Asymmetrical Information

Thanks very much for the link!

Before everyone dives in, it might be worth clarifying the various interests involved. For example, it would be great to know if the farms that Mr. Summers is talking about receive any federal susidies, either directly or through access to federal programs that provide capital (in whatever form) at lower rates for farmers.

Addressing the interest rate question. Market interest rates are determined by the supply of marketable securities and the demand for them. It is as simple as that. Currently we enjoy a very large demand for our bonds stemming from our trading partners, chiefly Japan and China (though Chinese purchases have collapsed in recent months) who would rather recycle their balance of payments surpluses into the US Bond market and thereby prop up the dollar rather than see their terms of trade diminish.

While in the short run this looks mercantilist in the sense that they are accumulating rather massive reserves in reality they are confiscating possible purchasing power from their populations (in dollar terms) in an attempt to maintain growth and employment in their export sectors. It is a game that cannot last forever and at some point, possibly as they realise that the dollar either will, or has to, fall, the music will stop and there will be a sharp correction to the dollar and US rates. (Not to mention a possible knock on to housing prices here)

This is not the whole story, but it is one very important part of it...

If the estate tax did what its supporters think it did Ted Kennedy would be flipping burgers.

The existence of all the Kennedy compounds is abundant proof that the estate tax does not accomplish what it supporters hope it would. However, it does keep lots of estate planners and life insurance salesmen very busy.

SomeCallMeTim,

If subsidies are received they are counted as income and taxes are paid on that income when it is received.

TJIT:

Not really what I was asking. If a subsidized estate is worth 5 million, at least part of that value is due to the subsidies; either b/c the estate can be used to generate further subsidies in the future, or b/c subsidies allowed it to float in the past when it should gone broke (and someone else could have picked it up cheaply). What I'd like to know is how much of that value is a result of subsidies. At a minimum, I'm not sure why a Republican would think (a) that the subsidies are a good thing, or (b)that the state shouldn't get 100% of the value of the invested subsidies back (perhaps with interest).

SomeCallMeTim,

I am opposed to Ag subsidies and would like to see them ended. However, they are not relevant to this discussion and direct attention away from the death tax to something else.

The trusts created in anticipation of the estate tax are perfect illustrations of what Robert Lucas and his associates at the University of Chicago economics department have been saying for years about "rational expectations". Per the UC Chronicle, "the theory of rational expectations is based on the belief that people make economic choices based on their previous experiences and their rational expectations of the results of those choices".

Of course, that is a tent big enough to cover a lot of issues in contemporary life. I can remember thinking the first time I had it explained to me, what it so earth shaking about that? Years of reflection, though, have given me an appreciation for its fundamental usefulness.

After it earned a Nobel Prize in 1995, I remember a few commentators taking the position that there was very little else of a profound nature to justify future economics prizes. Their position was that the econometrics and other empirically based thinking was pretty shallow in comparison.

You can't take it with you but you can keep it in the family if you care about them enough!

TJIT:

If the value of an estate is a function of government intervention, then it's hard to make either a fairness argument against the estate tax or (depending on the circs.) an instrumental argument against the estate tax. If you want to restrict the argument to estates whose size is not dependent on government largess, so be it. Paul Krugman's essay about the lottery aspect of income can probably be extended to estates as well, but let's be explicit about the cases we are talking about first.

It always surprises me that others find it difficult to comprehend how much taxation influences economic behavior. Perhaps it's because I am a tax professional and I help my clients manage their tax exposure, but I've come to believe there are few things that are more influential than taxes.

A quick example: Several years ago, when the top federal individual income tax rate was 39.6% and the top federal estate tax rate was 60% (reflecting the 5% surcharge to remove the benefit of the lower marginal brackets), a wealthy client of mine owned an attractive parcel of farm land not far from Dallas. One of his employees was recommending the parcel be developed and I was asked to forecast the tax consequences. My client lost all enthusiasm for the project once he learned his family would only get to keep 24 cents of each dollar of profit. ($1 less 40% tax equals 60 cents after income tax. 60 cents less 60% estate tax leaves only 24 cents for the family.) He felt the potential benefit just wasn't worth the effort (and the risk). Will that property be developed some day? Sure, just not as soon as it otherwise would have been. But, if you were a construction worker (one of the "poor" the estate tax and the progressive income taxes are supposed to benefit), when would you have wanted the project to be started?

OK David. But let's be a little more careful about this calculation. If you're going to knock income and estate taxes off his profits let's knock them off his investment too. Sixty cents comes off due to the estate tax, and a hard to figure additional amount due to income tax.

Just as his dollar of profit is reduced by taxes, so also is the size of his investment.

Bernard - I don't follow your argument. Taxes do not "reduce" my client's investment, unless you mean the value of his investment will be reduced by estate taxes. Indeed, since my client earned and paid income taxes on the funds he used to make the investment in real estate, he had to earn $1.67 for every dollar invested. ($1.67 less 40% in income tax equals $1 left for investment.) In that manner, taxes DID reduce my client's investment.

David,

Suppose the investment in question is a straight double-or- nothing proposition pre-tax. He invests one dollar and either wins a dollar or loses one.

You are correct that the dollar he might win amounts to only 24 cents after tax.

My point is that the dollar he is risking is not a full dollar either. If he loses his estate is worth one dollar less than if he didn't bet (Just like it's worth one dollar more if he wins) so his estate tax is less than otherwise. and there will be income tax savings produced by the loss. These, as you know better than I, can vary widely depending on the nature of the investment, etc.

If it is just an ordinary business loss it will reduce his income tax by 40 cents (just as winning will increase it by 40 cents) so he loses only 60 cents after income taxes. And then his estate is worth 60 cents less than otherwise, so he saves another 36 cents there. In other words, he loses 24 cents after tax if he loses, gains 24 cents after tax if he wins.

In this scenario, at least, taxes do not affect his odds.

Does the estate tax drive M&A activity for private companies? Up to a point, but only up to a point. Some founders do not want to leave the company to their children -- they are concerned that the children will screw up the company, or the company will get in the way of the dreams of the child. Other founders just want to blow the money on themselves. Other founders are serial entrepreneurs, and will sell companies automatically once they get to a certain size. And, finally, a lot of private companies are sold because of divided ownership (VCs vs. management, or shares spread widely among family members) and an immediate desire for liquidity.

I think liberal investment bankers support the estate tax because most investment bankers think of estates as primarily financial assets. And it is certainly the case that if all estates consisted of highly liquid portfolios of blue chip stocks, many of the arguments against the estate tax would fall away. The liberal investment bankers -- and I know a bunch of them myself -- are not thinking about the grain elevator just outside of Coralville, Iowa, and the impact of the estate taxes on the many people who patronize it or work for it.

good to see tim and bernard are being incoherent as usual, and that we are back on topics where incoherence is obvious

tim: as to your contention that the government should be able to seize things it grants, would you be willing to keep up that argument with respect to other things (say when the targets are less financially successful)? likely not, but your ideology lets you say screw the rich

fun discussions that let you avoid the obvious

but seriously, you need to be able to separate out the way that property is created or allocated from the way in which it is seized. no one that i have seen comment here from the right/libertarian spectrum agrees with any tariff or subsidy. we would happily do away with any and all such government programs, and most of us would eliminate nearly all government spending. nice try to wave your hands on the issue, but you do need to argue things modularly, or else there's the escape clause of communists (hell you probably use this yourself) that "communism is perfect but it has never been given a chance in the real world".. thta USSR wasn't communist... etc

nice try, things don't work like that... but then you wouldn't be a liberal/socialist if you lived in the real world

bernard.. wtf? seriously.. wtf?

we're talking about how investor has $1, with expected value of x after estate taxes. given the amount of work to increase that pie, and that his family only receives a marginal $0.24 for every dollar of success of his efforts, it wasn't worth the investment.

so instead he keeps the dollar, using it for other things, has less risk in his family's portfolio, and has more time for his family and himself.

how you can say that taxes have no effect on his marginal utility of investment is insane (but that's ok, you're a liberal/socialist and that's natural). we're talking about the actual real world effect of taxes on people's behaviour.

estate taxes do not do what they promise, do not provide net revenues, decrease economic activity and distort the way that people behave. but they look good and make a show of attacking the rich, which salves the jealousies of the liberals and the consciences of the limousine leftists. what a horrible thing.

hey,

What a polite and well-reasoned argument you make. Calling those who disagree with you incoherent, refusing to understand their point, and then spouting unsupported claims and wild generalizations about them is certainly a convincing way to make a point.

I was claiming that, subject to reasonable assumptions, the estate tax doesn't affect the odds on the investment. I realize you're probably a touch weak on arithmetic, but go over it again.

Hey:

" nice try to wave your hands on the issue, but you do need to argue things modularly, or else there's the escape clause of communists (hell you probably use this yourself) that "communism is perfect but it has never been given a chance in the real world".. thta USSR wasn't communist... etc"

This may be my favorite sentence of all. Does anyone have any idea what he's trying to say here? Getting old can be hard, huh, Hey?

The tax code is so complex and difficult to administer that it creates a huge drag on economic activity. A well-structured VAT tax could derive the same revenue in a much more efficient manner. However, this is impossible from a political standpoint because the folks in DC make their living selling tax breaks.

Shamus - I agree that the tax code is too complex, but I disagree that a VAT would either be more fair or easier to administer. From the average citizen's view point, the VAT (and it's close cousin the sales tax) is very simple because we simply pay the tax at the cash register -- we aren't involved in the calculations nor in the reporting. But as a tax professional, I can tell you from experience that a well designed VAT is very complex. At EACH step of the production process, a tax is collected on the "valued added". This means you need to calculate the value of the item (not too difficult) and then subtract out the portion of the value that has already be taxed (which can be very difficult). For example, let's say you manufacture wooden toys. You use wood, screws, glue, paint, and sandpaper to make the toys. To calculate the VAT on each toy you sell, you need to determine how much tax was paid on the wood, screws, glue, etc. -- oh, and don't forget the scraps that ended up on the shop floor. The tax paid to acquire the material that ends up as waste has to be allocated somehow to your toys. This kind of cost accounting is very complex and full of opportunities for disagreement between your accountant and the government.

One last word: Ours is a complex economy. To be fair, our tax system (whether that tax is on income or consumption) needs to reflect that complexity. There simply is no free lunch here. (That does NOT mean the tax code is not larded with provisions that have little justification.)

One last word: Ours is a complex economy. To be fair, our tax system (whether that tax is on income or consumption) needs to reflect that complexity. There simply is no free lunch here.

David,

On this we agree completely. It should be posted in great big letters at the top of any discussion of how the tax code could easily be simplified.

If I may enlarge on the point, part of the reason for the complexity is that terms like "income," "consumption," "investment," etc. while valid and useful for abstract discussions, are very hard to pin down, and calculate, in concrete cases, as your toy factory example illustrates well. Things like dividends and capital gains need careful definition. That makes even seemingly simple things complicated.

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