Known Unknowns

You are richer than you think


Welcome to Known Unknowns, a newsletter where wealth and income are worth more than you think they are.

What is good tax policy?

It seems like an unpopular question. When I learned public finance, I was taught that any tax is distortionary because the whole process of taking money from individuals and putting it somewhere else can result in loss. That loss may be worth it, however, as sometimes it pays off because we invest the money in useful things, like canals, or if we provide insurance to people who need it – but the whole tax process is distortionary, there’s no way around it. So the goal of tax policy should be taking as much revenue as you can while trying to minimize distortions. Some kinds of taxes are more distortionary than others. In order of least to most harmful, it goes

1.     Consumption taxes

2.     Income taxes

3.     Wealth taxes

Cut to our current tax debate, where these concerns get no attention. The goal seems less about minimizing distortions/maximizing revenue and more about punishment, i.e., rich people for making too much in a zero-sum world and corporations for being greedy. Now, I think our tax system should be more progressive, too. But there are good and bad ways to achieve that goal. Take the 130 countries who signed on to a 15% minimum corporate tax. Is this good policy? It sounds good, i.e., corporations will pay their share, but it does not eliminate the incentive for a race to the bottom to cut taxes and attract investment. Countries will now just compete on subsidies and deductions instead. That is more distortionary than a broader base and lower rate. Better to let countries set the rate they want and encourage them to eliminate distortions. Though it is less emotionally satisfying.

Or take the sudden interest in wealth taxes, both with taxing accrued wealth and Peter Thiel’s Roth IRA. Taxing accruals is bad tax policy – there is no good way to defend it, and it is unpopular. But if we want to make sure people “pay their share”, why not tax high-end consumption instead?

Now people argue that retirement accounts should have asset limits – also bad policy, as it will also create distortions. Why not just limit retirement account investing to publicly traded securities (but not Bitcoin) instead? Personally, I’ve never totally trusted that the tax treatment of Roth accounts will still be in place when I retire. Too many affluent people have money in them, so they are ripe for taxes when the revolution comes.

The fact is that good tax policy, which raises revenue, is progressive, and least distortionary is actually kind of technical and boring. Which is why our populist tax instincts won’t bring us anywhere useful.

Millennials don’t like to hear they are successful

As many of you know, I am a life-cyclist, which means I take a wholistic view of wealth. It’s not just your stock portfolio and your home – your future earnings count, too. So if you make an investment in yourself, get a degree or move to a city where wages are higher, that can be a good bet that increases your lifetime wealth. So if Millennials have more student debt and live in a high-cost city, where they can’t afford a house, they may have just made a smart decision to invest in human capital instead. No shame in that – in a knowledge economy, it’s a smart thing to do. Millennials also have accumulated more financial assets because they saved more for retirement. I did not even include a large impeding wealth transfer coming their way. So down with “the Millennials are the worse-off generation who live with unprecedented risk” it’s nonsense. They’ve never experienced high inflation.

I also suspect they are less risk-tolerant and that’s part of what is driving the confusion. They want more security before they take a leap into marriage, family, and a house. Their parents were willing to wing it a bit more. It is hard to make a call on if that is good or bad – it really comes down to preferences. No shame in risk-aversion.

I thought these were all fairly benign observations. But, wow! Remind me to never tell Millennials they are financially savvy – because there was a fair number of angry emails and Twitter mentions. I guess some people like feeling like they are having a hard time. Again, we all have different preferences.

Shaking up the NCAA

The NCAA gets a lot of criticism for not making cash payments to players. It seems outrageous to many that there are multimillion-dollar coaching salaries and large TV deals, while players get nothing. Though they don’t really get nothing: they get a scholarship, which in theory at least is worth more than any minor league salary. I always saw the NCAA as getting around a potential market failure. If an 18-year-old is facing a choice between a long-shot pro-career or education; many would take the long-shot. The good thing about the NCAA is that it is effectively a minor league system where players get paid in future human capital.

The Supreme Court decision may not change too much, at least initially. But it opens the door to schools one day competing on cash payments, which I argue will not really benefit students. Revenues are large, but profits are slim – even for men’s D1 basketball. The money needs to come from somewhere, which means fewer scholarships for more vulnerable or less-talented students or other kinds of benefit cuts. We’ve seen in other industries where regulations shift how people are paid and often they end up with less.

Though perhaps now that players can make money off their likeness, there will be less pressure on cash payments.

In other news

It is dangerous to mess with the risk-free rate for too long

So is breaking up big businesses, just because they are big

Until next time, Pension Geeks!