“If you tax investment income what will people do? Stuff their money in the mattress?”
“If you tax investment income what will people do? Stuff their money in the mattress?”
Steve Roth | October 15, 2012 9:25 pm
Richard Thaler asks exactly the right question. This from the latest IGM Forum poll of big-name economists, on the effects of taxing income from “capital.”
I’ve been over this multiple times before, but it’s nice to see the thinking validated by a real economist. If you’ve got money, there is no (practicable) alternative to “investing” it. (Those are irony quotes: referring to “buying financial assets,” as opposed to “buying/creating real [fixed] assets,” which is the technical meaning of “investing” in national-account-speak.)
Or actually — there is one alternative to “investing” your money: spending it.
Are the neoclassicals really going to argue that if we tax returns on financial assets at a higher rate — so “investors” have less after-tax income — they’re going to spend more? I don’t think I have to cite sources to prove that they consistently argue exactly the opposite.
But just for grins, let’s say they will spend more. That would be great! They’d increase the volume of private money circulation (P*T, or M*V, your choice) — boosting demand for real goods and services, stimulating production, and goosing GDP.
And if we’re lucky, they’ll use it for investment spending instead of consumption spending. They get to write off those real investment expenditures against their taxes, after all. Not true with consumption expenditures, much less purchases of financial assets.
In which case — this seems kind of obvious when you think about it — taxing “investment” income will increase investment (while reducing the federal deficit). What’s not to like?
See also David Cutler’s apt comment:
I prefer not to think of all capital as the same.
In particular my pet peeve, the rampant confution of financial “capital” with real capital.
Increasing corporate effective tax rates could also have some interesting effects if you look at it from a project management/approval and WACC perspective.
Higher tax rates could increase borrowing, cause companies to disaggregate, and also potentially increase “riskier” projects (higher return needed to overcome increased hurdle rates). Low tax rates encourage companies to do what they do, and decreasing them more just encourages them to take rents.
Following the logic trail says it would enhance innovation.
Whether that management psychology stuff actually translates into real business decisions is hard to say.
Consider someone who manages their own investments. Call it rental properties to make the example more or less concrete. I am not an accountant, but anecdotally, under the current tax system, in many (most?) circumstances it is wisest to not take a salary for doing so and to consider that income to be passive investment income, even though it takes actual work to manage those rental properties. If investment income gets taxed at higher rates, I imagine more of the “passive investment income” will turn out to be “managed” and thus requiring a salary of some sort.
Mr. Kimel,
I think the anecdote related to residential rental income “work” involved is relative.
I’ve owned a single rental (Single Family Dwelling) near-by… within 2 miles of my residence. since 1982. My “work” might average to ~20 hours a year, plus another 3 -5 hours at tax time …max < 30 hours a year. On an after tax and expenses basis, my "work" amounts to an annual salary of upwards of $20k (after considering major improvements, repairs, and upgrades over time). I manage it myself .. no management agent or firm is involved.
I know others who have 5 to 10 rentals they also manage themselves and for units much further distant — up to 250 miles from their residence. Their work" per unit is equal or less than my "work hours" per unit on an average annual basis with similar net income streams over time. They do however employ a tax-accountant at tax time — I do my own taxes… though this annual cost is miniscule as expenses on rentals go.
I also know some land-lords that own ultra low income housing and small apartment buildings… high turn-over, evictions for non-payment of rents, small claims cases, not to mention much higher maintenance and upkeep expenses (damage well beyond wear and tear).. Their "work" is far greater in actual real time devoted to managing their rentals…. on the order of 5x – 10x on average per unit….. with lower net after tax income streams. Their equity growth rate though is similar.. a bit less due to lower income neighborhoods, but not by enough to matter much..
So I'm not sure how you measure the difference between "taking a salary" and "passive investment income" on residential rentals "for someone who manages their own investments." which was your anecdotal stipulation.
"Passive investment income" is that income from investments which the owner does not manage themselves…e.g. for which their "decisions" are not material to the income. Investments in REITs are such an example in real estate investments.
BTW, I met a guy a few years ago who owned and managed over 250 rental units over a 500 mile radius from his residence. He had offices in several locations in which employed people to collect rents, advertise for and select new tenants, arrange for repairs and maintenance, send eviction notices, arrange for evictions when necessary etc. The owner spent full time managing his real estate empire, buying, selling, deciding on upgrades, major improvements, obtaining mortgages, negotiating rates. not to mention managing his various offices and employees.. His income was NOT "passive investment income".
So if he spent 60 hrs a week, 52 weeks a year for over 250 rentals then he spent 12 – 13 hours per year per rental of his own time or less than half as much as I spend of my time on my rental. Of course his per unit average net income after expenses was less as well… (due to his large employee base and offices to support them). But his net per unit after expenses was approximately half mine, so was making over 125x my annual income from rents and spending less than half the time per unit as I spend. Economy's of scale! And BTW, he had accumulated these units over a twenty year period and when I met him he owned most of them outright. it was not "passive investment income".
so I'm not sure what you were trying to say would occur if passive investment income were taxed at a higher rate then it is now.
I always imagined a late night ad for the NYSE, “Every $1000 worth of securities you buy on our exchange means an additional $1 worth of investment in capital goods and materials! Shop now!”