to tax that past investment now that it is made. I prefer stable rules.) 

Thus, I actually hope that the Supreme Court does blow up the tax system. It's a bloated crony-capitalist mess. Most people suspect that others with clever lawyers are getting away with murder, which is corrosive to democracy.  If the friends of the court are right that the tax system will not survive a narrow definition of income, that  might force a fundamental reckoning. We need a ground up reform. Not every decision taken in 1913 has to last forever. Let the income tax implode, and bring on a consumption tax. (Instead, not as well as!) 

I doubt it will happen though. The court is really good at constitutional law, but not at first-principles economics. With the continued political assault on their legitimacy, they will surely find a way to decide this narrowly, and wait to strike down the wealth tax when and if it is enacted.  But who knows, it's interesting that they took it in the first place. 


  1. "What's the solution? Well, duh. Tax consumption, not income or wealth. Get the rich down at the Porsche dealer. Leave alone any money reinvested in a company that is employing people and producing products. Now we can do it. And we can then throw out the income tax, corporate tax, and estate tax."

    First, unless you expecting the IRS to accept Porches for payment of taxes, someone's monetary INCOME is taxed no matter how you slice it.

    The only thing a consumption tax does is exclude income obtained from the sale of certain goods / services.

    Second, how are you defining an investment? The first Porsche that I buy is my daily driver. And the whole fleet of Porsche's, Ferrari's, Lamborghini's, and Mercedes that I have in my investment portfolio?

    Or my 5 investment residential properties in Florida, New York, California?

    1. Yes, but their cash is not taken in tax until they buy the Porsche.
      Whenever they consume resources they relinquish (in tax) a portion of their right to consume resources. So the government can use that cash to allocate resources to some other consumption. Like teachers. Or war machinery.
      The only problem arises when people with cash don't spend it (so no tax collected). Easy, says Keynes, just borrow the cash they are holding onto and pay it back when they start spending again.

    2. "Yes, but their cash is not taken in tax until they buy the Porsche."

      Exactly, and if you look at consumption trends, there is a significant amount of seasonality to it. US Consumption spending peaks in the months leading up to the holidays (November and December) and then falls off a cliff in the proceeding months (January and February).

      Part of the reason that the US (and most other countries) tax income and withholds taxes on income is that it stabilizes the federal government's revenue stream through the year.

      That is difficult (if not impossible) to do withholding with a "consumption" tax.

      With the large swings in seasonal purchases and a consumption tax, the federal government would be engaging in a LOT more short term borrowing to make up budget shortfalls.

      "The only problem arises when people with cash don't spend it (so no tax collected). Easy, says Keynes, just borrow the cash they are holding onto and pay it back when they start spending again."

      Keynes assumed that the only financing option available to the government is debt (war bond) financing. Keynes was wrong.

      With an income tax AND an equity financing option, federal debt falls regardless of other policy choices.

      "So the government can use that cash to allocate resources to some other consumption. Like teachers. Or war machinery."

      With an equity financing option, a third possibility becomes available - money received by government from sale of equity is used to retire debt.

    3. Once you understand the equity financing option, you will realize that this country needs a lot less "war bonds" and "war machinery".

  2. The estate tax predates the 16th Amendment. It was accepted by Supreme Court at that time as an excise tax, like the whiskey tax.

    Yes, it should be put down, but it is too much of a political symbol for some politicians to let it go.

    The tactic of opponents has been to hollow it out by increasing the exempt amount. The exemption for 2023 is $12.92 million per person. ($25.84 mil for a couple). So the tax is of very little relevance to 99+% of the populace.

    Half of the exemption will expire in 2026 unless Congress does something about it. At this point it is hard imagine Congress being able to order a pizza. Lawyers and consultants will have a field day selling products (convoluted trust instruments) to capture the expiring exemption.

  3. I agree with you that the US Supreme court is not going to do anything to impugn the validity of the Federal Tax system as it stands.

    A lot of right of center people would like to blow up the system that feeds the Federal beast. But, as nice as that is to think about. It is pure fantasy.

    There is no meaningful set of voters who want to shut down Social Security, Medicare, Medicare, and the other engines of social welfare.

    Additionally, the world is a dangerous place and our existing defense establishment needs to expanded, recapitalized, and modernized to meet the challenges.

    Finally, the cumulative political irresponsibility of the government has left us with a debt of about 123% of GDP. Every dollar of that debt is a dollar of taxes that must be collected, even if it is in the form of hyperinflation. (You people just don't know what fun really is.)

    And, no we are not going to grow fast enough to out grow these problems. Think about it. To cut the debt to 60% of GDP, we would have to double the size of the economy, and incur no more debt. To do that in 10 years requires a growth of 7.2% (rule of 72).

    An aging and soon to be shrinking population, a collapsing educational system, a severe shortage of savings, and limited technological headroom, all add up to low growth. Fiddling the income tax won't change those fundamentals.

    We have had the income tax now for 110 years. Its shape is the result of hundreds of political battles. Its ability to produce revenue has been little affected by all of the remodeling over the years.

    It is what it is and it is not going to change very much or produce enough revenue to prevent a catastrophe.

    The real tax question is what kinds of excise taxes do we need to impose to produce the amounts of revenue we need to run the Federal Government?

    1. It’s well known in Biology that even very simple organisms avoid pain. Even Liberals avoid it, although they might try to gloss over their behavior. In our case, when we came into some money we decided to pay off our home rather than putting everything into investments. No interest, no interest deduction and lower income on paper looked best to us. That is the tax code driving behavior. The other truth is that tax avoidance is as old as taxation.

    2. "Additionally, the world is a dangerous place and our existing defense establishment needs to expanded, recapitalized, and modernized to meet the challenges."

      1. Presumes that we (and we alone) are the "world" police.
      2. Even if what you say is true, without any cost control, it's a fools errand.

      "Finally, the cumulative political irresponsibility of the government has left us with a debt of about 123% of GDP. Every dollar of that debt is a dollar of taxes that must be collected, even if it is in the form of hyperinflation."

      "To cut the debt to 60% of GDP, we would have to double the size of the economy, and incur no more debt."

      To cut the debt, all that you need to do is switch to equity financing.

  4. The US, oddly, does not require taxpayers to detail their wealth in their income tax statements. I could never figure out how the IRS finds out if one is enriching himself criminally. With a Declaration of Wealth done every year one can compare income with yearly wealth variation and catch those whose increase in wealth is unexplained. I can think of some prominent American politicians who might get in trouble under such a system. A country that requires taxpayers to list their assets and liabilities can easily transform the income tax statement into a consumption tax statement. The taxpayer would continue reporting his income, which would be compared with the wealth variation. The difference would be the consumption, which would be taxed. The consumption tax could be much more progressive than the income tax, with marginal rates exceeding 100% without eliminating all incentive to work or invest.

    1. I have a simple question with regard to taxing consumption. If we tax ideas in the form of books, how would we tax ideas carried by the internet. If we listen to a podcast or watch a tv broadcast, does the sponsor advertising budget cover the ideas being consumed also. And does a stock market purchase/sale also see a consumption tax? There’s a lot to figure out, and a lot of future work for lobbyists.

  5. 1. the 2017 tax change was a regime change for international holdings of companies.

    there has to be a change advisement of sorts.

    my sorry understanding is that in general terms, the new levy wasn't a once off grab. at least not by intention. and those international accumulated gains were always fully taxable on repatriation anyway.

    if my reading is correct, than its not the abusive stealing described in the article. even if for certain individuals it accidently happened to be. assuming this was mostly not the case.

    2. the court's job isn't to maximize economic efficiency
    but narrowly to interpret the law. I agree that like legitimacy, they try to factor in societal welfare if possible.

    but did anyone yet to educate them on this specific case?

  6. Could you address the arguments against consumption tax...such as a decrease in demand threatening the existence of certain companys?

    1. See the several blog articles that were posted earlier this year on the subject of a consumption tax of 30% on all domestic consumption proposed by a Republican congressman from the State of Georgia.

  7. Can you imagine the impact on Long Term Capital Gains Tax? People would be howling in the streets with assets they're getting taxed on with revenue that may or may not exist...

  8. Do you then propose to tax rent, medical care, and U of C tuition? All are classified as "consumption."

    1. He does, unapologetically. Especially medical care for the elderly in nursing homes in the last stages of life when Medicare covers but a small fraction of cost of care.

    2. Tax is already paid on real property and that cost is passed on in the amount of rent that is charged. Nothing would change there. The profits from all of the companies that provide medical equipment/drugs/technology is taxed, also no reason that cost to the patient would change. Universities' non-profit status is regularly debated here and elsewhere. If you receive a scholarship, it is taxable in many cases. We could figure that out easily enough. Perhaps people would stop getting useless 'studies' degrees, etc.? But probably not. Hey, nothing is perfect.

    3. All well and good for explicit rent. However, to prevent distortions, homeowners imputed rent should also be taxed (I guess the argument would be that it already is in the form of property tax, but it would be a fairly dramatic change in administration to have some sort of assessment of imputed rent, rather than value of the asset).

      As for the medical care argument, it includes an unstated claim about the incidence of taxes on medical business income (corporate and otherwise). The assertion seems to be that it is on the owners of the entities providing care. The incidence could also be, for instance, on the workers, or on the consumers or some combination thereof. Not an area in which there is a lot of knowledge. Even tougher in this case than in other enterprises, given the massive information asymmetries here and the existence of many administered prices.

    4. A consumption tax of 30%, as proposed by the FAIR TAX lobby, on the tax-exclusive price would introduce enormous economic frictions on residential, commercial and industrial property and new construction. On a tax-exclusive price of $1 million, the IRS would collect in excess of $300,000 at closing (comprising tax on the real estate, legal fees, title insurance premiums, transfer taxes, and broker commissions).

      In terms of medical costs at the end-stage of life for the elderly who have savings set aside to pay for those costs, a consumption tax of 30% would be levied on savings that have already been taxed; it would force the elderly to choose between foregoing medical treatment (and needlessly suffering pain and torment) or ending their lives early via medically-assisted suicide. A consumption tax on the after-income-tax savings of the elderly is in effect a lump-sum tax on savings (wealth) at the rate of 30%. Under the consumption tax, the elderly face a very stark choice under the consumption tax proposal that they cannot plan for or avoid other than via an untimely death.

  9. Taxes on consumption and land property should be the obvious way to go. Taxes on income and companies above 10 to 15% are always asking for trouble. The use of companies and trusts becomes essential for many. When the tax situation gets really bad, then offshore companies and trusts come into play. Enjoy.

  10. "When you sell an asset, you get some cash, and it's easy for the government to demand it. When you do not sell an asset, you have no extra cash. It's a "paper profit." What are you going to pay the government with?" -- JHC.

    This is not a problem, as may be seen in the case of the income tax levied on partnerships, LLCs; and state and local property taxes levied annually on real estate. The tax liabilities are settled from other income (cash), or borrowed funds (cash); or ultimately from the cash proceeds of the sale of the property taxed (cash).

    The practical side of the problem lies in defining the taxable value basis of the asset as at the valuation date. For tangible assets with multiple sources of comparable value, this is largely an actuarial problem; for intangible assets where uniqueness determines value, the problem is that of determining fair value on a theoretical arms-length basis between a hypothetical willing buyer and a hypothetical willing seller. For example, what is the market value of the Hope diamond between auctions that are few in number and far between? It is not the equivalent value of the number of industrial diamonds of equal caret weight. It is not the last received price at the most recent auction of the diamond adjusted for inflation. Multiply that problem by many millions of owners and many more millions of unique assets held by those owners. The practical answer is to avoid taxing unrealized gains (losses), and stick to realized gains (losses) which can be measured and recorded in databases and which do not depend on hypothetical arms-length sales to determine value (gain or loss) between fixed valuation dates, and to concentrate the tax collectors' efforts on restricting non-arms length transactions that seek to avoid transaction taxes.

    As to the proposal to rely on a consumption tax to take the place of the income tax, the nature of the consumption tax is not as economists would have us believe -- more efficient than the income tax and less distortionary (fewer 'frictions') than the income tax. As Adam Smith stated, "the purpose of production is consumption." Where a consumption tax is levied on the purchase of articles and services, consumption is depressed and in consequence of this production is depressed. Tax evasion efforts are multiplied and are not less a drain than tax evasion efforts to avoid the income tax are. Where the consumer is wealthy, the consumption tax if it is high enough impresses social status elevation on conspicuous consumption as behavior. E.g., in Malaysia during the 1990s, the import duty on foreign-made automobiles was 100%, in order to protect the market for domestic-made automobiles of inferior quality and performance. Wealthy Malaysians imported Mercedes-Benz, BMW, and Rolls-Royce automobiles in large number because those vehicles were seen as status symbols of ostensible wealth and demarcation in a socially stratified society. In the 1980s, the federal government levied a 10% surtax on the sale price of pleasure craft (yachts) and private aircraft. In the case of the pleasure craft builders that had yards on the Atlantic coast, the tax had devasting effects -- the market for pleasure craft disappeared and most yards closed with the knock-on effect on employment in those specialized trades and reduced production in the trades supplying hardware specialities to those yards. As Adam Smith stated, the purpose of production is consumption; conversely, absent consumption, production does not occur. Choose your own poison, but understand that simple notions that abound in the academic economics trade are far from simple when translated into and applied to the real world of commerce.

    1. Dr Cochrane's objection does apply to partnerships and LLC's (many LLC's are taxed as partnerships). Those 2 entities do not have to pay tax on unrealized gains - same as individuals. If they did have to pay tax on unrealized gains, they would be in the same boat as an individual with stock investments worth far more than their costs: paying tax on a gain that they have not converted to cash yet.

  11. One of the things I really love about a consumption tax is that it can be progressive in a very straightforward way. One major objection to a consumption tax is that, since poor people and rich people pay the same tax on the same consumed goods, it is claimed to be regressive. However, I think an intelligently engineered consumption tax would exempt (or tax less) things like food, rent, inexpensive clothes - things on which poor people spend most of their income. Hence it can end up being quite PROgressive. Of course, the devil is in the details, but this is conceptually quite appealing (to me, at least).

  12. The best way is the Fair Tax. It taxes consumption. is where you can see it. Interestingly, in the hearing on Dec 6 at the subcommittee on Taxation for the House Ways and Means Committee, the Democrats came out strongly against the Fair Tax. They kept asking the Brookings Institution's economist about it and he said it would be easy to avoid (and then gave a fallacious unchallenged example about driving over state lines to avoid taxes which you couldn't do with the Fair Tax). The AEI economist also had negative views on consumption taxes. Republicans on the committee wanted to fight the war over tax cuts, rather than reimagine the entire system. Steven Hayes spoke out in favor of the Fair Tax. Only Cal economist Dr. Auerbach was for consumption taxes but in a different form than the Fair Tax. Unfortunately, some representatives on this committee don't even understand that FICA taxes are regressive.

  13. Yes, it is easier to tax the rich at the Porsche store; but people can set up a firm to avoid calling consumption "consumption" just as well as they can to avoid calling labor income "labor". A consumption tax should actually be a sales tax on goods agreed to be more associated to personal consumption rather than production.

    1. If I set up a phony corporation to buy a Porsche, I still have to go to the dealer to buy it and the dealer would charge me retail sales tax, right?

    2. Only if you tell the dealer that you are purchasing it for consumption and use.

      If you tell the dealer you are buying it as an investment then (by Cochrane's way of thinking) you pay no tax on it.

    3. Believe it or not, the people who have been advocating and using consumption taxes (sales tax, value added tax) for decades... actually thought about the obvious armchair comment, how do you tell consumption from investment!

    4. Was that a little grumpy? I guess so. But this happens over and over again. First seeing an idea that has been talked about for decades (like final theory), people come up with the first obvious armchair objection, then figure those who have been working on this are such morons that they have never thought of it before and it's a brilliant new observation that suddenly destroys decades of work. When meeting new ideas, we should all assume just a little more intelligence of our fellow humans.

    5. "Believe it or not, the people who have been advocating and using consumption taxes (sales tax, value added tax) for decades... actually thought about the obvious armchair comment, how do you tell consumption from investment!"

      Okay, you have thought about the obvious armchair comment. Where is the answer in your article?

      The "Fair Tax Act" doesn't define a consumption good:,administered%20primarily%20by%20the%20States.

      Instead it excludes from taxation certain types of goods and defines what those exclusions are:

      (A) GENERAL RULE.—The term ‘taxable property or service’ means"

      (i) any property (including leaseholds of any term or rents with respect to such property) but excluding—

      (I) intangible property, and
      (II) used property, and

      (ii) any service (including any financial intermediation services as determined by section 801)."

      Intangible property is defined here:

      (A) IN GENERAL.—The term ‘intangible property’ includes copyrights, trademarks, patents, goodwill, financial instruments, securities, commercial paper, debts, notes and bonds, and other property deemed intangible at common law. The Secretary shall, by regulation resolve differences among the provisions of common law of the several States."

      Notice that the sale of ANY type of used good (consumption or otherwise) is excluded from taxation under this proposed law.

    6. "First seeing an idea that has been talked about for decades (like final theory), people come up with the first obvious armchair objection..."

      The FIRST obvious armchair objection is that if you look at US consumption trends, there are significant seasonal peaks and valleys coinciding with the holiday seasons (higher consumption during the holiday months of November and December, lower consumption in the preceding months).

      The US chooses to tax income and withhold those taxes through the year in part because of the seasonal variations in consumption.

      With a consumption tax, withholding would become nearly impossible and the government would rely on significantly more short term borrowing to make up the difference.

  14. On the first day of my class in federal income taxation in law school, the Professor announced to the class that the field was the most intellectual in all of law, precisely because the concept of "income" was so indeterminate and metaphysical even. One of my favorites was "imputed income": one could (and some would argue ought) to be taxed on the rental income one would receive were one to rent out one's owned home instead of living in it; the choice to "consume" one's home rather than turn it into an income stream did not mean that one did not receive the benefit of that potential income. Given the Founders' sensitivity to the whole subject of taxation, the Court should have set firm and narrow bounds on the concept of "income" right from the start, but of course they didn't. That Court full of progressives would have made Hamilton blush.

    1. The Court DID make a determination on the concept of "income" in the very first test case, Brushaber v. Union Pacific RR. To fully grasp the jurisdictional issue of this subject I would direct you to the 1833 case - Barron v Baltimore {32 US 243}. The third clue is this: The 16th Amendment is published in the Statutes At Large, Second Vol. titled "Private Law."
      The "concept of income" is indeterminate until the terms and their definitions are statutorily satisfied as per 26 U.S.C.: "employee" (3401{c}); "wages" (3401{a}); "employer" (3401{d}); "trade or business" (7701{a}{26}); "employment" (3121{b}; "American employer" (3121{h}) = "wages" (3121{a}).
      This, my friend, is what you should have learned in law school.


  15. There are interesting implications for things like immigration, too.

    With something like a Fair Tax, everyone pays the tax, regardless of your status. Tourists, migrants, etc., would all instantly become US taxpayers. And, there would be no incentive to hire under-the-table employees.

  16. The Estate Tax doesn't tax wealth. It taxes the transfer.

    1. It (sort of, given 'stepped up basis') taxes the value at time of transfer which is subject to many of the same issues as imputed income. Do you get an estate tax refund if those stocks you inherited go down in value instead of up?

    2. Estate taxes tax the value of the estate, not the transfer of the estate; ergo, the estate tax is just what it says it is -- a tax on a wealth.

    3. "IRC Section 2001(a) - A tax is hereby imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States." So, it's a transfer tax that happens to be measured by value less exemptions. Most states have transfer taxes on real estate sales. Roughly the same thing.

    4. Regarding the estate tax refund if stocks go down. The heir gets a new cost basis - the value of the stock in the estate transfer. So, if the stock goes down in value and is sold, the heir would get a loss.

    5. Also, Old Eagle Eye: the case before the SC is under Title 26, Internal Revenue Code, Subtitle A, Income Taxes. Estate Taxe is under Subtitle B - estate and gift taxes. There's other subtitles (C for employment taxes; D for excise taxes, E for alcohol etc.). So, you have various kinds of direct and indirect taxes under Title 26, Internal Revenue Code.

    6. Without question, Anonymous. But, the transfer of the property of the estate is merely the event that gives rise to the taxation of the estate's property. An estate tax is not a property transfer tax. A property transfer tax is in the sense of a "stamp duty" on the paper evidencing the transfer of title from Party A to Party B.

      Certainly, there are other forms of taxation, but the focus was on the estate tax form of taxation.

  17. Not all remarks appearing in the comments section of the weblog are ill-informed, or malignant in intent. A proposal to radically change the system of taxation in any country will raise concerns, and the Fair Tax Amendment is just such a radical proposal deserving of a deep and skeptical examination. Another such radical proposal would be a "lump sum" tax which is highly favored by macroeconomists engaged in modeling national economies. The U.K. proposed a "head tax" as a means of raising revenues for local governments in the U.K. A "head tax" is a form of "lump sum" tax. The proposal was strongly opposed by those who would be subject to the tax, i.e., all adults resident in the U.K. Other taxes, such as the 10% excise tax on all imported goods entering the U.S. is another proposed tax that is deserving of thorough examination and skepticism even though it is supported by a former high-ranking U.S. trade official.

    One could fairly argue that each of these tax proposals has been examined previously, and then conclude that anyone questioning the proposals was not deserving of an audience because the proposal had been thoroughly examined by experts in the field and was therefore not susceptible to re-examination, etc. That form of argument is common enough in land-use change proposals that come before local governments and give rise to objections from affected residents and interest groups. In an oligarchy or autocracy those arguments do prevail, but in a representative democracy or a participative republic such arguments must be restated again and to prevail those arguments must achieve a measure of broad acceptance without coercion or threat to those who argue in the negative.

    You have mentioned elsewhere the phenomenon of 'regulator capture'. In certain respects, in local government, the non-elected staff employed to advise an elected commission or council go to great lengths to 'capture' the majority of members of the commission or council in order to have the staff's preferred outcome chosen by the commission or council even in the face of objective and impartial opposition to that outcome.

    The technocratic solution is not necessarily the social welfare improving outcome, but an outcome that is biased in favor of a preferred solution that serves one or more narrow special interests and has political impetus behind it.

    The republican form of government adopted by the U.S. should be proof against such proposals, and perhaps it has been more successful than representative democracies elsewhere that have chosen not to adopt a republican form of government. But, each new proposal and every former proposal newly pushed forward for adoption must be examined anew and without professional bias attending to it in order to 'work around' objections (new or old). The Fair Tax Amendment is one such proposal previously examined and rejected now resurfacing for another attempt to obtain Congressional approval. Old arguments, pro or con, have been resurrected and new information or views brought forward. That is only natural, and expected. Even old pols must campaign anew in order to win election to a political position they occupied previous to the termination of their term in office.

  18. As an aside that takes nothing away from the gist of the post, an *expected* wealth tax will induce behavioral responses from both income (or wealth) and substitution effects. Only the substitution effects yield inefficiency. A one-time "unexpected" wealth tax would not distort perceived relative prices between savings and consumption. However, people would not respond to the wealth effect (until after the tax is announced) either. For efficiency sake, we want people to respond to the wealth effect -- probably by increasing work and savings, while reducing consumption in the periods prior to the unexpected tax.


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.