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[]

What do Income Tax Returns, Demonetization, and Fast Tag have in common?

It may help to read last Thursday’s post before you start reading this one.

Why are there such long lines at all the toll plazas across India at the moment? You may give  a lot of answers, and if you have recently passed through a toll plaza yourself, your answer may well be unprintable.

Here’s mine though: you are, currently, assumed guilty until proven innocent.

All cars must wait in line, pay cash/have the RFID tag scanned, and for each car, once the payment is done, the barrier is raised, and you may pass through. The barrier stays put until the verification is done: that’s another way of saying guilty until proven innocent.

But the cool thing, to me, about implementing Fast Tag, is that once a certain percentage of vehicles in India is equipped with Fast Tags, the barriers can stay up. We will transition to a regime in which all vehicles are assumed to be innocent.

Now, as we learnt the previous week, with a large sample, there will  be problems. In the new systems, in which vehicles just pass through because we assume all of them have Fast Tag implemented, there will be exceptions. There will be vehicles that don’t, in fact, have Fast Tag implemented, and so they may end up not paying the toll.

But the vast majority will have Fast Tag, and don’t have to pay with money and waiting time. The government will miss out on catching a few bad apples, but a lot of Indians will save a lot of time. On balance, everybody wins.

And of course, given technology, it should be possible to have notifications sent to those vehicles that pass through without paying. Yes, I know it seems a long way off right now, but the point is that as a statistician, we move to a world where we assume all vehicles are innocent until proven guilty, rather than the other way around.

Fast Tag implementation, when fully functional, will get the null hypothesis right.

And pre-filled income tax returns, sent to us by the government, with minimum of audits and notices, is exactly the same story. The government assumes innocence until proven otherwise, leading to a system in which every tax-paying Indian is assumed to be an honest tax-payer until proven otherwise. We already have a system that is closer to this ideal than was the case earlier, and hopefully, it will become better still with time.

And now that we’re on a roll, that’s the problem with demonetization, if you were to ask a statistician! All notes were presumed guilty, until proven innocent.

Here’s the point: if you are a student of statistics, struggling with the formation of the null, and wondering what the point is anyways*, the example from last Thursday and the three noted above should help make the topic more relatable.

And to the extent that it does, statistics becomes more relatable, more understandable and – dare I say it – fun!

 

*Trust me, we’ve all been there

 

India: Links for 23rd September, 2019

  1. Income tax reforms: in my opinion, an urgent necessity.
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  2. ““If we wake up a little late after there is daylight, and go to defecate in the open, the railway authorities pelt us with stones or beat us with big sticks,” said Sumanben, a migrant Adivasi woman who lives on public land near a railway track. “Sometimes there is a watchman at night. If he is there then we cannot defecate that day.”.”
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    Indiaspend, ostensibly, on the Minimum Wage stipulations – but it is about more than that.
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  3. “We must therefore recall that if the India story plays out well in the world’s capitals, boardrooms, think tanks and editorial offices today, it is because of three developments: the development of a nuclear arsenal with a no-first use doctrine, the revulsion against international terrorism after 9/11, and India’s emergence as a high-growth economy with several globally competitive sectors. In the past two decades, India has come to be seen as an engine of global economic growth, a potential counter-weight to China, and a country that has taken a liberal democratic path to prosperity. It is high economic growth that created the conditions for India to tango with the US, be taken with grudging seriousness by China, and clear the way for better relations with East Asia, Australia and Europe.”
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    High growth matters: the geopolitical argument.
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  4. Amol Agarwal reports on the proceedings of ‘The International Conference on Indian Business and Economic History’. This deserves to be widely read, and widely shared.
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  5. “What is needed is a change in the policy regime in many cross-cutting systemic issues, such as the role of politicians, stability of tenure, size and nature of Indian bureaucracy, accountability, monitoring of programmes, and civil service reforms, which will transform the individual competence of IAS officers into better collective outcomes.”
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    In a sense, a frustrating article to read, because more than the what, which is clear to all, it is the how that is important – and that is missing.