DBCFT – An Untested Tax Policy For Strange Days

paul_ryan_tax_reformWith Congress and the White House unified under the same party, radical corporate tax reform is coming our way very soon. Although some reform is welcome, this is a column about the part of the reform that worries me the most, known by the non-mellifluous label “Destination-Based Cash Flow Tax With Border Adjustment.”

Let’s say you are a tax-policy maker in Washington and you wanted to address two problems at the same time with US businesses that make money overseas. The first problem might be that US multinationals leave a big pile – an estimated $2 trillion – of profits overseas, which they do in order to avoid having to pay our relatively high 35 percent corporate tax rate. The second problem might be that you want to create more jobs here by encouraging an “America First” approach to global trade. You would do that by giving US corporations tools to export more stuff, and maybe import less stuff, to encourage businesses to expand in the US, create jobs, and help our trade balance.


The solution among tax nerds is this so-called “destination-based cash flow tax with border adjustment.” It’s a mouthful, I know. The Twitterati have shortened it to #DBCFT for the newspaper readers who want to follow along this debate, in real-time.

But DBCFT is NOT just for tax nerds, it’s the core of House Speaker Paul Ryan’s “A Better Way,” the proposal that sets the blueprint for the major tax reform that’s likely to pass with Donald Trump in the White House.

DBCFT says that US companies would not get taxed on sales revenue generated outside of the country, only revenue made on sales inside of the country. It also says that US companies would pay taxes on the full value of all their imports into the US, rather than deducting import costs like other ordinary business costs.

A_Better_WayThis reform would take care of the accumulated $2 trillion pile of cash, since US multinationals would not pay US taxes on revenues generated overseas. They could onshore future profits with no consequences. Presumably some tax amnesty plan would bring in the existing pile, and there would be no incentive to create a new pile offshore.

DBCFT also appears to offer a massive subsidy to exporters through tax breaks. Like, if Apple earns $1000 in profit (to use numbers absurdly small and simple) from sales in Europe, it would owe Uncle Sam nothing, rather than the current up-to-35 percent rate, or $350. Without that tax burden, big exporters like Apple can turn around and sell stuff even more cheaply than foreign competitors.

Mission accomplished, right? On-shored profits and strengthened export businesses! Everything’s good?

Actually, we don’t know for sure.

A tax plan like this has never been implemented.

We have some economic theory about why everything will be fine – which I’ll explain in a moment – but it’s also fair to say that a massive shift like this could have unpredictable consequences. DBCFT is untested in reality, and like a lot of what’s happening in other policy areas, things could get weird.

Former Treasury Secretary and economist Larry Summers argues that DBFCT could have at least two big troubling consequences.

The first worry is that big exporting companies might generate negative tax bills in perpetuity – meaning a big tax refund every year – which seems super odd, and maybe something the US government wouldn’t really allow.

The second troubling consequence is that companies that import a lot of stuff which they then sell inside the US might have tax bills that are equal to – or bigger than – their entire amount of profits – also a weird result. It wouldn’t feel good – or be financially sustainable – to pay more in taxes than you even earned as a business.

This is scary, and potentially highly disruptive for a company that depends on imports to produce its product.

Think of the kittens?!?

Maybe a small business example can help illustrate this problem for importing companies that sell only in the United States. I have a buddy in San Antonio whose online business delivers disposable cat litter boxes to households, based on an online monthly subscription plan. GoGoGato imports Chinese-manufactured litter boxes from Canada, and then ships them to anywhere in the United States. So, he has significant import costs, and purely domestic sales.

GoGo_GatoLet’s say each imported litter box cost him $5, which he retails for $25 each, and manages to eke out a $1 profit (remember, he has shipping, marketing, packaging, and storage costs) on every box shipped.

At a 20 percent corporate tax rate (the new Paul Ryan-proposed rate) on his $1 in profit, he’d owe $0.20 in taxes on every box he sold. But under DBCFT, the $5 cost of each box imported from Canada would not be tax deductible. Instead, suddenly GoGoGato would owe taxes on $6 – That’s the $5 import cost, plus his previous $1 profit. Instead of owing $0.20 in taxes per box, he’d owe $1.20 in taxes per box, more than his entire profit per box. That’d be a business killer for GoGoGato. Litter-ally.[1]

UC Berkeley economist Alan Auerbach, an advocate for DBCFT, argues that the fears are overblown. The economist’s view is that the tax change would cause an immediate upward move in the value of the US dollar compared to other currencies, which would leave importers and exporters equally well-off from before the change.

How does that work? A strengthened US dollar – the economic theory goes – boosts imports and suppresses exports, in roughly equal proportions to the tax benefits and costs caused by DBCFT. That’s the theory anyway, which Auerbach and other tax policy experts like Kyle Pomerleau at the Tax Foundation say make fears about DBCFT overblown.

The fact that economists say “Don’t Worry!” isn’t stopping retailers, however, from heavily lobbying against the tax proposal.

With the example of even a small business like GoGoGato, it should not be surprising that big-importing retailers like Wal-Mart are gearing up to fight DBCFT.

America First?

Ready for one more potential problem with DBCFT? Summers further argues that if the US dollar appreciates by 20 percent versus other currencies as a result of DBCFT, it might cause disruptive effects on world markets. Heavily-indebted emerging market countries, for example, could find their dollar debts 20 percent more expensive to pay. Financial chaos could ensue.

In an “America First!” world we might not care about the potential devastation our tax policies cause. I would argue, however, that we brush off the risks of untested tax changes at our own great peril.

[1] I apologize.



Please see related posts:

Corporate Tax Reform is Coming

How to Evade Taxes Offshore – Wyly style

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JEB!’s Future Tax Policy

Happy Jeb

I’m going to start this post with the controversial thing, before moving on to the analytical thing.

Now, I know you. You’re going to want to angrily write to me about the controversial thing, and especially how I’m wrong. I don’t care. What I’m hoping is that we can turn quickly to the analytical thing, which is far more important to discuss.

Controversial thing

Jeb Bush is going to be the Republican nominee for President. I mean to say, Jeb!

I know, I know, he’s nowhere in the polls, lackluster in the debates and the exclamation point on his campaign logo can really only be understood ironically. Doesn’t matter.

I write as a “recovering banker” because I think a financial framework is a useful starting point for viewing the world. Jeb! is the only one in the Republican race with $100 million backing him. He will win. I expect all of you who write in an angry note about my controversial statement will also agree to mail me a dollar in Summer 2016 when I turn out to be correct. Ok? Thanks.

Analytical thing

Having said that, I want to talk about the future Republican nominee’s tax policies. Tax policy matters tremendously. Jeb!’s got a 50-50 shot at the White House (I just mean any D versus any R is a coin flip in any quadrennial) We should know what he stands for.

Tax code overhaul

In the second paragraph of his policy statement on taxes, Jeb! calls for a complete overhaul of the US tax code.

He’s troubled by the ‘thousands of special-interest giveaways, subsidies and other breaks” for Washington insiders.

He correctly points out – as have others before him – that the complexity of an 80,000-page tax code leads to unfairness, cronyism, and the need for a virtual standing army of tax lawyers and accountants. Jeb! cites a study that found the cost of complying with the US tax code reached $168 billion per year in 2010 for individuals and corporations. Which is crazy, and infuriating.

All of which is to say, I love where Jeb! is going on simplifying the tax code.

Thoughtful Jeb

Lower Taxes

Jeb! proposes reducing the number of income tax rates to three, at 10, 25 and 28 percent respectively. Most controversially, the highest tax rate would drop from the current 39.6 to 28 percent. I don’t make a million dollars per year, but if I did, that drop would save me a cool $100,000 in taxes right there, which sounds pretty, pretty sweet.

I don’t have a calculator powerful enough to tell me whether lowering and simplifying income tax rates will leave us closer or further from balancing the federal budget – which remains an important fiscal goal – but I expect some finance nerd in the campaign to fire up their spreadsheets to examine that one. Hopefully before enacting legislation.

Mortgage Interest Deduction

Jeb! would cap that at 2 percent of Adjusted Gross Income (AGI). Yay! While I benefit personally from it, I kind of hate the mortgage interest tax deduction.

Corporate Taxes

The current top corporate rate is 35 percent.

Jeb! would “lower our corporate tax rate to 20 percent  – below China’s – to bring jobs and manufacturing back to the United States.”

Ok, stop. I have to call foul on that one. Maybe the lower corporate rates are cool, I don’t know. But that’s going to bring manufacturing back to the United States? From China? No. Labor-intensive manufacturing (the kind that creates those new jobs) is not coming back that way. I’m sorry, but it’s gone. Perhaps if you lowered labor costs in the US to – I don’t know – $2 dollars an hour?

World-wide Taxation

Jeb! proposes eliminating US taxation of corporate income earned overseas. This issue comes up periodically when we read about Apple, for example, holding a $181 billion cash hoard or Microsoft amassing a $93 Billion cash pile overseas (for an estimated $2 Trillion cash-pile overseas among all US corporations) to avoid paying relatively high US tax rates on foreign earnings.

In my deep-dive into this issue (yes, ten minutes = deep dive), I’ve learned that the US is one of only six developed countries that maintains this tax on foreign earnings, down from twenty-five countries, thirty years ago.

A wave of corporate reverse mergers is currently under way in which companies like US-based Pfizer sell themselves to companies like Ireland-based Allergen in order to avoid this tax on foreign earnings.

You can choose to blame greedy companies for acting in their shareholders’ interest. Or you can choose to blame tax policy. Not that other countries are always right, but most of them have eliminated this tax and I can imagine the complicated and inefficient incentives this taxation causes. On balance I’m willing to give Jeb! the benefit of the doubt on this issue about which I’ve just now read a few articles.

This proposal by Jeb! seems reasonable to me, but I could be wrong. You can sort of see why some US multinational corporations might find a Jeb! presidency particularly to their advantage. Not that there’s anything wrong with that.

Estate/Death Tax

Jeb! would eliminate this entirely. Boo! The estate tax is the best of all taxes.

I’ve already written about that and gotten plenty of hate mail on the issue (so feel free to restrain yourselves) but the estate tax is progressive, democratic (with a small D), and distorts consumption far less than other taxes.

Jeb so much looks like W in this photo
Jeb so much looks like W in this photo

Carried Interest Tax

I saw nothing on the campaign website about carried interest tax policy – a favorite pet topic of mine – but I remain interested to learn Jeb!’s views.

Still skeptical that Jeb! will capture this nomination? Just remember, nobody actually liked Mitt Romney either as the Republican nominee in 2012. So, you know, follow the money.

A version of this post ran in the San Antonio Express News.

Next week: The Clinton campaign’s tax proposals.


See related posts:

Hillary Clinton 2016 Campaign Tax Policy

Interview on Mitt Romney and the Death of The American Dream

Adult Conversation about Income Tax Policy



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Clinton Proposal on Capital Gains Tax: I Like It

hillary_stormbornI’ve written before about carried interest taxes, estate taxes, and real estate tax policy using the contrasting lens of what is ‘fair to me,’ (typically, If I don’t have to pay it, it’s fair to me) versus what is ‘fair to society,’ (My attempt to take the broad view, even if it hurts me personally.)

Another common way of thinking about tax policy – today’s way – would be to think specifically about what behaviors the policy would encourage and discourage.

Now, I understand you may resent the idea that Big Brother imposes its will on you via tax policy. I don’t have a big problem with it myself. The way I figure it, behavior-modification is one of the main things that determine good or bad tax policy.


My state and local governments already discourage me from using tobacco and gasoline through targeted sales taxes on those products. The federal government discourages me from working for a living through income tax policy. In addition, the federal government encourages me to be born into a wealthy family via the $5.43 million estate tax exemption.[1] All of these behavior modifications are just part and parcel of tax policy, forming part of what we use to think about what makes for a good or bad tax.

Democratic Party candidate Hillary Clinton recently proposed behavior modification through changes in the capital gains tax.

I expect I’ll have plenty of critical things to say in the future about Clinton as she moves from candidate to President, but I actually dig this proposal.

Before getting into her tax proposal, however, I’m troubled by the insufficiency of the title I just used, “Democratic-Party candidate.” Because she is far, far more important than that title implies.

Can we instead go with something like “Hillary Stormborn, First Lady of the House of Clinton, Democratic Senator from New York, Secretary of State, Encourager of Benghazi Jihadists, Webmaster of Clinton.com, Queen from Across the Narrow Sea, First of the Andals, and Unburnt Mother of Dragons?”


I think that about covers all of her past experiences accurately, no?

Anyway, back to tax policy.

Clinton’s campaign proposes capital gains tax changes for the highest income tax bracket that would step down each year that an investor holds securities.

Currently, taxpayers in the highest tax bracket pay 39.6% in taxes on gains for securities held less than a year, and 20% for holdings held longer than that. Taxpayers in lower tax brackets currently pay their regular income tax rate for holding securities less than a year, then 15% for anything held longer than one year.

Clinton’s proposals would incrementally lower the capital gains tax rate on the highest taxpayers, for each year that those investors hold securities. The tax rate on capital gains would drop to 36% by year 2, then step down to 32%, 28%, 24%, and finally to 20% by year 6.

clinton_capital_gains_proposalHave I lost you yet? I’m not trying to. Here’s the deal. If you make a lot of money each year, the Clinton proposal would encourage you, via tax incentives, to hold on to securities for a long time horizon, of at least six years or more.

This behavior modification tax has two explicit targets. The first target is investors, who would be rewarded for holding stocks for six years or more. If investors find they can lower their taxes by holding stocks for a longer amount of time, they likely will approach stock ownership with a greater emphasis on long-term wealth creation.

The second target is public-company managers.

“It’s time to start measuring value in terms of years – or the next decade – not just next quarter,” she announced in her speech proposing these changes, according to the Wall Street Journal.

Longer-term investors, the idea seems to be, will encourage longer-term thinking among the management of public companies. Without the pressure to perform on a quarterly basis, maybe, public companies will avoid short-termism in their decision-making.

By the Clinton campaign’s own telling, the capital gains tax modification would not raise much additional federal revenue.

One reason is that her proposal only affects investors already in the highest tax bracket, earning above $464,850 for married couples, or $411,500 for singles, or somewhat fewer than 1% of all income earners in the United States.

The second reason this would raise limited revenue is that many investors hold a majority of their investments in tax-protected accounts such as IRA and 401Ks, Investors do not need to pay taxes on capital gains on securities held within these accounts.

So again, the entire point of this is behavior modification, not revenue generation. If you already hate behavior modification via tax policy, you’re not going to like this idea as much as I do.

Since I feel so strongly that the correct time horizon for equity investments falls somewhere in the range between five years and forever, I think Clinton’s on to something good here in encouraging a six-year minimum holding period for securities, via tax policy.

One criticism I have of the proposal is that it doesn’t apply to the bottom 99% of earners. Since the point here is behavior modification of both investors and public company managers, I don’t see why the rules wouldn’t equally attempt to modify their behavior as well.

Everybody should have a six-year-or-greater time horizon with their investments, so everybody should be subject to the rule.


Please see related posts on taxes:

Can we have an adult conversation about income tax policy?

Real estate tax – Agriculture exemption rant

Carried interest tax rant #1

Carried interest tax rant #2

Estate taxes


[1] Think about it: Heavy taxes on income if you work to earn it, but a tax free $5.43 million if it comes from Daddy!

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The Problem of Tax Code Complexity

The Taxes is Too Damn Complicated!
The Taxes is Too Damn Complicated!

With the nightmare US debt default temporarily avoided, let’s review some basics.

The budgetary responsibility of the US Congress has two parts:

1. Set spending levels (money outflow) and

2. Set taxation levels (money inflow)

Congressional rhetoric in the recent nonsense weeks mostly focused on spending (money outflow), whereas the harder but more meaningful discussion should be about taxation (money inflow).

We know this happens because neither we the public – nor our Congressional leaders – have the capacity to take on the complexity of taxes.

I mean ‘capacity’ in a couple of senses.

The first most relevant sense of capacity is: cojones.  It takes political courage to engage in a conversation about taxes.  It takes leadership to engage in a conversation about taxes.  It’s risky to engage in a conversation about taxes.  Hence: No capacity to talk about taxes.

I also mean capacity in the sense of intellectual firepower.

Federal taxes are so darned complicated at this point that we just don’t have the required gigabytes and RAM inside our skulls.  The human brain 1 cannot adequately capture all the parts of our tax policy.  The Federal tax code defies our understanding.

Imagine a world in which we needed to precisely legislate the movement of quarks and protons, with respect to the Higgs Field. 2

Imagine a policy discussion about this
Imagine a policy discussion about this

I’m picturing Harry Reid and John Boehner in a debate about the Higgs Field:



One point is, obviously, that I know nothing about the Higgs Field.3

The other, more serious, point is that our tax laws have gotten so complex that we can no longer expect Congressional leaders to understand anything but the most simplified ideological tripe 4; nor can we, citizens and voters, meaningfully engage in the topic either, for the same reason.

We’re structurally inhibited when it comes to budget policy and discussion by the existing complexity of taxes.

Tax Complexity Paper

All of this was on my mind this week when I read this paper about “Tax Complexity, History and Humor.”

Investment advisor David Hultstrom 5 recently linked to it in his newsletter, and despite its intimidating name, there’s quite a bit of both fun and information, worth your while.

A few highlights from the paper:

The loopholes, the humorous quotes, the expert disagreement


1. Inexplicable loopholes in the tax code:


  •        Whaling Charitable Deduction. Code §170(n) reads: ” In the case of an individual who is recognized by the Alaska Eskimo Whaling Commission as a whaling captain charged with the responsibility of maintaining and carrying out sanctioned whaling activities and who engages in such activities during the taxable year, the amount described in paragraph (2) (to the extent such amount does not exceed $10,000 for the taxable year) shall be treated for purposes of this section as a charitable contribution.”
  •           Parsonage Deduction. Code §107 provides: “In the case of a minister of the gospel, gross income does not include: (1) the rental value of a home furnished to him as part of his compensation; or (2) the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.” This income exclusion applies even if the minister receives the non-taxable parsonage allowance to cover real estate taxes and mortgage interest that the minister deducts on a personal income tax return.
  •         Parsonage Allowance after Retirement. Pursuant to Code §1402(a)(8) any parsonage allowance provided to a minister after retirement is not subject to self employment or social security taxes.
  •          Newsboys. Pursuant to Code §§3401(a)(10), 3121(b)(14) and 3306(c)(15), the earnings of certain people paid for newspaper delivery are not subject to FICA or FUTA taxes.

…you get the idea.


2.  Humorous Tax Quotes:

  •  “If Patrick Henry thought that taxation without representation was bad, he should see how bad it is with representation.” 

  • “A society which turns so many of its best and brightest into tax lawyers may be doing something wrong.”

  • “For every Tax Problem there is a Solution which is Straightforward, Uncomplicated and Wrong

  • Hiring a tax expert isn’t always a help. If you give the same problem to three tax experts, you are likely to get at least six different answers.”

  • A tax lawyer is a person who is good with numbers but does not have enough personality to be an accountant.” James D. Gordon, III

  • Definition of a Tax Attorney: Someone who solves a problem you didn’t know you had in a way you don’t understand. “


3.    And even the paid experts cannot agree:


  • In 2007 USA Today provided five tax preparers with a set of facts and asked each of them to prepare an income tax return. The five preparers produced five different tax results and could not agree among themselves on which result was correct.

  • From 1987 to 1998, Money magazine conducted an annual study in which it submitted facts to a group of tax return preparers. In Money’s 1998 report, forty-six tax return preparers had forty-six different tax results, with the tax liability ranging from $34,240 to $68,912. This was the 7th time that Money noted that none of the tax return preparers came to the same conclusion.

  • In an April 4, 2006 report, the Government Accountability Office noted that it submitted tax preparation information to nineteen commercial tax preparers around the US to determine how accurate their work was. Every one of the completed returns contained errors and some overlooked common deductions.

  • But it is not just the tax preparers who are confused. In 2002, the IRS reported that 28% of the answers given by its call centers were wrong, 12% were incomplete and 12% of the time taxpayers’ questions were not answered and taxpayers were told to do their own research.

  • If the tax professionals don’t know how to handle the complexity of our tax laws, what hope does the average taxpayer have?

My own attempt to illustrate tax complexity

As a thought experiment/illustration of the complexity of tax law, I created an infographic last Spring on just a tiny (but important!) portion of the tax code – the rules for making individual IRA contributions.  The visual joke of course is that this little thing is extraordinarily confusing, and we wonder why more people do not fund their individual IRAs.

At the very least, do not try to do your taxes on your own, as I wrote about on tax day this year.

No solutions at this point

I have no realistic solution to offer with respect to simplifying tax codes, except my belief that the complexity itself causes bad budgetary policy.   Including the kind of nonsense we all just endured from Congress.

As with investing, complexity is usually the enemy of the good.  If you can’t understand it, it’s more likely you’ll have suboptimal thoughts about it, and suboptimal decisions.


Please see related posts on taxes:


2012 IRA Contribution Infographic

Do NOT Do Your Own Taxes

A Tax Proposal Worth Considering

Shhh Please Don’t Talk About My Awesome Tax Loophole

Adult Conversation About Income Tax Policy


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  1.  Until a sufficient number of aliens complete a sufficient number of abductions leading to brain enhancement surgeries, obviously.  But I don’t expect this kind of work to be complete until the year 2035, and SOCIAL SECURITY WILL BE BANKRUPT BY 2032!  WE DONT HAVE ENOUGH TIME FOR ALIEN BRAIN-ENHANCEMENT SURGERIES!  GAH!
  2.  Warning:  I have no idea what I’m talking about here.  What follows is merely an analogy, and a dramatic re-enactment of a theoretical discussion between our Congressional leaders.  The actual Congressional debate  about Higgs Boson is likely to be even more inane.
  3.  Except this!  On the day Higgs won the Nobel a few weeks back, The New York Times linked to an awesome graphic illustration of the Higgs field.  Ok, I confess, the entire analogy was a set-up to show off this amazing graphical illustration.
  4.  Left unaddressed here is the fact that while we lack a capacity to understand the tax code as a whole, our business and Congressional leaders are very capable of creating narrow loopholes for their narrow benefit.  That’s relatively easy.  So that’s usually what we get.
  5.  I have no relationship with, or info about, David Hultstrom except that I’m on his free newsletter mailing list, and that his monthly and quarterly letters are totally awesome.

The View From The Fiscal Gorge

fiscal gorgeHappy Fiscal Gorge[1] Day!

Guess who’s really happy from last night’s tax deal? Heirs, financiers, and people who live off their piles of money.

Guess who’s not saddened by the Fiscal Gorge tax deal? The top 2% of earners that Obama spent his campaign promising would pay a larger share of federal taxes if he won.

Let me explain what I mean.

All along this Fiscal Cliff discussion our leaders have focused our attention on top marginal tax rates and top income thresholds for taxing ordinary income, as if that was the most important way to raise revenue while simultaneously addressing growing societal inequality.[2]  The sticking point in discussions, at least in so far as most media followed it, appeared to be whether top income earners would pay the existing 35% income tax rate or Obama’s preferred 39.6% income tax rate, and where in the range between $250K and $1million in income that higher rate kicks in.

Why do wealthy folks celebrate the Fiscal Gorge?  Just this:  If you’re Sheldon Adelson[3] you really couldn’t care less about ordinary income.  What matters most are estate taxes, dividend taxes, and capital gains taxes.  Adelson makes $1 million a year in ordinary income, now taxed at a higher rate.  No big deal.  He makes billions of dollars in dividends and capital gains, now permanently taxed at 20% for Adelson.  Now that’s a big deal.  Now that’s cool.[4]

Did you notice what happened to those taxes?

Estate Tax: The estate tax exemption rises to $5 million, up from the $1 million it would have been without a Fiscal Cliff deal, and up from $675K when George W. Bush came into office.  The tax rate on inheritance locks in at 40%, down from 55% at the beginning of the Bush Administration.  Throughout the Bush administration the estate tax exemption stepped up each year or two, and the estate tax rate stepped down every year or two.  Under the Obama administration, with the new Fiscal Gorge law passed, the W. Bush-era generous estate tax rates become permanent. Richie Rich is so happy.

Dividends Tax: If you were Sheldon Adelson – which you are not, but let’s pretend you were – right now you would be celebrating a Happy New Year because you just took a special dividend payout in December 2012 from Sands Casino of an estimated $1.2 Billion, based on your ownership of 431.5 million shares and a declared dividend of $2.75 per share.  Adelson took the dividend in December fearing that his 15% dividend tax rate might rise to something like the 35% or 39.6% ordinary income tax rates, which would cost him close to $300 million in additional taxes in 2012.  He needn’t have worried.  The Fiscal Gorge law makes a 20% dividend tax rate permanent for folks in Adelson’s income range, a pillar of the Bush administration’s tax cuts.  The dividend rate stays at the 15% rate for those earning less than $450K.

Capital Gains Tax – This tax rises from 15% to 20% under the Fiscal Gorge law.  Given that top earners and top wealth holders benefit substantially from capital gains, the permanence of this change represents another victory for Bush-era tax cuts.

My logical mind tells me that political leaders and the media underplay the importance of these taxes because, firstly, they only somewhat affect the highest earning 10% of American citizens, and secondly, these taxes only substantially affect the highest earning 1% and above.  So the majority of the electorate and the majority of the media-consuming public doesn’t really know or care about these taxes.  It’s only logical they would ignore those taxes that are irrelevant to the majority of people, right?

My more paranoid mind[5] tells me that it’s convenient for political leaders on both sides of the aisle to ‘hide the ball’ when it comes to tax discussions because you can enact a devastatingly effective ‘win’ for Republicans while at the same time allowing Obama and the Democrats to point to higher marginal taxes on ordinary income as if they scored something important.

They didn’t.  They got rolled, at least when it comes to tax policy.

When it comes to spending, of course, they delayed any cuts in government spending.  Which I suppose makes Democrats feel smug as well.[6]

Which leads to the larger critique and larger structural issue highlighted by the Fiscal Cliff process.

  1. The Fiscal Cliff was an invented political crisis technique – which managed to hold the economy hostage – to force compromise and hard, responsible, fiscal choices from elected leadership.
  2. The resulting Fiscal Gorge law, in the end, involved no significant compromise.  Republicans got overwhelming tax cuts, permanently enacted, and Democrats got all their desired spending continued for a little while longer.  So we got the crisis, but no real compromise.  Thanks guys, awesome job.
  3. It’s easy to cut taxes.  Everyone’s happy.  It’s also easy to spend a lot of money because, again, everyone’s happy.[7]  The hard part is cutting spending or raising taxes, the two things required to, you know, pay our extraordinary debts.
  4. Hard choices like raising taxes or cutting spending require compromise and long-term thinking, of which we received no evidence of either throughout the Fiscal Cliff crisis.


One additional point about tax policy and my use of Sheldon Adelson as an example of a wealthy citizen.

I pick on Sheldon Adelson because, in the new era since the Supreme Court’s Citizens United decision, which allows for unlimited campaign contributions as a First Amendment-protected ‘free speech right,’ Adelson represents the paragon of a stated willingness – and most importantly ability – to use money to tilt the political process in his favor.  Multiples of those same campaign contributions then return to him through favorable tax treatment.

Adelson has become – for me at least – a short-hand way of pointing out a glaring structural flaw in our electoral democracy.  I’ve got no particular animus against his wealth accumulation, and I really don’t blame the guy personally for pursuing his self-interest as he understands it.  But we haven’t figured out a way to prevent, for the sake really of systemic integrity, guys like him from tilting the table too far in their favor.

While acknowledging that I’m re-stating the incredibly obvious, I like to talk about Sheldon Adelson simply because he’s my way of showing we’re light on the whole ‘checks and balances’ thing when it comes to the influence of money in politics.

[1] My friend “The Professor” who recently wrote a guest post about Sheldon Adelson, deserves credit for the “Fiscal Gorge”, which naturally follows when you go over the Fiscal Cliff.  The actual name for the legislation passed yesterday by the House and Senate to address the Fiscal Cliff is The “American Taxpayer Relief Act of 2012.”

[2] I know, we don’t talk about growing inequality in a straightforward way when discussing tax policy.  But that is clearly what Obama had in mind when he campaigned on raising taxes on people who make more than $250,000 a year.  Yes, it would have a small effect on fiscal solvency, but it would have a larger effect on our notion of what’s fair in an increasingly unequal society.  One simple illustration of the increase in inequality in the United States is captured by the picture of the historical increase in the US’ Gini Coefficient measuring income inequality from 1947 to 2007.

[3] Obviously I’ve written about him already, but he’s an incredibly convenient stand-in for wealthy Americans and their successful capture of the political process.

[5] What!?  You don’t have multiple voices in your head debating tax policy at all times?  Am I over-sharing?  Why won’t you answer me, damn it?

[7] Which reminds me of one of my favorite Jack Handey quotes: “It’s easy to sit there and say you’d like to have more money. And I guess that’s what I like about it. It’s easy. Just sitting there, rocking back and forth, wanting that money.”

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Sheldon Adelson Should Bet Even More on the GOP

Two things you can count on with a casino entrepreneur like Sheldon Adelson: he knows the odds better than you do, and the house always wins.

In a recent Wall Street Journal interview, Sands Casino owner Adelson shares his left-of-center political beliefs, including support for abortion rights and stem-cell research, the DREAM act, and socialized medicine.  So why would he pour a reported $150 million[1] in 2012 into losing Republican candidates in the last election?  And why would he vow to double that amount in the next go around?

The answer clearly lies in his odds-based analysis of tax policy, and his views of expected value.

I’m going to assume some simple numbers for Adelson’s net worth and annual income, and go through a quick analysis of the kind of odds Adelson works with in his head that leads him to be so generous to GOP candidates.

Let’s assume Forbes Magazine’s estimated $20 Billion net worth for Adelson, and my estimate of $2 Billion for Adelson in annual income.[2]  To begin by stating the obvious, when you make $2 Billion a year[3], tax policy matters quite a bit.

Throughout the Presidential election, I’m going to assume Adelson knew the odds of a Romney victory were always around 40%.[4]  I’m going to further assume a 25% chance that a Republican Presidential victory can lead to lower taxes.[5]

These seem like reasonable assumptions about the odds of influencing different tax rates, but of course you’re free to disagree and propose your own.[6]

Ordinary Income Tax

Adelson pays himself $1 to 2 million a year to run his Sands Casino empire. [7]

If I assume a GOP victory influences the highest marginal income tax rate by 5%, the expected value to Adelson of a GOP victory becomes his highest marginal income (I’m going to use $1,000,000 for easy math again) multiplied by the change in tax rate, multiplied by the odds of a GOP victory, multiplied by the odds of successfully influencing the tax rate.  In other words:

$1,000,000 x 5% x 40% x 25% = $5,000

So…When Obama talks about raising income taxes on people earning more than $250,000 a year, Adelson really couldn’t give a flying whoop about the marginal tax rate on ordinary income.  You might care, but believe me, Adelson doesn’t care.  Retaining an extra $5,000 a year is not why Adelson gives to the GOP.

Dividend Tax

The qualified dividends tax rate currently stands at 15%, but will jump to 39.6% without a new provision to favor this type of income by January 2013.  As I wrote earlier, wealthy folks care more about dividends and capital gains taxes than taxes on salaries.  A GOP victory could have as much as a 20% effect on the marginal tax rate.

To avoid that, and in a move that should be surprising to precisely nobody, Adelson just announced a special dividend of $2.75 per share to be paid on December 18, 2012.  With 431.5 million shares of Sands, Adelson will be sending himself a nice $1,186,625,000 holiday present.[8]  This dividend supplements the typical 25 cents per share per quarter that Sands pays, or $431,500,000 per year that Adelson earns in ordinary dividends even before this special dividend.

If Adelson plans to make himself an estimated $1,500,000,000 qualified dividend payment annually, his expected value of a GOP victory is:

 $1,500,000,000 x 20% x 40% x 25% = $30,000,000

Now that is something worth trying to influence through political donations.  Heck, he could have made his money back in 6 months if Newt Gingrich had gone all the way to the White House.


Long Term Capital Gains Tax

Adelson, like the rest of us, pays 15% on his long term capital gains, from harvesting gains in securities that appreciate in value.  With no deal before January 2013, that rate jumps to 20%, still comfortably better than the kind of suckers-rate of 35% that high salary earners pay for working for a living.[9]

I assume Adelson’s got about $100,000,000 in long term securities gains he can harvest, and a GOP victory could influence that rate by 5%, leading to an expected value of:

$100,000,000 x 5% x 40% x 25% = $1,000,000

Corporate Tax

Corporations the size of Sands Casino pay a 35% rate on corporate profits.  For a number of non-crazy reasons either a Democratic or Republican tax regime might lower this, but let’s assume the GOP’s ability to lower this top rate by 5%.  Just for kicks, to reflect the fact that corporations can greatly influence the amount of ‘profit’ they declare domestically in any given year, and to come up with round numbers, I’m going to assume a scenario in which Adelson’s proportionate share of Sands’ corporate profit is $399,000,000 annually.[10]  His potential tax savings from a GOP victory therefore are:

$399,000,000 x 5% x 40% x 25% = $1,995,000.

Corporate profits may be voluntarily reduced or heavily managed through off-shoring earnings,[11]  offsetting earnings against previous year tax losses, or by incurring new, costly expansions to eat up profits in the current year.

It’s obviously nice to lower corporate taxes, but nothing is as nice as being able to influence the estate tax.

Estate Tax

Now it gets REALLY interesting for Adelson.  Bush-Cheney managed to eliminate the Estate Tax for one year in 2010,[12] but that kind of success is like flopping a low st when the other guy thinks he’s sitting pretty and ready to go in on pocket Aces…in other words, it happens rarely and it’s the greatest feeling in the world.[13]  Realistically, a 10% change in the estate tax rate would fully satisfy Adelson.  Because if he dies with a $20,000,000,000 estate, those numbers still multiply out for the following expected value:

$20,000,000,000 x  10% x 40% x 25% = $200,000,000

An expected value of a $200,000,000 million one-time payout upon his death certainly justifies a large investment in GOP candidates!

Of course, unlike the other taxes above, Adelson would only reap those rewards once, from the other side of the grave.

On the positive side, however, all of the other expected values for income, dividend, capital gains, and corporate taxes are annual expected values.  Meaning, to make this as perfectly clear as a royal straight flush, Adelson wins the expected value every single year that he can influence tax rates to go lower through a GOP victory.[14]

When I add up the annual expected value of changes in tax rates due to a GOP victory, I get to $33,000,000 per year, plus a one-time $200,000,000 estate tax win.  And for that kind of payout, you only need to invest $150 million every four years.  At that point, you’re playing blackjack after the gorilla has crossed his arms to signal the count is right.[15]  Or more plainly, those are some good odds.

In sum, Adelson should be investing even more in GOP candidates, as he’s getting back more in expected value than he’s giving.  Which, as a casino guy, he knows perfectly well.  Hence, the plan to double down next year.

[1] Included an estimated $100 million to help nominee Mitt Romney, a man he tried very hard to defeat during the primary by propping up Newt Gingrich’s chewing gum and paper bag campaign in the Spring of 2012.

[2] Adelson may very well average better than a 10% annual return on his assets, but I’m just going to estimate with round numbers to make my life and the math easier.

[3] I’m not at this point literally speaking from experience.  But like all Americans, I believe the fact that I am not yet earning $2 Billion per year is just a quirk of timing.  As John Steinbeck reportedly said: “Socialism never took root in America because the poor see themselves not as an exploited proletariat but as temporarily embarrassed millionaires.”

[4] I’m picking a single ‘average’ again to make my math easy.  This number is based on the Iowa political market’s implied rates.  I’m a big fan and participant in the online political trading markets supported by the Iowa Business School.  Between July 2011 and just a few days before the election, the implied odds of the Republican presidential candidate of winning fluctuated between 35-50%, with just a month above that range in the Fall of 2011, and a few weeks below that in September 2012, before the first televised debate.

[5] This may be too low.  The Bush-Cheney Administration, in gambling terms, managed to ‘run-the-table’ on lowering tax rates that mattered to people like Adelson. (I.e. dividends, capital gains, and estate taxes)  Other Republicans, especially in the face of today’s hefty deficits, would have a harder time reproducing their success.

[6] Heck, this being the interwebs and all, you’re free to put on your troll hat and call me either a socialist drone or a capitalist dupe depending on where your own views took root.  It’s a free country.  Or at least “it used to be a free country before those [fill in the blanks: Communist/Socialist/Corporatist/Fascist] jack-booted SWAT teams of the [fill in the blank: Bush/Obama] Administration started clandestinely snuffing our last remaining freedoms.  Uh, also, pass me the Cheetos.”

[7] Pffffhht, nothing more than enough to occasionally play the penny slots.

[8] Other similarly situated individuals will do the same before the end of the year, such as Oracle’s Larry Ellison. Founding entrepreneur-owned firms like Microsoft, Dell, Ralph Lauren, Nike and Gap may be expected to do the same.

[9] For more on how tax policy encourages or discourages work, see my post here.  To sum up: Your government would like you to earn a living through 1. Receive gifts and inheritance (0% taxes for the first $5 million) 2. Make money with your money pile (0% on Triple Tax Free bonds up to 15% taxes on capital gains and dividends) and 3. Earn a salary (up to 35% tax on ordinary income).

[10] I just picked this because that way I can say Adelson earns an even total of $2 Billion per year, which sounds about right.

[11] Earning money overseas and declining to ‘repatriate’ the earnings, something Microsoft, HP and other tech giants do successfully.

[12] New York Yankee’s irascible owner George Steinbrenner famously benefitted his family to the tune of hundreds of millions of dollars by dying in 2010, the best of all estate tax years to die.  Is it ok to mention here, apropos of nothing, that I hate A-Rod?  I’m going to answer my own question: “Yes.  A-Rod sucks.”

[13] Except for that part about your dead relative who left you money in the estate.  That part is still sad.

[14] I haven’t even got into State level taxes.  But in a discussion with my uncle about the value of paying for GOP candidate victories, he rightly pointed out the risk/reward for political investment and tax savings is probably even more attractive at the state and local level.  He said it best: “You think paying for a US Congressman is good value?  You should see how cheap it is to buy a state or city official!”

[15] Please remind me to do a Bankers Anonymous review of Bringing Down the House, which would make this analogy explicable if it doesn’t already make sense.

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