Saturday, July 14, 2007

Taxes, capital allocation, risk

With the recent Blackstone IPO there has been a lot of discussion on financial TV about various tax rates, and what's "fair". The WSJournal points out that the US has the highest corporate tax rate and seems to be suffering from it. (Oh, there's that Laffer curve. Totally debunked I see, appearing in a mainstream financial publication.) What's a fair level of taxation for one sort of activity versus another?

Anecdotally, I'm still in shock about doing my taxes this past year. I made a small investment in a Canadian oil royalty trust, leading to an unreasonably complicated tax situation as their K1 form had a mysterious "other" line, a twelve page tax prep guide with it, and a special website to download personalized IRS forms which were not fully supported by any popular tax software. I struggled through it, ignoring a few dollars worth of deductions I could have taken in order to save myself some time.

Everybody knows the federal tax code is overly complicated. Politicians often say they want to simplify the code, but all they ever do is offer "targeted" tax cuts, further complicating the tax structure.

I think we would benefit from treating all income alike. Capital gains (short and long term), interest, dividends, "earned" income. Why not treat the sources of income the same? Why the heck are some dividends "qualified" and others not? Should we really be subsidizing FDIC guaranteed savings, perhaps promoting overly conservative investment? (Bank savings are already subsidized by the mere existence of FDIC, though I view this as a good thing as one shouldn't need to have a safe full of gold or inflation-depreciating cash at home in order to save for financial Armageddon.)

Treating income differently depending on its source distorts how capital gets allocated. Perhaps poorer people should be buying more equity investments in order to try to advance financially. Why are we treating risk like a redheaded stepchild? What's so grand about CDs and qualified dividends? If one is concerned about losing capital in an investment then one shouldn't be concerned with whether selling immediately is a short term or long term capital gain/loss. Basically, anything that a person does to avoid taxes represents a market distortion, and a misallocation of capital.

Why do local governments tax "earned" (i.e. wage) income, while the Federal government subsidizes poorer individuals through the earned income tax credit? Taxing earned income instead of all income is a bogus subsidy to those with substantial investment income (mainly the elderly, but also the very wealthy), coming at the expense of working schlubs.

I say treat Blackstone's income the same as Goldman Sachs', and the same as Microsoft's, the same as Caterpillar's. Make it a nice low corporate rate, then adjust the "progressive"* individual tax to suit whatever the political system comes up with in terms of "fairness". Get rid of targeted tax breaks - no marriage benefit or penalty, no student loan interest deductions, nothing except a standard deduction based on number of dependents. I'm even questioning the mortgage interest deduction, but for the moment I'm undecided.

* - One might wonder how a largely libertarian rant could end up with a defense of the progressive income tax. First there's the pragmatic angle - we have a giant bloated government to pay for. Secondly we must notice that individuals with large incomes and assets benefit more from our economic and political system more than poorer individuals. I'm not prescribing how steep the curve should be, just saying that there should be a curve.

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