All About Taxation

I write this blog for folks who are looking to learn more about economics. And if you are in this group, you can’t help but have noticed that there’s been a bit of a brouhaha over taxes, both in the United States of America and in India.

ProPublica has obtained a vast trove of Internal Revenue Service data on the tax returns of thousands of the nation’s wealthiest people, covering more than 15 years. The data provides an unprecedented look inside the financial lives of America’s titans, including Warren Buffett, Bill Gates, Rupert Murdoch and Mark Zuckerberg. It shows not just their income and taxes, but also their investments, stock trades, gambling winnings and even the results of audits.
Taken together, it demolishes the cornerstone myth of the American tax system: that everyone pays their fair share and the richest Americans pay the most. The IRS records show that the wealthiest can — perfectly legally — pay income taxes that are only a tiny fraction of the hundreds of millions, if not billions, their fortunes grow each year.

https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax

What exactly is income tax? And what is its history?

Well, the first question is simple to answer (to begin with): it is a tax on your income. Ah, but that then begs the (pardon the puny pun) million dollar question: what is income?

But a question remained: What would count as income and what wouldn’t? In 1916, a woman named Myrtle Macomber received a dividend for her Standard Oil of California shares. She owed taxes, thanks to the new law. The dividend had not come in cash, however. It came in the form of an additional share for every two shares she already held. She paid the taxes and then brought a court challenge: Yes, she’d gotten a bit richer, but she hadn’t received any money. Therefore, she argued, she’d received no “income.”
Four years later, the Supreme Court agreed. In Eisner v. Macomber, the high court ruled that income derived only from proceeds. A person needed to sell an asset — stock, bond or building — and reap some money before it could be taxed.

https://www.propublica.org/article/the-secret-irs-files-trove-of-never-before-seen-records-reveal-how-the-wealthiest-avoid-income-tax

As the article I have excerpted this from goes on to say, folks were warning us even back then that this was not going to end well (it is nowhere close to ending, and it is not going well). But this talks to us about the difficulty of defining income, about which more in a bit. Here’s a brief snippet about how the idea of income taxes originated:

The universal taxes of ancient times, like the one that brought Mary and Joseph to Bethlehem just before the birth of Jesus, were invariably head taxes, with one fixed sum to be paid by everybody, rather than income taxes. Before about 1800, only two important attempts were made to establish income taxes—one in Florence during the fifteenth century, and the other in France during the eighteenth. Generally speaking, both represented efforts by grasping rulers to mulct their subjects. According to the foremost historian of the income tax, the late Edwin R. A. Seligman, the Florentine effort withered away as a result of corrupt and inefficient administration. The eighteenth-century French tax, in the words of the same authority, “soon became honeycombed with abuses” and degenerated into “a completely unequal and thoroughly arbitrary imposition upon the less well-to-do classes,” and, as such, it undoubtedly played its part in whipping up the murderous fervor that went into the French Revolution.

Brooks, John. Business Adventures: Twelve Classic Tales from the World of Wall Street (p. 93). Hodder & Stoughton. Kindle Edition.

That… is not reassuring.

The chapter on income tax from this excellent, excellent book makes for great reading. As it turns out, it was the (surprise, surprise) Civil War that finally provided the impetus for the imposition of an income tax across the length and breadth of the nation1 And the imposition was celebrated! Well, at least by some:

“I am taxed on my income! This is perfectly gorgeous! I never felt so important in my life before,” Mark Twain wrote in the Virginia City, Nevada, Territorial Enterprise after he had paid his first income-tax bill, for the year 1864—$36.82, including a penalty of $3.12 for being late. Although few other taxpayers were so enthusiastic, the law remained in force until 1872. It was, however, subjected to a succession of rate reductions and amendments, one of them being the elimination, in 1865, of its progressive rates, on the arresting ground that collecting 10 per cent on high incomes and lower rates on lower incomes constituted undue discrimination against wealth.

Brooks, John. Business Adventures: Twelve Classic Tales from the World of Wall Street (p. 96). Hodder & Stoughton. Kindle Edition.

Back, as it were, to the future. Anand Giridharadas wrote an article in the New York Times about the ProPublica report:

Mr. Buffett is almost the perfectly made billionaire for this moment in which, at last, many Americans are beginning to question not only corruptions of the system but the matter of whether billionaires should exist at all. He doesn’t do the things the worst of them do. He isn’t in it for what they’re in it for. He clearly must care about money, but he also kind of doesn’t care about money. Even in his generosity, he has avoided the imperial lording over that others cannot resist.
And this is what makes him so troubling, because through him we are tempted into believing that a system can be defended that allows a man to accumulate more than $100 billion while people are sleeping, in hock to him, in his mobile homes, shortening their lives with the beverages he’s invested in, scampering around the warehouses whose nonunion status has redounded to his money pile.
It can’t. And who keeps us from seeing that simple, stark truth more effectively, more perniciously, than the Good Billionaire?

https://www.nytimes.com/2021/06/13/opinion/warren-buffett-billionaire-taxes.html

The second card in my three card trick is a response to this essay, from V Ananta Nageswaran2:

So, notwithstanding Anand Giridhardas, we can still think about the manner in which incomes and capital gains & dividends are taxed. I see three issues, at my level.
There needs to be a discussion on unrealised capital gains and dividends. Dividends are avoided and companies buy stocks back to avoid dividend tax. What if the tax policies take away that choice?
Second, even if we accept that only realised capital gains are to be taxed, why are they taxed at much lower rates than tax on wages?
Third, even if we accept this logic (which, in addition to the above arguments, is also a reflection of who made those laws, their incomes and wealth status, etc., over time and across the world) of the primacy of capital, for the sake of argument and hence accept the conclusion that capital gains will be treated differently from regular labour income, then the question is one of defining short-term and long-term. Why should short-term be just one year? In economics, anyone’s definition of short-term is not one year but a business cycle, i.e., minimum three years. Extending the definition of ‘short-term’ to 36 months from 12 months will earn more revenues.

https://thegoldstandardsite.wordpress.com/2021/06/19/the-inequity-of-the-tax-system/

That is, the author is saying that that are indeed problems with capital being taxed the way it is, but (as he points out elsewhere in the blog) the way forward is evolution, not revolution.

Which brings me to the third card: TALISMAN.

The truth, as always, lies somewhere in the middle – and that, of course, is the point of the excerpt above too. On the spectrum of Current System Bad:::Current System Good, reasonable people can and should argue about the “sweet spot”.


And if you are a student of economics (and especially public finances), where do you go to learn more before trying to figure out where you should be on this spectrum?

  1. Please read the chapter on income taxes from the book Business Adventures
  2. Read this essay by Tim Taylor (and note that it was written before the ProPublica report came out!)
  3. Farhad Manjoo, a while ago, on abolishing billionaires (and the response to that essay)
  4. Gulzar Natarajan on this issue
  5. And for a theoretical understanding – always a good idea for an issue as complex and important as this one – Chapters 20 and 21 from Stiglitz’ Economics of the Public Sector.
  1. do read the entire chapter, though. The snippet about the experiment in Rhode Island is fascinating.[]
  2. note that I am excerpting the outline of the argument, please visit the blog to read it in full[]

Links for 21st March, 2019

  1. “In a 2011 paper, trade-policy researchers Anwarul Hoda and Shravani Prakash analyzed the impact of “the proclivity of the U.S. administration to leverage the GSP program to achieve its economic and political objectives.” They found that with major developing-country trading partners “the reciprocity requirement has proved to be ineffectual.” In 1992, the U.S. stopped India’s preferential access for chemicals and pharmaceuticals in an effort to improve intellectual-property protection. New Delhi shrugged off the pain, and waited for a World Trade Organization agreement before amending its patent law, the researchers noted.”
    Andy Mukherjee doesn’t think the removal of the GSP support by the USA will have any meaningful impact on India’s exports to that country. He also cites an interesting paper (which I haven’t read yet), which seems to say essentially the same thing.
  2. “The opportunity is simple to describe but requires real effort to achieve: the community must enforce systems that build the external costs into the way that the industrialist does business. Faced with an incentive to decrease bycatch, waste or illness, the industrialist will do what industrialists always seek to do–make it work a little better, a little faster, a little more profitably.Industrialism can’t solve every problem, but it can go a very long way in solving the problems that it created in the first place.”
    Seth Godin (whose blog is a remarkable thing, by the way) gives his take on externalities, and makes the case that economists take a far too restrictive, anti-septic view of the problem. I’m putting words into his mouth, but that’s how I interpret it – and I’d agree. Certain problems can be identified best by economists, but perhaps the solutions lie outside the textbook. A useful article to read for starting discussions around externalities, the Coase theorem, Elinor Ostrom’s work, the role of culture in economics.
  3. “When it comes to the institutional framework, there are obviously massive differences between India and China. Any leader in India must contend with parliament, the courts and state governments. Also known as democracy. That limits how quickly stuff can get done. It can also save politicians from serious mistakes. China has competing interests and constituencies as well, but it’s not the same sport, let alone ballpark.”
    The article is about India’s less than stellar economic growth in the previous quarter, but that paragraph above was important to me. India is a functioning democracy, China anything but. That has it’s advantages, and its disadvantages – to both. A point worth remembering in many ways – one of which part of the focus of this article.
  4. “In the process, Netflix has discovered something startling: Despite a supposed surge in nationalism across the globe, many people like to watch movies and TV shows from other countries. “What we’re learning is that people have very diverse and eclectic tastes, and if you provide them with the world’s stories, they will be really adventurous, and they will find something unexpected,” Cindy Holland, Netflix’s vice president for original content, told me.”
    Farhad Majoo in the NYT about why Netflix is such a good thing. It’s a useful article to understand the impact Netflix is having the world over – but also a good article to learn about pricing, the implications of pricing, content discovery on Netflix.
  5. “For several years, India’s banks have been in the spotlight over their problematic lending to prominent industrialists. Now the mutual funds and non-bank lenders — who have taken increasingly important roles in the credit system amid the banks’ woes — are coming under similar scrutiny. That is good for the development of the Indian financial sector. But it is yet another headache for some hard-pressed members of the promoter class.”
    Simon Mundy in the FT on how the IBC has provided teeth to creditors in India – which is genuinely good news. But the transition is unlikely to be smooth, and there may well be some unexpected skeletons waiting to tumble out of the closet. A good read for finance, bankruptcy and non-bank lending in India.