The Taxman Always Thinks Twice

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There are many ways to go about justifying tax avoidance.

I’ve already written here and here about my own justifications for trying to decrease my tax burden.

But this is such a ripe area for ethical exploration. So why not dig in a little deeper?

My gestalt is that people’s opinion on tax avoidance is very similar to people’s opinion on the miles game.

Some people just feel it is right and good, while others feel it is smarmy and wrong.

But I’d like to go beyond mere feelings and look at this issue more formally from a variety of angles.

An obvious place to start is to consider all of the possible justifications for seeking to pay less taxes that I have heard or can come up with on the fly.

(Feel free to add more justifications, to the ones mentioned here, in the comments section below.)
1. The Conscientious Objector.

 

“My tax dollars go to so many things that I don’t believe in, like American imperialism, corporate welfare for petrochemical companies, The nanny state, (insert boogie man here.) So by avoiding paying taxes I’m choosing not to support that which I don’t believe in.”

 
Positives: it cloaks tax avoidance behavior in a morally justifiable veneer.

Negatives: It strikes me as fundamentally dishonest. Unless you live alone on a mountaintop completely disconnected from the grid, you’re benefiting from government and taxation every single day. In addition, legal tax avoidance is not exactly an act of courage. It’s not like you’re refusing to pay taxes and going to jail for it.

Furthermore just because you don’t like something doesn’t mean it’s not justifiable.

And finally if you’re honest isn’t it true that the real reason you avoid taxes is simply to keep your own money?

2. The Charity Argument.
“The more money I keep, the more money I can give to charity. And my charity is more effective and less wasteful than government social programs.”

 
Positives: It establishes your bona fides as a good person who wants to help others. It’s not that you’re selfish, it’s just that you want your money to go further.

Negatives: The problem with charity is that it is voluntary. Because people have to pay taxes even when times are tough, social programs stay functional even during times of recession. Charities on the other hand suffer (And often fail to deliver services) during times of economic despair (When they are needed most.)

Besides I would suggest that we tend to overestimate our own efficiency and generosity.

And finally the charity argument could be used to justify any form of wealth gathering, be it drug dealing, embezzlement, or fraud.

3. The Fair Share Argument.
“I’ve been taxed higher than average for a long time, and I use less Government resources than average. Shouldn’t I be allowed to even the score a little bit now?”

 
Positives: this is a pretty solid argument on ethical grounds.

The ethical model here is a retributive one (an eye for an eye and a tooth for a tooth. Or you should only have to put in to society what you take out.)

Negatives: this is just not how society works. The whole point of civilization is to have the strong communal body protect weaker individuals by the pooling of resources.

Also, who died and made you judge of what is fair ? People always overestimate their own value and underestimate the value of others. People tend to be poor judges of themselves. (It allows us to sleep well at night.) Given this limitation, isn’t it better to have society as a whole judge what is right and wrong?

Furthermore this is an in effect argument against progressive taxation. The whole idea of progressive taxation is for the rich to pay a higher percentage of their income as taxes than the poor. Because,

A. They can more afford it.(I.e. taxes hurt them less.)
B. Money retained by the poor is more likely to be spent, and thus to stimulate the economy.
C. This form of taxation encourages a strong middle class as opposed to a polarized society with only the very rich and the very poor.

In other words unless you’re a fan of regressive-taxation-a-la-banana-republic, this is an argument that is very hard to defend.

4. The Realpolitik Argument.
“I, like everyone, do not enjoy paying taxes. However I realize that taxes are necessary tool for society to function.Furthermore I wish for society to be as fair as possible. Because of these views I support (and vote for) a simple, Progressive, System of taxation where money earned in any manner is simply classified as money earned. Also there should be no deductions for anything.But because of my desire to keep my money as an individual, I also consciously attempt to avoid taxes whenever legal and possible.”

 
Positives: it is simple and honest and it acknowledges the necessary distinction between thinking as an individual, and thinking as a citizen.

Negatives: it is hypocritical. If you believe in progressive taxation, and you avoid taxes altogether when you are rich, than this is the ultimate ethical inconsistency as an individual.

You can tell by the length of my quotation for the realpolitik argument, (and the brevity of my criticism) that this is, in fact, The argument that I use to justify my own philosophy and behavior.

This means that you will likely be better at critiquing it than I.

So fire away.

I can take it.

Sticks and stones and broken bones and all that good stuff…..

firing-squad

Another fun visual metaphor.  Courtesy of Miles Dividend MD.

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15 Responses to “The Taxman Always Thinks Twice”

  1. Robert February 20, 2014 at 10:03 am #

    Oh, boy… You probably could have predicted that you’d get my goat with this post! LOL. I’ll respond briefly to a few of your comments, but this is obviously a topic that could be (and has been) debated extensively, and with respect to which much of our nation’s current political divide is centered. The hypocrisy to which you allude is in fact much in evidence when you look at the political parties. The “tax and spend party” is populated by politicians who enjoy castigating the rich while gorging themselves at the trough. Akin to flying private jets around the world to warn of climate change. (Couldn’t the father of the internet have just Skyped? But I digress…).

    The charity argument (#2) is more involved than what you present. By making a charitable contribution you REDUCE your tax liability. Thus, you are simultaneously reducing taxes AND giving to causes you believe in. It could even be combined with your first argument because by doing both of these simultaneously, you are also reducing your contribution to the government programs you don’t believe in. (But since you can’t direct your remaining tax payments to what you do believe in, there remains the freeloader problem, which I agree with you on).

    My biggest dispute is with part of your argument against #3. You said, “People tend to be poor judges of themselves. (It allows us to sleep well at night.) Given this limitation, isn’t it better to have society as a whole judge what is right and wrong?” I strongly disagree. While individuals do need to check their views against societal benchmarks, I would argue that moral authority derives from God, not government (or the collective). But regardless of whether you believe in God or not, just ask yourself with respect to your quote, How would that have played out for an individual in Nazi Germany? (or pick your favorite despotic government).

    Furthermore, while I’m not making a case for or against progressive taxation, I do think that you are both inconsistent and incomplete in your analysis in your statement 3B: “B. Money retained by the poor is more likely to be spent, and thus to stimulate the economy.” I’m no economist so you may be correct, but surely that is an incomplete analysis. First, the rich may not spend as high a fraction of their income as the poor, but by investing, they are strengthening the economy. Capital investment is critical for economic growth (just ask developing countries why they seek foreign direct investment, or why states compete for companies to invest in their state). Second, you seem inconsistent. Your website strongly promotes saving and investing. But now you argue that isn’t good for the economy? (If you believe that, the hypocrisy of your lifestyle advocacy extends well beyond taxation issues!). Do you believe a consumption lifestyle is actually better than a saving/investing lifestyle, as far as the economy is concerned? I don’t. Keep in mind that GDP is not a complete measure of economic and societal wellbeing. It may measure consumption, but to what extent does it measure depletion of limited natural resources, or pollution, or climate impact, or impact on health and happiness? It doesn’t.

    You conclude #3 by saying that, “unless you’re a fan of regressive-taxation-a-la-banana-republic, this is an argument that is very hard to defend.” Again, I’m not arguing for or against progressive taxation, but I have heard a number of intelligent people arguing for a flat tax. One can certainly be concerned about a society in which roughly half pay no federal income tax and thus aren’t aligned with the goal of reducing government spending/debt. Without restraints, we risk destroying our economy and the futures of our kids. The very “savings lifestyle” you advocate, and the impact of compounded earnings that you repeatedly cite, are the antithesis of our government’s approach to our collective future, and we are compounding a negative interest rate (debt) rather than compounding a positive interest rate (savings). By the way, here’s a very old argument in the N.Y. Times, no less (hardly a conservative newspaper), about the flat tax. Back then (1982), there were people on both sides of the aisle proposing a flat tax. http://www.nytimes.com/1982/04/30/opinion/essay-the-flat-tax.html. So, I think it is fair to say that “hard to defend” is not the case.

    Finally, regarding your preferred argument, #4. “Because of these views I support (and vote for) a simple, Progressive, System of taxation where money earned in any manner is simply classified as money earned.” Simple, or simplistic? I believe the latter. I assume here you are arguing aganst the Mitt Romneys and Warren Buffetts of the U.S. being taxed at lower rates than average workers because they are paying capital gains tax rates and using business accounting methods to minimize tax rates compared to what a person pays on earned income. (Incidentally, if that is your beef, could it be that your real issue is that you as a doctor have so much earned income that you resent having to pay so much tax, and you are taking it out on those whose income is mostly investment income?).

    Remember, first of all, that taxing investment returns at the same rate as earned income is a form of double taxation. If I own a business, I pay a business tax; if I own stock, I am a business owner and am paying corporate tax. If one then has to pay capital gains tax on top of that, it is double taxation. That is like saying an individual earning $100,000, paying $30,000 in taxes, and saving the other $70,000, should have to pay another tax on the $70,000 when he deposits it into his bank account. Furthermore, there is the effect of inflation. The government controls the inflation rate through its fiscal policy and the actions of the Federal Reserve. The government has a multi-decadal policy of maintaining positive inflation. It is a small but insidious “tax” on your savings (the government uses inflation to fund spending through its issuance of government bonds which are paid back in inflated dollars). The government, by taxing capital gains, taxes you on gains that are purely due to inflation. (Capital gains include other factors too, of course, but inflation is one component). Thus, for example, using this calculator http://www.usinflationcalculator.com/ you can see that an item purchased in 1974 for $1 would cost $4.74 in 2014, representing a cumulative rate of inflation of 374%. If you bought a gold bar or a bond or a stock that happened to grow 374% during that period, your investment would nominally return 374% but in real terms 0%. However, the government would tax you for a 374% gain, i.e., you’d pay a capital gains tax on the $3.74 “gain”. Thus, three-fold taxation is at work. First, you are taxed on the income that earned the after-tax $1. Second, you are “taxed” by government-supported inflation. Third, you are taxed on the capital “gain” of any investment that manages to recover some of the inflation losses in real terms . I have here examined just two of several examples one can use to show why it is unreasonable to treat “money earned in any manner” as equivalent for tax purposes.

    Thanks for yanking my chain! 😉

  2. Miles Dividend MD February 20, 2014 at 2:37 pm #

    Robert,

    Great points, all.

    One quick point. The post is really about some possible ways to justify the dichotomy of the aggressive pursuit of tax shelters as someone with a fundamental belief in fair and progressive taxation.

    I think the weeds that we (happily) get into when we talk about this stuff, is the really about whether progressive taxation makes sense or not.

    If one truly believes that taxes are unnecessary, or that richer people should not pay higher rates than poorer, then there’s really nothing left to justify. There’s no inconsistency to address. (Incidentally if “one” truly believes this, I would argue that “one” is engaged in a massive self deception.)

    And now, into the weeds!

    1. The charity argument is really that charity is voluntary, while taxes are not, it is not specific to the charitable deduction in our current tax code, which is what I believe you are referring to.

    2. America is not Nazi Germany. It is a flawed representative democracy (and one of the best political systems around). Of course paying taxes to the third reich is an immoral act, and is a fatally flawed analogy for paying taxes to OUR government. But more generally common laws are a good idea in a system such as ours. They promote peaceful resolutions of disputes, and counteract the tendency of wealth to concentrate in an anti-competitive and inefficient way.

    3. The idea that wealthy investors promote growth by investing their tax savings in the capital markets is the cornerstone of supply side economics. Would that it were true but empirically and demonstratably it is not. because

    A. Demand (ie spending) is more stimulative than investment.

    and

    B. What would the wealthy do with their money if it were taxed at a higher rate? eat it? No, they would invest it and pay more taxes on the profits.

    4. There are inconsistencies, I will admit, between advocating for saving more and investing more on the individual scale, and being concerned with the health of our current economy as a whole. If every one kicked their saving percentage up by 10 % tomorrow it WOULD be devastating to our economy. But a slow transition to such a world would have many benefits (lower workforce participation yielding lower unemployment,) less carbon emissions/depletion of resources…more on this to come….

    5. The editorial cited is by William Saffire. the fact that it is in the NYT is irrelevant He could write in Pravda and still safely be called a true conservative.

    6. The beauty of the flat tax is that it is simple. But the simplicity has almost nothing to do with its flatness. It has to do with the fact that there are NO deductions and all income is treated the same. Having progressivity adds very little complexity to the system. A postcard would still work just fine as a tax return.

    7. The double taxation argument is a canard. To use your metaphor, capital gains taxation is like an individual making $100,000, paying 30,000 in taxes, depositing 70,000 in a bank account and paying taxes on the INTEREST earned on his principle, (which is exactly what happens when such a worker deposits his money in the bank.) Principle is not taxed as capital gains.

    8. Calling inflation a tax is a stretch. The Federal Reserve is a non governmental agency. It is a central bank. Inflation is an important factor in wealth planning of course, but it effects all dollars. (Inflation effects earned income dollars every bit as much as it effects investment dollars.) Government benefits of course are also adjusted for inflation. Taxing inflation is a small issue as well. Even in a 50% tax bracket it is a 1% additional annual tax historically (50% of 2%- the historical rate of inflation.) Compare this then to the difference between the long term capital gains tax rate and the highest income tax bracket 15% compared to 39.6% ! So if you want to add complexity to a progressive tax system and tax the capital gains at 2% less than earned income across all brackets, so be it I say! Probably not worth the hassle.

    9. If anything being in the highest income bracket and planning to live off of my retirement income in the future should make me more sympathetic to scoundrels like Mitt Romney. Warren Buffet of course argues that taxing capital gains at such a low rate for high income earners is patently unfair. He is a smart dude, and decidely not a scoundrel.

    I truly love these exchanges Robert, as you know,

    Alexi

  3. Robert February 20, 2014 at 10:11 pm #

    I wrote a brilliant response to your response and then it all vaporized when I clicked “Submit comment” before remembering to solve the little math problem. Usually I can go back, but this time it didn’t work. I wasted an hour on it and now it is past midnight. So, you win by default. :-(

  4. Miles Dividend M.D. February 20, 2014 at 11:19 pm #

    Robert,

    That’s terrible.

    The post will be even better rewritten after a nights sleep.

    Don’t deprive the world of your genius!

    Alexi

  5. Robert February 21, 2014 at 7:53 am #

    Well, OK, you tempted me to try again! This version will be shorter but not as well documented as I’m too lazy to look up all the references again. LOL.

    Regarding your response #2. I didn’t argue that America is Nazi Germany. No, I argued (and you didn’t respond) that your comment that “it [is] better to have society as a whole judge what is right and wrong” than have people judge for themselves represents a dangerous attitude. I don’t believe you really think that, do you? That people should check their consciences at the door and let society decide right and wrong? That attitude ENABLED a Nazi Germany and in principle could someday enable a despotic USA as well. I think that individuals should use societal norms as a benchmark and analyze where and why their own views may deviate, but not give up their own views if they hold up under that examination, and never assume that society knows best what is right and wrong. Sometimes a single well-informed individual can transform societal norms (for better or worse). We have already seen an erosion of our personal liberties under recent administrations (both Obama and Bush), and some individuals have suffered for speaking out against the abuses. Only time will tell if history judges Manning or Snowden, for example, to be heroes or villains, but from what I’ve read, it seems that in both cases they were motivated by their repugnance at the atrocities or privacy invasions they learned about and the extent to which these were concealed from Congress and the public. Regardless of the extent to which you think society is the arbiter of right and wrong, I think you can agree that an ill-informed society cannot be a good judge. Thus the importance of freedom of the press (thought that, too, is manipulated by powerful interests). And, I think, the importance of principled individuals who will stand for the right regardless of the personal consequences.

    Your argument 3A is a strawman. I didn’t argue that spending wasn’t stimulative or even that it wasn’t more stimulative. I just argued against your implied assertion (unless I misread you) that capital investment was not stimulative. I don’t know if capital investment is more or less stimulative than spending (especially over the long run), but I do know that it is stimulative. I don’t think history is kind to the view that big redistribution of wealth from the rich to the poor is stimulative to an economy in the long run. Even among democratic nations, the most regressive tax structured economies like Sweden of the 1970’s have abandoned that idea for a flatter tax structure. Your response #3 is weak in total, because you ignore analysis of the effects of capital investment on economic growth; why do nations and companies starved for capital fail, and why are they constantly trying to get more? Whether nations, companies, or personal finance, excessive spending and limited investment limits economic growth. I don’t see the empirical evidence you allude to for the unimportance of capital investment vs. spending.

    Regarding response #4, read the recent Mr. Money Mustache interview on the topic of “what if everyone lived a frugal lifestyle?” It addresses this issue. http://www.mrmoneymustache.com/2014/02/06/an-interview-with-juliet-schor-author-of-plenitude/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+MrMoneyMustache+%28Mr.+Money+Mustache%29. Juliet Schor argues that provided the shift was gradual, it would not destroy the economy. I don’t necessarily agree with her (see my zero sum game argument regarding unemployment in my response to your next blog post), but she makes some interesting arguments. I haven’t read her book.

    Good point on #5, but regardless of the author’s conservative credentials or where it was published, what about his argument?

    Regarding #6, I am not interested in the flat tax for its simplicity. I’m interested in it for how it changes motivation to be a productive member of society and aligns the interests of voters with the long-term interests of the nation (which is the collective interest of the citizens, “we the people”). Instead of having roughly 50% who BENEFIT from increased government indebtedness and spending, a flat tax would get everyone on the same page about reducing government debt. Yet, without killing the golden goose. And hopefully while also enabling voters to vote against special interests (banks, pharma-medical-industrial complex, military-industrial-complex, etc.) that are so influential today. If all voters were negatively impacted by increased government spending, they would reduce it. I just don’t see how a debt-plagued nation can be more successful than a debt-plagued individual; the same principles apply. I am not advocating a flat tax, by the way, but I was arguing that cogent arguments HAVE been made for it by intelligent people.

    Regarding #7, I believe you are incorrect. If you owned a business and paid $30,000 out of $100,000 income as a corporate tax, then paid yourself a salary of $70,000, and paid income taxes of $20,000 on the $70,000, you’d end up paying $50,000 taxes out of $100,000 income. That would be double taxation. The tax code does not do that for sole proprietors and other Schedule C type businesses; their business income passes directly to their 1040 AGI and is taxed only once. Why should it be different for fractional business owners who happen to own their businesses through stocks? When the earnings go up, the corporation pays taxes on those earnings, while the higher stock price (resulting from those higher earnings) produces a capital gains tax for the stockholder. That is double taxation. That is the rationale for having capital gains being tax-free or taxed at a reduced rate. Ditto for reduced or eliminated taxes on dividends. Thus, to your original argument, I argue that one should NOT treat all income as equivalent to earned income for tax purposes.

    Regarding #8, you are mistaken. The Federal Reserve’s own website says they are an “independent GOVERNMENT agency”, not a non-governmental agency as you assert. http://www.federalreserve.gov/faqs/about_12799.htm. I’m no gold-bug (I think stocks are a better inflation hedge), but here is a great chart that illustrates just how much of an impact Federal Reserve policy has had on inflation: http://www.24hgold.com/english/contributor.aspx?article=4269461978G10020&contributor=Tim+Iacono.

    Inflation is indeed a “tax”. It is heavily determined by government fiscal and monetary policy. And, it is NOT insignificant like you portray. It is like the effect of expense ratios in mutual funds–those small differences add up over time. That’s one reason you are an advocate for passive investing, right? Well, same applies here. You seem to be arguing that 50% of 2% is 1% and that is a small number compared to marginal tax rates. That makes the wrong comparison, in my view. Look at it this way: Assume 7% real rate of return (approx. US stock average), and let’s use your 2% inflation rate and 50% marginal tax rate. That means a 9% nominal rate of return. If you were taxed 50% of the 2% inflation, that is “only” 1%. But that is 1% out of the 9% (on an absolute percentage basis, not a relative percentage basis, i.e., it is 1/9th). Thus, 11% of your growth is taxed just due to inflation. That isn’t insignificant. (You’ll also pay 50% tax on the 7% of real growth, but we aren’t arguing about that here). But let’s look at this another way, which may help you understand my point better. Suppose the tax rate is 7/9 or 78% (not unprecedented, btw). You get taxed on your nominal growth. Thus, if you have $100 and you earn a 9% return, your $9 gain results in taxes of $7. But you don’t now have $102 in spending power. You only have $100 in spending power because the inflation “tax” took the other $2. And if tax rates are higher than 78% or inflation is higher than 2%, you actually lose spending power. It is the hidden power of this “small, insignificant” tax that makes it so popular with politicians. Most voters don’t notice it or don’t connect it to politicians and government fiscal and monetary policy.

    Regarding #9, I would be interested to know why you think Romney is such a scoundrel. And why, by contrast, is Buffett not one? Just because he has supported a Democratic president and higher income tax rates that are popular with progressives? Just for balance, here’s another take on the saint of Omaha: http://dailyreckoning.com/bashing-buffett-once-again-with-feeling/. Hint: all his cozying up to Washington has been great for his bailed-out Goldman Sachs, Wells Fargo, etc.

    Well, this was better last night, but at least you get the gist of my response. And probably wish you hadn’t tempted me to rewrite it! LOL. On the other hand, I am officially a year older and wiser today (Feb. 21), so maybe this version is better after all! :-)

  6. Miles Dividend MD February 21, 2014 at 3:08 pm #

    Robert,

    1. I am arguing that tax policy needs to be decided politically and democratically, because we are all so biased towards our own economic self interest as individual economic agents. I am not suggesting that we should check our consciences at the door and display blind faith in government.

    I’m not jumping into the worm hole on Bradley Manning and Snowden, and civil liberties except to say that I have similar concerns about civil liberties, and believe that we are still a long way off from fascism.

    2. You fight my “strawman” with one of your own! I never argue that investment is not stimulative. Of course investment is stimulative. It’s just that

    A. Spending is more stimulative.
    B. People will still invest if their even if capital gains taxes are in line with income taxes. (Because they lack any better alternative.)

    So if you are deciding whether regressive or progressive taxation is more stimulative, then evidence suggests that progressive taxation is to a point well beyond our current tax structure.

    (Obviously if you tax gains at 100%, no-one will invest, so I am not suggesting that there is no limit to the benefits of progressivity.)

    3. Regarding the Schor article, I’ve read it , I love it, and I think it is very in line with my (unarticulated to date) argument that the early retirement movement, is a possible model for a transition to a more sustainable economy.

    4. I thought I had already addressed the problem that I have with the flat tax. It is regressive. Love the simplicity (no deductions, income is income) dislike the regressivity for reasons already covered (less stimulative, and more unfair.) Exempting those below the poverty line is a start, but I see no reason not to include progressivity in the tax code.

    5. I find the argument that 50 percent of the population doesn’t pay income taxes to be incomplete at best and intellectually dishonest at worst. Why? because if you take into account FICA taxes, sales taxes, etc. and focus on on the effective tax rate (the actual amount of pay lost to taxes) it is usually much higher for the working poor than for those at the very top of the income scale. In my view the real takers are those at the top, and the income tax argument is nothing but a clever misdirection.

    6. Inflation is inflation, and taxes are taxes. They both decrease the value of both the earned dollar and the investment dollar. But they are not the same. Inflation is not collected from individuals and deposited into the government treasury. Inflation is quite simply not a tax by any reasonable definition.

    It is not engineered (as you imply) by politicians as an insidious form of taxation. It is effected by the fiscal policy of central banks, (which in this country are subject to oversight by congress, but whose monetary decisions are made independent of elected politicians.)

    I understand that 1% compounded is not an insignificant amount. But inflation effects all dollars, invested or otherwise. When 35 % of a dollar of earned income is taxed and only 15% of a dollar of capital gains is taxed, in both cases the take home dollar is subject to the destructive effects of inflation. The difference is that the invested dollar starts of with 85 cents of buying power, while the earned dollar has only 65 cents of buying power.

    If you cut investment tax rates then your choices are to increase earned income rates, create new taxes like a VAT, cut spending, or run a deficit. Taxation is largely a zero sum game.

    7. I understand that you are equating stock ownership with owning a small business. But this is a flawed analysis. For an individual, owning stock is an investment in future earnings, and one that has historically paid generously (7+% annual after inflation even with all of the argued burdens of “triple taxation”.) I can see no good reason not to tax this as income the same as any other. And hey, if the triple taxation hurts profits, the glass is half full: less taxes! (joke)

    On the other hand I can get behind the argument for not taxing businesses at all, but just taxing wealth gained by individuals in any manner at any time. This way profits reinvested in the corporation are not touched, but profits taken by shareholders or salaried workers are taxed dollar for dollar whenever and however they are extracted.

    8. Romney is a scoundrel because he advocates for policies that help his tiny faction of plutocrats, and hurt everyone else.

    Buffet is not because he can see beyond his own nose, and he makes the obvious point that billionaires will still invest their money if profits are taxed equitably.

    The blog post that you linked strikes me as a hack job and poor journalism, (presumably because Buffet dared point out that the emperor has no clothes when it comes to the rich and taxation.) What does the author advocate for Buffet to suggest, to tax his gains before they are taken? I am certainly no better than Buffet when it comes to taxation. I advocate for a fair progressive tax code without deductions and scheme to take every tax break that I can. Fair is fair and self interest is self interest and never the twain shall meet.

    Anyway, Happy birthday you old libertarian! I hope you make a killing in the market this year and are taxed at a low low rate.

    Alexi

    • Robert February 21, 2014 at 5:47 pm #

      Doc, I think you are blinded by your ideology! But you probably think I’m wearing dark sunglasses myself. LOL!

      Wishful thinking is a poor substitute for data or factual evidence. Can you back up your opinions with reputable research? I’ve argued with my progressive sister-in-law long enough to know that such arguments are futile, even if sometimes enjoyable exchanges of ideas, because too often we talk past each other, as if speaking two different languages or even from two different planets! I feel like you and I are doing the same thing. I trust we can keep this discussion fact-based and avoid personal attacks, otherwise I’ll do what I do with my sister-in-law, which is to drop the discussion as soon as I hear the pitch of her voice starting to rise! LOL. Relationships are more important to me than having ideological arguments (which can’t be won in any case). You said you do enjoy these exchanges, though, so let’s carry on a bit longer. (It is your blog so we can drop it if you wish; it is your space, and I respect that).

      Let me focus on just two of these points of dispute and see if I can get you to agree that (1) inflation is a tax; (2) consumer spending is out of balance with capital investment and we need capital spending to increase right now, and need to encourage more saving. Instead of offering my opinions, I’ll provide references from Federal Reserve officials/authors to support these arguments. If you choose to respond, I challenge you to provide comparable quality references to support your point of view.

      I am amazed that you think inflation isn’t putting money in the government coffers or isn’t controlled by the government–that it is a “tax”! It is written about over and over in the financial press. Basically, inflation is a way for the government to repay its debts with deflated dollars. Thus, it is transferring wealth from the private sector into the public sector. That is, in effect, an asset tax. Incidentally, corporations do the same thing; my former employer made out well in South America in the 1980’s by recognizing the inflationary environment there and so issuing a lot of corporate bonds (i.e., borrowing money) in local currencies to build hard assets on the ground. The assets appreciated in value while the debt decreased in real terms–a winning combination. Furthermore, the inflation tax is regressive, since wealthy people are better positioned to protect themselves with financial assets that appreciate with inflation, while poor people see price increases that aren’t kept up with by labor income. May I suggest you read the interesting Wikipedia article on this topic? http://en.wikipedia.org/wiki/Inflation_tax. See especially the last sections entitled “Tax on the inflation tax” and “Inflation tax benefits to governments”. Note the regressive nature of this tax (you as a self-proclaimed Progressive should be appalled by that!). Then, please watch Ron Paul’s brief explanation of this effect and then note Ben Bernanke’s agreement and explicit statement that, “Inflation is a tax”. http://www.youtube.com/watch?v=D4yBrxmEOkY.

      The second point regards the economic impact of consumer spending vs. capital investment. Again, let’s consult the Federal Reserve itself on this issue. There is no question that consumer spending is a large driver of the U.S. economy, but as you yourself indicated in your response, you can’t get out of balance vs. capital investment or the economy will slow. Where are we in the U.S.? Here are some key points from a recent Fed paper: “What’s wrong with a consumer-driven economy? In a pure accounting sense, an additional dollar of consumer expenditure increases GDP just as much as an additional dollar of business investment or exports. So what’s wrong with a 70 percent share of consumer spending in GDP? There are both theoretical reasons and empirical evidence that suggest U.S. long-term growth prospects may have been harmed by the consumer boom that played out in the decades before the crash….Moreover, just as in cross-country studies, higher investment spending has been associated with higher economic growth, while years of relatively high consumer spending have been associated with relatively low economic growth in the U.S….In sum, the primary reason a consumer-dominated economy may not be desirable is that consumer spending may crowd out investment spending, which is a key determinant of long-term growth….Only a few policymakers have discussed the significant challenges posed by our consumer-dominated economy. Our objective is clear, if not easily attainable: We must actively restructure our economy to become more friendly to business investment and exports in order to put long-term growth on a sustainable foundation. We must come closer to balancing our trade and our government budgets, and we must generate a far higher share of the savings we need for investment in our own economy. Higher saving rates also would insulate us somewhat from potential disruptive shifts in capital inflows and outflows initiated by foreign investors.” You can read the entire document here: http://www.stlouisfed.org/publications/re/articles/?id=2201

      I could, of course, point you to various papers by Austrian economists. Thus, for example, http://civitasreview.com/budget-taxes/the-myth-of-consumer-spending/ quotes Mark Skousen who explains why even the figure of 70% of GDP being attributable to consumer spending is misleading because GDP ignores intermediate stages of production to avoid double-counting, and thus naturally overweights the impact of consumer spending on the economy. He estimates 50% of economy due to business investment and only 30% to consumption. Slightly different figures in this version: http://policydialogue.org/files/publications/GDP.pdf. But, you may prefer to stick to the Fed references. Do they alter your thinking at all?

      Thanks for the birthday wishes! Life is good. I’m skeptical of a killing in the market this year, but then I didn’t expect the windfall last year, so who knows?! The low tax rate will certainly be true. I live frugally on a low income.

      Robert

  7. Miles Dividend MD February 21, 2014 at 6:36 pm #

    “The inflation tax,” is a metaphor. It is quite simply not a tax by any reasonable definition of taxation.

    From the first paragraph of the wikipedia page on the inflation tax:

    “Inflation tax is a term which refers to the financial loss of value suffered by holders of cash and fixed-rate bonds, as well those on fixed income (not indexed to inflation), due to the effects of inflation; or capital gains tax resulting from inflation. This financial loss of value is often expressed as a loss of purchasing power. It may be better characterized as a wealth transfer than a tax – since many people including debtors, holders of hard assets and some equities may simultaneously gain.”

    Whether or not it is regressive is also open to debate. Poor have a greater allocation of cash AND debt relative to the wealthy.

    More to the point, Here’s a nice article from Paul Krugman about the folly of worrying about inflation during a liquidity trap.

    http://economistsview.typepad.com/economistsview/2013/05/paul-krugman-not-enough-inflation.html

    Krugman has been predicting that the fed monetary policy would not cause hyper inflation for years (as the Austrians have been arguing the converse.) Who’s right? Who’s theory is predictive? Is 1-2% inflation too much?

    As far as I can tell Austrian economics is like creationism. It can be believed but not proven, and it predicts nothing. I see little use in it.

    • Robert February 21, 2014 at 8:26 pm #

      You have to read more than the first paragraph of the Wikipedia article, and I find Bernanke’s statement more authoritative than Wikipedia’s anyway. He calls inflation a tax. You didn’t respond to the Fed’s paper on the need for more capital investment vs. consumption. So, I guess we’ll let this thread die; probably just as well. I’ll leave you with this comment: I don’t think the Austrians have been predicting hyperinflation, but they are against inflation. Krugman is for it. He has been advocating inflation for some time. e.g., http://www.nytimes.com/2012/04/06/opinion/krugman-not-enough-inflation.html?_r=2&partner=rssnyt&emc=rss&. An Austrian response to Krugman is that his prescription creates worse problems down the road, such as stagflation. http://mises.org/daily/6016/Not-Enough-Inflation. I guess time will tell. I’m not an economist nor have I any training in that field, other than reading through Paul Samuelson’s textbook many years ago and understanding half of it. So this may be simplistic, but I think that even though some economic principles are counterintuitive, there are many things that occur at a national level that have parallels at a personal level. I think one of those is debt. Spending more than you earn for long periods of time is personally and nationally ruinous. Economists like Krugman can spin it other ways, and argue that doubling our national debt in the past 5 years is good for the economy. But I think of it as about as genius as bundling bad mortgages into securities and magically converting them to A+ bonds. Some things that seem good on paper don’t work out in practice. I can’t see an exponential increase in our national debt as a good thing. And I see inflation in our future to reduce that debt, and that inflation is effectively a tax, and not a good thing.

  8. Miles Dividend M.D. February 22, 2014 at 12:56 am #

    Robert, I read the whole Wikipedia article. Calling inflation a tax is sophistry pure and simple.

    The Ron Paul/Ben Bernanke YouTube video is troubling because it is edited in such a disruptive, and amateurish way. Why not let Bernanke finish his thought? Did he go on to contradict the Ron Paul doctrine?

    For further evidence that Ben Bernanke is not an inflation hawk, take this post from a right wing blog written before he was named fed Chairman. It Is doubly delicious because it both quotes Ben Bernanke to make the point that he is not an inflation hawk, and makes the hilariously wrong prediction that a Bernanke chairmanship will be good for gold! These freshwater guys! Better not to time the market using their advice.

    http://dailyreckoning.com/ben-bernanke-on-inflation/

    As to the Fed paper, as I read it is arguing that is an economy can be too weighted towards consumer spending. I agree with this. But Do not see it as germane to our conversation.

    It does not answer the question as to what is more stimulutive, spending or investment.

    And saying that the Austrians did not predict inflation at specific time but just sometime in the future is a bit of a copout.

    By that standard, we can all be great predictors of useless , unactionable information.

    Here then is the first prediction of Dividendian economics.

    In the future there Will be inflation. In the future there will be hyperinflation. And the future there will be deflation. In the future there will be stagflation. In the future there will be time periods of Great growth and prosperity. In the future there will be a depression.

    I know that this comment is sarcastic. But I’m trying to make the point that we should judge Economic theories by their ability to predict and provide us with useful information. Keinesians have done pretty well. And the Austrians have not.

    Finally I think it’s a big mistake to compare personal-finance with macro economics. Our finances are nothing like America’s.

    It was intuitive to think that all of the monetary expansion would’ve caused inflation. But we remain stuck near the lower limit six years after the financial crisis.

    And the use of mortgage-backed securities as example of an idea that seemed to good is an unfortunate example for a conservative to make.

    The Housing bubble was caused by many factors. Chief among them were the failure of federal authorities to regulate derivatives, And the failure the “free-market” to regulate itself.

    And so you don’t think I am a strict partisan hack, the politician I most blame for these failures is Bill Clinton (with an honorable mention for Alan Greenspan.)

    • Robert February 22, 2014 at 7:27 am #

      Arguing that inflation is a tax is sophistry? So how do you view the Obamacare penalty, er…I mean…”tax”?! 😉

      I like the way Len Penzo put it on his blog:
      “Assume you earn 4% interest in a savings account. Whether you pay a tax of 100% in a non-inflationary environment, or collect that interest tax-free with 4% inflation, the end result is the same. In other words, inflation is a tax that requires no approval from legislators. This concept isn’t lost on our government, which is currently mired in over $100 trillion of debt and unfunded obligations.
      The bottom line: Legislators know it’s political suicide to impose such onerous taxes on their citizens, so they’ll continue to encourage the Fed to recklessly print money, thereby devaluing our currency and letting inflation do the dirty work for them.”

      Here’s an article that explains it nicely: http://directlendingadvisors.com/index.php/inflations-insidious-effects/

      I never said Bernanke is an inflation hawk; obviously, he’s not. I merely used him as an authority who said that, “inflation is a tax” most certainly. For that purpose, it is irrelevant what else he or Ron Paul said. Bernanke wouldn’t have used those words if he didn’t mean it. (I’m sure they didn’t edit out Bernanke saying, “Just kidding! Inflation is not a tax. Calling it a tax is pure sophistry!”).

      I don’t think the value of a theory necessarily depends on predictability; explanatory power is also useful. In the case of economics, where intervention and manipulation is involved, timing is difficult if not impossible to predict. (I’m not an Austrian, by the way; I’m not even an economist! LOL).

      The Fed paper does in fact say that we have had too much spending and not enough capital spending over the past decades (and Mark Skousen’s analysis answers your other point, that capital investment has a greater economic impact than consumption). And it is germane to our discussion–quite central, in fact. You argued in your original post that a dollar should be taxed the same regardless of how it is earned. You supported that by arguing that spending/consumption is more beneficial to the economy than investment and saving. These are precisely the issues that I am speaking to now.

      This is also relevant to your blog. You may retire early with a large investment account somewhere and live off inflation-hedged investments, just as other wealthy people do. However, while I have money in such accounts, the majority of my retirement income currently comes from a fixed pension, much like many other retirees. It has no COLA provision. So, inflation is eating away at my standard of living every year, and the effect compounds. And this is a result of government policy.

      These course notes explain it well: http://webnt.calhoun.edu/distance/internet/business/eco231/downloads/lnc14.pdf

      To conclude, though, let me cite your own progressive, inflation-friendly economist, Paul Krugman. He and Robin Wells wrote an Economics textbook. In their chapter 32 entitled, “Inflation, Disinflation, and Deflation”, they discuss the “inflation tax” and explain why and how governments use inflation as a tax and the implications thereof. For example, in countries like India where tax compliance is low, the government uses inflation to collect taxes. They write, “Who ends up paying for the goods and services the government purchases with newly printed money? The people who currently hold money pay. They pay because inflation erodes the purchasing power of their money holdings. In other words, a government imposes an INFLATION TAX, the reduction in the value of the money held by the public, by printing money to cover its budget deficit and creating inflation.” (Page 448)(the capitalized text was bolded in the original).
      http://books.google.com/books?id=BVOn0FX7iPAC&pg=PA448&lpg=PA448&dq=krugman+wells+macroeconomics+%22inflation+tax%22&source=bl&ots=CYZmgEUS86&sig=Nnv7Kbp4C7OZOaJpV7eI7MzOKpk&hl=en&sa=X&ei=YbsIU_GiD-ScyQGal4C4Cg&ved=0CDkQ6AEwAg#v=onepage&q=krugman%20wells%20macroeconomics%20%22inflation%20tax%22&f=false.

      To summarize: Calling inflation a tax is not sophistry. It is a way of calling a spade a spade. It is accepted terminology by leading economists, including Bernanke and Krugman. By denying this you are trying to create your own reality. Why not set semantics arguments aside and recognize it for what it is? I believe if you would recognize inflation as a tax, it would have implications for how you think about savings, investment, spending, retirement, rich vs. poor, progressive vs. regressive taxation, how you rationalize tax minimization (which includes how you reduce the inflation tax by not putting your money in the bank)–pretty much everything you blog about! This is your territory–embrace it! :-)

      • Miles Dividend M.D. February 22, 2014 at 11:32 am #

        Robert,

        These exchanges are terrific. And I think you have taught me several new things in the exchange that have helped my understanding of both the issues, and how you see the world.

        Let me try to come to a conclusion here then, I conceding some points (and not conceding others.)

        1. The dictionary definition of a tax:

        “1. a sum of money demanded by a government for its support or for specific facilities or services, levied upon incomes, property, sales, etc.
        2. a burdensome charge, obligation, duty, or demand.”

        I will concede that inflation can be Called a tax by the second definition, but not the first.

        2. I will concede that Ben Bernanke at one point said “inflation is a tax.”

        3. I will concede that the above Krugman quotation Calls inflation a tax (again seemingly using the second definition of tax.)

        4. I can understand your extreme concern about inflation, given your sensitivity to inflation economically.(Much as I can understand an unemployed person’s concern about high unemployment given his sensitivity to unemployment.)

        5. I think you underplay the importance of prediction ability in the evaluation of a Theory. If you don’t evaluate a theory on its ability to predict outcomes, then on what grounds do you evaluate A theory?

        6. The freshwater guys, and the salt water guys keep on making predictions about the effects of monetary policy on things like inflation, unemployment, and growth. And one group is wrong time and time again, well the other is right more often than not. I know where I will put my penny.

        7. You’ll have to ask John Roberts why he called the Obamacare penalties a tax. I’m glad that he did, but it strikes me as mental gymnastics to avoid the obvious admission of the constitutionality of the law under the commerce clause.

        Alexi

        • Robert February 22, 2014 at 2:21 pm #

          You’re gracious! Thanks.

          On the dictionary definition of tax, I think there is an element of the first definition in “inflation tax” as well as the second, because truly, the government has a dominant role in governing inflation (and targeting a positive inflation rate in recent history). I’m not sure you are ready to concede that the government is largely responsible. If you are, then you can appreciate that it is a tax indeed and can move on in the discussion. If you aren’t, look up Krugman’s textbook.

          If we have resolved that question, we can move on to the next one, which is about whether capital gains should be taxed at the same rate as earned income. Again, there is already an inflation tax on all your cash equivalents. And there is an inflation tax on all your investment returns as well, which is a significant percentage of their gain. So why should you be taxed on the nominal gain instead of the real gain? And why should you be double-taxed in the first place? Do you agree with the Fed paper that says we need more savings and investment now, and that we’ve over-emphasized spending in the past decades, to our economy’s detriment? If you agree with that, then you should support NOT treating capital gains the same as earned income (for both the double taxation reason and so that you encourage saving and investing).

          But maybe you’d rather drop this for now and continue our discussions at a future date in another thread. There are so many issues here that it could take hours of correspondence to even scratch the surface. (Like, you now raise the issue of the commerce clause, which is whole other can of worms! LOL).

          Thanks for the discussion.
          Oh, and by the way, watch out for asteroids striking you tonight. We have a really good explanatory theory that gives us a lot of understanding about asteroids–what they are, how they were formed, where they are found, what happens when they enter our atmosphere, etc. It is a very useful body of scientific work–lots of good theories there, well-tested. BUT…since all the inputs are too complex and unknowable, we can’t predict when the next one will hit. Makes the theories pretty useless, I guess. (Makes one wonder why do we use tax money to support astronomers?). 😉

          Incidentally, if you take the really long view (look back at that chart I sent a link to earlier on historical inflation rates), the last 70 years is an aberration. Do you think there is a risk that we may have been lulled into excessive comfort with Fed policy and economic theories because the last 70 years have been relatively innocuous? Kind of like someone who builds a house in a 100-year flood plain because there has never been flooding there in his lifetime or his parents’? My limited understanding of Keynes’ primary idea was that governments should stimulate when times are tough and save when times are not. Our federal government doesn’t do that–it spends excessively in both situations. State governments, which don’t have the option of printing money, are less likely to do so. Many states have rainy day funds which act as Keynesian flywheels. The feds, however, just print money. It can’t be done infinitely. The timing question, however, cannot be answered. But with debt/GDP reaching extremes, I’d be reluctant to bet that “this time it’s different”, as is the title of Rogoff and Reinhart’s recent book that explores this topic.

  9. Fatchance February 27, 2014 at 11:38 am #

    I hate to even chime in after that comprehensive exchange with Robert.

    My problem with taxes are based around to efficiency of our national government spend. I do not actively avoid taxes. I do try and pay the minimum that is legally required. Congress puts the rules into place and I play by those rules. I make 6 figures. I do not feel over taxed. I do, however, cringe at the way we spend money tax money in the US.

    My 3 biggest issues:

    Why is the federal government paying for that? I live in a city that just announced a new fleet of busses. It was made possible by a $36M grant by the federal government. What? I guess I should say thanks to the 99.8% of tax payers who do not live in my city for contributing to our bus fleet but why is the federal government involved in this? Would you like 1000 more examples of stuff our federal government s spends money on that would make our founding fathers turn in their graves?

    I was in DC reading about the Articles of Confederation. When we were 13 colonies, getting together to form one big entity was HOTLY debated. When in doubt, there were tons of assurances that the states would hold the power unless it explicitly made sense for the federal government to be in charge (think national defense, interstate commerce).

    I would love to see my local taxes go up and federal taxes by cut by about 75%

    Basic Math: Let’s just say you make $100K a year and spend $136K a year. How long is the bank going to continue to lend you money? How this is sustainable at a federal level is beyond my comprehension.

    I would love to see a balanced budget amendment to our constitution. As I said before, I do not feel overtaxed. But if my tax rate was lifted to a level needed to pay for our national spend, I would be outraged and would openly campaign for candidates that are for smaller government and less taxes.

    Why is HE getting preferential treatment? There can only be one reason our tax code is 78,000 pages long. That is years and years of lobbying and favor giving.
    I would love to see a flat tax rate over a certain poverty level to make sure I was paying my fair share along with everyone else.

    Dr. D, I love your site. I know I am late chiming in to this one but I am just now sifting through you older posts.

    • Miles Dividend M.D. February 27, 2014 at 1:29 pm #

      Fatchance,

      I’m so glad you found the site, and like it.

      I’m also glad you chimed in. Your perspective had certainly not been represented yet.

      Where I Agree with you on the flat tax, is that deductions are a source of corruption, inefficiency, and regressivity.

      I am all for simplifying the tax code and elimiminating all deductions.

      But I see no reason to eliminate progressivity in the tax code.

      I think I’ve already represented why I believe progressivity is worth preserving (fairness, better economically, better effects on wealth distribution in society.)

      A couple of points then about balancing budgets.

      While it is intuitive, I don’t think there’s much in common with personal-finance and The federal budget of our government. As an individual I cannot print the gold standard currency for the world whenever I wish too. And if Global investors stop buying treasuries, where will they put their money?.

      That being said, I’m all for balanced budgets except in extreme situations.

      But if we look at the federal deficit under progressive versus conservative party power we will see an interesting finding. Deficits tend to shrink under Democrats, and expand under republicans.

      The deficit has decreased under Obama each and every year of his presidency.

      When Clinton left office we had a budget surplus and were on track to eliminate our debt.

      So I reject the idea that the Republicans actually care more about deficits. If they did, they would not take a no new tax pledge and take revenue increases completely off of the table.

      Alexi

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