Cacophony

Earlier this week on CNBC’s Squawk Box (a program dedicated to business news), host Andrew Ross Sorkin featured a discussion on taxation between former congressmen Jeb Hensarling and Barney Frank. The contenders for the nomination to be the Democratic candidate for the 2020 presidential election appear to be trying to out do each other in heaping taxes on the rich in order to fund the outrageously expensive new programs they are promoting (such as the Green New Deal, free college for everyone, Medicare for All and anything else they can think of that might get them another vote or two) and Mr. Sorkin attempted to engage the two ex-representatives in a thoughtful discussion. Unfortunately, the discussion was anything but thoughtful as Mr. Hensarling (a founding member of the tax cuts cure everything wing of the Republican Party) and Mr. Frank (Long serving Democrat with ties to the Democratic Socialists of America going way back) soon fell to talking over each other’s comments so that the discussion quickly soon became an unenlightening cacophonous hodgepodge of noise (which is how most discussions between the left and right end up these days). Luckily for the viewers the station soon had to go to a commercial break.

But Mr. Sorkin had begun the discussion by referencing his editorial in the New York Times, Tax the Rich? Here’s How to Do It (Sensibly). Given the title of the editorial and platform it was published on I think we can safely say that Mr. Sorkin supports soaking the rich to pay for whatever the Congress comes up with and he came up with six proposals to extract even more money from the rich.

1) Patch the estate tax

Mr. Sorkin begins by writing,

“Gary Cohn, the former president of Goldman Sachs who once led President Trump’s National Economic Council, says aloud what most wealthy people already know: 'Only morons pay the estate tax.' If you pay taxes, it’s hard not to feel like a patsy.”

Of course, very few people actually pay the estate tax so anyone dumb enough to actually have to pay it probably is a moron. Mr. Sorkin wants more people to pay more tax but generously declines to address whether the current $11.2 million exemption is too high (and then addresses it by stating it is too high). His main complaint is that when a person dies his or her heirs inherit the assets of the deceased without having to pay a tax.

But if heirs had to pay tax on inherited wealth (that the deceased had worked a lifetime in order to give to his or her heirs) they might have to sell the family farm or company in order to raise the cash to pay the tax. But Mr. Sorkin also noted that the deceased estate gets a stepped up basis which means that the gains earned during a lifetime are wiped out and the inheritors start from scratch. That means that the inheritors could turn around a sell the family farm or business and not pay any tax. Although it may be difficult to determine what the original basis was, the step up of the basis is a step too far. Although many people (mostly Republicans) want to get rid of the estate tax altogether, as long as you have a tax it should be taxed on a consistent logical basis.

2) Increase the capital gains rate for the wealthy

Mr. Sorkin gripes that the top capital gains tax is only 20% and notes that a person making $40,000 a year is in the 22% tax bracket. He implies that this is patently unfair. But although he says he consulted with tax accountants, lawyers, political leaders and (even) billionaires in preparing his recommendations he fails to note that a person earning $40,000 a year is, after applying the standard deduction, is only in the 12% bracket and would actually pay $3,619.50 in tax or about 7.9%. He even dragged up Warren Buffet’s statement that his secretary pays a higher rate than he does. A fallacy that has been dealt with in one of my very first posts (The Conundrums of Warren Buffet, September 29, 2011).

The problem with paying a tax on capital gains is that there may not be any actual gains in real terms. If you put $1 million in a bank account earning three percent interest at the end of ten years you would have $1,343,916.38. But if inflation was three percent during that period you will have gained nothing (but you would owe $68,783.28). If you are going to charge capital gains taxes, they should, at least, be indexed to inflation.

3) End the perverse real estate loopholes

In the case, I believe Mr. Sorkin is correct. 1031 exchanges defer the capital tax on investments when, in fact, there has been a taxable event – the sale of a property. The rationale for the 1031 exchange exclusion is that the property owner is exchanging one property for a similar property and that the taxpayer’s financial position is the same as before. But that is clearly not the case or there would be no exchange at all.

4) (Eliminate) fixed Carried Interest

This non-sensical provision allows fund managers whose earnings are based on a client’s gains in the fund, to be taxed at a capital gains rate even though it is their operating income because they have no capital at stake (if they did put their own capital in the fund the gain on that capital would be taxed at the capital gains rate). Even President Trump agrees this is wrong. Get rid of it (which may be difficult given how much these billionaires give to political campaigns on both the right and the left).

5) Let’s talk about philanthropy

Charitable donations are tax deductible in most countries although some countries put some limitations on such deductions. And Mr. Sorkin and I agree that it is a good thing that wealthy people donate much or even all of their wealth to charitable non-profit organizations. But the benefit of deducting charitable donations can be abused. Bill Gates has put much of his vast fortune of primarily Microsoft shares into the Bill and Melinda Gates Foundation and neither Mr. Gates or the foundation paid any tax on that donation. The Bill and Melinda Gates Foundation follows in the footsteps of other well-known foundations such as the Ford Foundation, the Rockefeller Foundation, the Carnegie Foundation, etc. and donate to many worthy causes. But other foundations can be set up by anyone having enough money and can be used to further a family’s business interests or employ family members at high salaries. The Clinton Foundation has been accused pay for play and as, at the very least, a convenient way to park Clinton political operatives while out of office. The Donald J. Trump Foundation has been accused of using the Foundation’s funds for numerous ill-advised causes. The use of these personal foundations has to be closely monitored.

6) Fund the Internal Revenue Service

The IRS has been chronically underfunded and, as a result, has had to reduce the number of IRS tax audits, which has impaired its ability to collect taxes due. Mr. Sorkin is correct that this agency should be given the money necessary to fund its constitutionally mandated functions (and which would probably more than pay for themselves). Reducing

government expenses by not funding the IRS is a stupid policy.

Some of Mr. Sorkin’s ideas have merit and some do not. The inability of the government to collect taxes was a principal reason that the Articles of Confederation were replaced by the Constitution. And the citizens of the United States have granted the government the power to impose taxes in order to fulfill its constitutionally mandated obligations. A problem arises, however, when the government taxes the people in order to provide non-mandated services and functions.

A progressive income tax that collects more money from the wealthy can be ethically justified by the idea that taxes place a heavier burden on the poor (who have to choose between taxes and other essentials such as food and shelter). But this is very different from the concept of confiscating the wealth of rich people for whatever ideas the politicians in Washington come up with. This confiscation is not based on America’s Founding Principles but on Marx’s theory that profits are based on exploitation and are, therefore, illegitimate and subject to confiscation.

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And while we’re at it:

TV news shows are chock full of stories about how income tax refund checks from the IRS are down 17% this year compared to last year and Democrats are slamming this as a middle-class tax hike.

This merely shows Ms. Harris’ financial ignorance (a fact that should be taken into account when evaluating her as a potential president). The tax refund is not a gift from the government but a return of your own money that you have lent to the government at zero percent interest. The less you lend to government in the form of excess withholding tax, the better off you are.

For a reasoned and logical discussion of the principles on which taxation should be based, I suggest that your read my pamphlet, a Summation of the Principles of Taxation, available on my website (www.edificeoftrust.com) or on Amazon, Barnes & Noble and other outlets.

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