Taxing Borrowed Wealth

 ProPublica did a piece on how the rich avoid paying their share of tax. You can find the article here. 

Off the bat, they get a few things wrong. True income is not change in wealth. In 2009, all homeowners lost value on their properties caused by the foreclosure crisis. My family lost about $120,000. Should we have been able to deduct that from our gross income? No. If everyone had been able to do that, there would have been no tax revenue.

In accounting, change in owner's equity and income are NOT the same thing. The best way to lose all credibility is to try to invent your own reality.  can have a lot of definitions, depending upon how you attribute health and tax costs and benefits. While it is true that you can calculate a form of absolute income. I did it myself in examining whether a wealth tax is possible. It is a moving target. You can read these analyses at http://fiscalequity.blogspot.com/2020/05/

One cannot have one set of definitions for the rich and one for the poor. While it seems at times that the system does that, this is not the case. To count asset gains as income subject to tax for rich people, the government would have to do the same thing for the working and middle classes, as well as retirees. 

Then there is the question of defining who is in what class. I divide classes into three groups based on how big a pile of income they actually receive. These are the poor (lucky and not), the working class, the middle class and the rich. The poor have no AGI, for the most part, nor do they pay anything in Social Security tax that they don't get back. They are about 40% of households.

The working class and the poor make up 75% of households, with an AGI of $85,000. The next 20% are the middle class, leaving the top 5% in the upper class (and the bottom half of the top 10% as the upper middle).While average income figures can be misleading, so can median income figures. About a third of total income is not taxable, most of which is paid to the poor and retired (although some retired people are the lucky poor, living off of their investments and paying little in tax). 

The war against the working class started with the Kennedy-Johnson tax cuts, which decreased the top rate to 70%. At 91%, CEOs had little interest in cutting salary and benefit costs. The government would eat the savings. The cuts ended relative labor peace and the war over who gets to share in productivity gains was on. 

Reagan dropped the big bomb in 1981, with a Social Security compromise solidifying his gains by creating the Social Security Trust Fund rather than repealing his signature tax cuts. The Tax Reform of 1986 set those gains in stone. While there has been nibbling around the edges, the same basic structure has not changed since then.

Social Security cannot be considered as just another federal tax. The article makes that mistake in doing so, as does Buffett in his usual elevator speech on not paying enough in taxes.  FICA benefits set up a claim on future revenues. They are an asset. To match like with like, only income income taxes can be counted in examining tax equity. FICA payroll taxes have a ceiling, by design. If they did not, Social Security benefits based on wages would be huge for the top 10% of households.  

If anything, the cap on the FICA employee contribution should go down to $85,000, with the employer contribution shifted from an employer-payroll tax matching the employee tax to a Value Added Tax with no caps and the collection of revenue from both payroll and profit. What was the "employer contribution" would be credited to workers on an equal dollar basis, including and especially low wage workers (who, instead of getting EITC, would simply pay no tax on the first $16,000 of income).

The biggest tax benefit is the ability of mutual funds to dodge capital gains and dividend taxation. When taxing asset transactions rather than individual taxpayers, there is no longer any justification for such a wealth building device. It is mostly the richest who accumulate wealth in this way. The working class get no such benefits and the upper middle class does not need them.

ProPublica needs to look at the Federal Reserve's 2019 Survey of Consumer Finance to get the best picture of who owns what in assets. It then needs to apply the Pareto rule to estimate who owns what assets among the top 10%.  Currently, the top 10% of any distribution own 77% of the assets in question among mutual fund holders. I ignore stocks, because they hold no intrinsic value. My analysis is part of a project to determine who owns assets holding the national debt. Bond holdings are distributed about the same way.

My estimate of what the top 0.001% own is therefore 28% of total mutual fund assets, or $3.9 Trillion. They own $1 Trillion of the national debt held in mutual funds and $.9 Trillion held in bonds.

The debt is owed as a percentage of income (and only income) taxes paid - FICA taxes create an asset for the bottom 90%. My latest calculation (I have not updated it in a few months) is that for every $1 you pay in federal income tax, you owe $17.  If you pay nothing, you owe nothing. The top 2.5% owe half the debt. The top 0.001% owe about a trillion dollars. In other words, they own $1.90 for every dollar of debt that they owe. This is why they care more about the debt held by the Social Security Trust Fund than the total debt held by the public. 

This is also the best argument for increasing what the rich must pay. If we do not, the rich get richer on interest received alone. For society to merely break even, their tax bite must double at the highest levels. The salaried income tax rate should be 50%, with up to 25% of salaried income paid to by employers as higher tiered subtraction value added tax and only those making over $425,000 in salaries paying income taxes. 

Let us clarify tax reform terms as the basis for reform: a value added tax usually refers to a credit-invoice goods and services tax which everyone pays. If the VAT is to replace income tax filing, it should be very broad based. In most countries, there are loopholes. These should be minimized in a new system. 

A subtraction VAT is an employer-paid tax where all revenues are subtracted from all expenditures, with a tax on the gross profit. This is how it is done in Japan. Such a tax is not that different from the American system of taxing wages. Essentially, the employer collects all payroll and wage taxes and remits them to the government, as well as the relevant information on individuals. At the end of the year, households reconcile the reported collections of tax and revenue, as well as income from capital gains and returns.

Backing out capital gain and return income into a separate tax allows taxation of assets rather than households. This would be called an asset value added tax. The existence of such ta tax allows for ending household tax filing for all but the wealthiest. There would be no taking capital losses to reduce income tax. If you have a capital loss, you eat it, just like the working class must. 

An asset VAT would end the gaming of income distribution. When capital gains taxes are high, everyone shifts income to dividends. When income tax rates are higher, everyone incorporates. The sweet spot is to get capital income and salary rates to end the incentive for income shifting. If the asset VAT rate is negotiated internationally, market shifting will also be avoided.

Berkshire Hathaway buys companies as a holding company. It is a glorified mutual fund and should be treated that way (as should similar conglomerates). With an asset VAT, buying companies and taking income from them would be taxable events. Berkshire may not pay dividends, but it gets them. When they get them, they would pay an asset VAT, or rather, subsidiaries would pay the SEC before sending the profits to Berkshire.

There is a solution to mega-borrowing. When a plutocrat borrows money, he pays interest. When he does so, that interest should be taxed at the Asset VAT rate. If the plutocrat borrows money to make a new investment, the shares purchased will be taxed, with the seller sending the tax to the SEC. 

For example, if Bezos took out a loan to set up Blue Ocean, when it is capitalized, the public or private shares pay the asset VAT when the shares are issued. Only by selling the shares to a broad based ESOP will the tax be avoided. If the firm goes public, the buyers pay the Asset VAT at market, with the amount of taxes already paid in setting up the firm deducted from what is collected from the buyer and sent to the SEC.

When a plutocrat is paid in stock, the asset VAT will be due at the market rate, not the capital gain when exercising the option. If the asset is inherited, gifted or donated, the recipient must pay the asset VAT on the dividends and the sale is marked to market unless sold to a qualified, broad-based employee stock ownership plan. 

Contrary to the urban legend in the financial media, most multi-generational fortunes are cashed out or put into Trust Funds. Heirs who do not wish to continue in the family business will sell. If they sell to employees, they keep all of their money. If they sell to anyone else, their broker will send a check to the SEC and give them only a share of the purchase price.

Everyone would pay a VAT, on purchases but higher minimum wages and child tax credits would hold the vast majority of families harmless. The rich would not be held harmless, especially not heirs. People with cash can either buy assets (we propose a 24% to 28% asset VAT) or spend the money (13% to 19.5% VAT). If you sell an asset and use the money to buy something, you pay both taxes. 

As I stated in May of last year, a wealth tax is not an option. It has the liquidity problems of property taxes and the reporting issues of capital gains taxes. If you want more tax avoidance, go down this route. The only way to avoid liquidity issues is to have the business held pay the wealth tax. To get the money, it will either decrease cash, lower wages if the job market is monopsonistic (and it always is), raise prices if the product market is monopolistic (and it always is) or by decreasing everyone else's dividends. 

The plutocrats will be held virtually harmless and the wealth they hold will be legitimated. The working class will get nothing but a better cage, rather than the eventual ability to control the workplace they would receive from an asset VAT.

In the end, the wealthy need to want to pay more. If they don't, the European Union or China will link their currencies to their government debt and income taxes that service it. This will give the billionaires themselves another currency to buy and hold and safer harbors for their government lending. Anticipating this, as well as revealing an alternative to increase taxation of assets with an asset VAT, combined with the current inflection point, will lead to real change, such as those I have laid out. This is especially the case if the bottom 98.5% can end the annual ritual of personal income taxation while still receiving such benefits as a refundable child tax credit and comprehensive healthcare.