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 13th May, 2019

  1. “There should be limits, too, on the rights investors can sign away. In recent years, some companies — such as Smartsheet and Twilio — have done dual-class issues in which the extra voting rights expire after a certain number of years. These sunset provisions preserve the potential benefits of leaving initial control in the hands of founders, while avoiding the risk of creating a dynastic birthright. That’s a sensible compromise. The Securities and Exchange Commission, or the exchanges it oversees, should make such provisions mandatory.”
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    A very useful article to help understand how to think about IPO’s, Uber, Lyft valuations, mandatory disclosures from firms and how they try to get around the issue – and the excerpt above is yet another example of a favorite adage of mine: the truth always lies in the middle.
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  2. “We find that between 1300 and 1400 a 10 percentage point higher Black Death mortality rate was associated with a 8.7 percentage point fall in city population, but between 100 and 200 years later, the impact of mortality was close to zero. When we examine the spillover and general equilibrium effects of the Black Death on city populations, we similarly find negative effects in the short run, and no effects in the long run. Cities and urban systems, on average, had recovered to their pre-Plague population levels by the 16th century.”
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    A worrying article, especially towards the end, but two major takeaways for me: cities matter, and trade matters. But my major takeaway is there is (yet more) cause for worry.
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  3. “Unfortunately, the world’s most prominent specialists are rarely held accountable for their predictions, so we continue to rely on them even when their track records make clear that we should not. One study compiled a decade of annual dollar-to-euro exchange-rate predictions made by 22 international banks: Barclays, Citigroup, JPMorgan Chase, and others. Each year, every bank predicted the end-of-year exchange rate. The banks missed every single change of direction in the exchange rate. In six of the 10 years, the true exchange rate fell outside the entire range of all 22 bank forecasts.”
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    Forecasts are useless. I cannot be more serious when I say this. Forecasts are useless. But foxes are better at the impossible then the hedgehogs – this article helps you understand these terms, and their usefulness. This blog is about becoming a better fox!
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  4. “Again, one can argue that the amount of redistribution should be larger. But it would be untrue to argue that a significant amount of redistribution–like doubling the after-taxes-and-transfers share of the lowest quintile–doesn’t already happen. ”
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    The always informative Timothy Taylor on taxes, their composition, their effectiveness and the resulting redistribution in the United States of America. Also, read the book that is reviewed in this article – the entire book is worth your time, but the chapter on income tax is what I was reminded of.
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  5. “When Paul Romer expresses an opinion, it is always worthwhile to listen because it is always well-considered. In an opinion piece in the New York Times, he puts forward a proposal to restore what he terms is the “public commons” of the provision of information in support of democracy. He actually puts forward two linked proposals: one for a target on targeted ads by digital platform companies and a proposal that the tax is progressive (which may be a check on dominance). The latter is interesting but I will just focus on the former here.”
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    I do not recollect if I linked to the Paul Romer piece that is linked to in the excerpt above – in case I did not, please go ahead and read it. The rest of the current article speaks about why Romer’s proposal is a good idea, but not necessarily implementable right away.