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What could you do in this case?
Old 01-09-2012, 07:46 PM   #1
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What could you do in this case?

In today's WSJ, there is an opinion article from Professor Ronald McKinnon at Standford University. Basically, he proposes a new tax levied on personal wealth assets in addition to income tax. The arbitrary baseline figure he suggests is 3 mils and above (domestic and foreign all together) because it "effectively excludes more than 95% of the population", at 3% tax rate. 3 mils might sound reasonable at this time, but no doubt it will be subject to change. Maybe 90% or lower population will be excluded by then.

So hypothetically if an ERer accumulated a lot of assets after decades of frugality, even if at a very low SWR, (s)he will still be potentially facing hefty tax based on this proposal. This just throws a monkey wrench at FIRE calculation. What could you do in this case if it does become true?

Here is the excerpt from the article:

The Occupy Wall Street protests have faded from the news, while the unemployment rate fell to 8.5% in December, the lowest level since February 2009. Still, unemployment and income inequality remain justifiable concerns for tens of millions of Americans and are two of the most pressing issues in the 2012 presidential election.

Reforming the income-tax system is commonly seen as the principal way to reduce inequality. But any attempt to impose higher marginal tax rates on even moderately high income earners as President Obama wants for families earning more than $200,000 per year can lead to losses in economic efficiency and even to losses in sorely needed government revenue if high earners work less or seek out more loopholes and tax shelters.

The basic problem is that defining "income" becomes progressively more difficult as income and wealth rise. Straight wage income is relatively easy to define and tax for middle-income earners through payroll taxes for Social Security or through the personal income tax. But wealthy people live much more off returns from their asset holdings. They receive capital gains, stock options, interest and dividends; and carried interest for owners of hedge funds that, to avoid double taxation, are taxed at lower rates than wage income. They may receive imputed rental income from multiple homes and major consumer durables such as automobiles, art collections or yachts, which the federal income tax misses altogether.

In order to have a fairer tax system, we should implement a new federal wealth tax in addition to the federal income tax. Unlike the current income tax, the wealth tax would not rely on how income is defined. Rather, it would require that households list all their domestic and foreign assets on, say, Dec. 31 in the relevant tax year. With a large exemption of $3 million that effectively excludes more than 95% of the population, a moderate flat tax say 3%, on wealth so defined could then be imposed.

If on Dec. 31 a household declares total net assets of $5 million, and the "standard" wealth tax exemption is $3 million, then its wealth tax is $60,000 ($2 million x 0.03). Because wealth will generally present a much larger tax base than income, tax rates can be kept low and still raise substantial revenue. The incentive for tax avoidance is minimal unlike the incentive created by a high marginal income-tax rate of 40% or more for earners paying both federal and state income taxes.

Another advantage of a modest wealth tax, in contrast to high marginal income-tax rates, is that it would hit old wealth along with new wealth. Wealthy people living off their inheritances who are not affected much by the income tax would be hit relatively harder by a wealth tax, whereas "strivers" with higher wage and salary income would be hit less hard. This is especially true if marginal income-tax rates could be reduced because of revenue generated from a new wealth tax.

The new wealth tax would be levied on both the domestic and foreign assets of Americans. Overseas real-estate holdings an Italian villa or a Parisian "pied--terre" as well as foreign bank accounts, many of which their holders try to keep secret, would all be taxable. In 2009, when the Union Bank of Switzerland was fined $780 million for hiding the bank accounts of wealthy Americans, bipartisan outrage set in motion the Foreign Account Tax Compliance Act, or Fatca, which passed in 2010. By 2013, foreign financial institutions will be responsible for reporting to the U.S. Treasury American assets held with them. So Facta would nicely complement collecting a new wealth tax as well as a flatter income tax.

Beyond mollifying Wall Street protesters, a modest flat wealth tax is the key to flattening the income tax to make it more revenue-efficient. Everyone agrees that the current U.S. income-tax system, with its many deductions, exemptions and special credits, is an inefficient mess. The GOP candidates want to simplify the tax code by flattening the rate structure and closing "loopholes."

But they all want to keep the two biggest loopholes: (1) to allow charitable or philanthropic contributions to be deducted, and (2) not to tax the imputed rental value of owner-occupied homes while allowing full deductions for mortgage interest rates. Owners of mansions and possibly multiple other properties are the biggest beneficiaries. Both (1) and (2) disproportionately benefit the very wealthy aka "the top 1%."
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Old 01-09-2012, 07:50 PM   #2
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Don't some European countries have a similar wealth tax?
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Old 01-09-2012, 08:02 PM   #3
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he he, who woulda thunk!
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Old 01-09-2012, 08:17 PM   #4
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Quote:
Originally Posted by ratto View Post
So hypothetically if an ERer accumulated a lot of assets after decades of frugality, even if at a very low SWR, (s)he will still be potentially facing hefty tax based on this proposal. This just throws a monkey wrench at FIRE calculation. What could you do in this case if it does become true?
I'm not sure I have enough for a wealth tax to affect me, but if it did then I'd go back to LBYM. Spending is easier for me to control than income, and always has been. I don't see what else a person can do, especially someone like me who would not consider living outside the country.

There is a saying that "Living well is the best revenge", and in this case I'd define living well as enjoying the oceans of free time that I would still have in retirement (even though spending less).
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Old 01-09-2012, 08:20 PM   #5
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Take the amount >$3M and buy an annuity that makes periodic payments - problem solved (as long as the cost of annuitizing is less than the tax).
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Old 01-09-2012, 08:22 PM   #6
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Yes, you are correct.
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Originally Posted by REWahoo View Post
Don't some European countries have a similar wealth tax?
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Old 01-09-2012, 09:38 PM   #7
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So, some hard working person has accumulated $3,100,000. Let's assume this person spends every dollar he earns from his asets. Take 3% a year and by the 2nd year, our millionaire is below $3,000,000. No more tax! Problem solved?
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Old 01-09-2012, 09:50 PM   #8
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Take the amount >$3M and buy an annuity that makes periodic payments - problem solved (as long as the cost of annuitizing is less than the tax).
If I were writing the implementing legislation, I'd make the annuity companies report the discounted present value every year and add that amount to your asset base. Problem not really solved.
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Old 01-09-2012, 09:53 PM   #9
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Would it not make more sense to simply tax all income at the same rates? Why should a working stiff pay 25% on his income when a guy who makes 10x more in capital gains only pays 15%? Are not both contributing to our economic health? Enlighten me, please.
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Old 01-09-2012, 10:32 PM   #10
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More FI people would learn the words to O Canada.
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Old 01-09-2012, 10:35 PM   #11
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Seems like everyone would end up $3M-aires. Hurts the pool of available capital, which is why I thought we didn't do it. Seems like that was discussed in history class.
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Old 01-09-2012, 10:48 PM   #12
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There go the family farms and family businesses. In a lot of cases, the majority of the wealth is tied up in hard assets. Yes ..even those worth over 3 mil.

I think most people would "hide a significant portion under the mattress" so they didn't have to report and would qualify under the 3 mil exemption.
I'm sure this is done now in those countries with a wealth tax.

This is no solution. I agree with GrayHare. Canada here we come or should I say there we go.
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Old 01-09-2012, 11:09 PM   #13
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Income redistribution to steal more money for more failed social programs. This would never effect me but I oppose it.
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Old 01-09-2012, 11:11 PM   #14
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Would it not make more sense to simply tax all income at the same rates? Why should a working stiff pay 25% on his income when a guy who makes 10x more in capital gains only pays 15%? Are not both contributing to our economic health? Enlighten me, please.
Chuckanut...consider the fact that the person paying 15% tax on dividends already paid an income tax on the money that was invested. Unless they cheated of course.

The government already got a percentage when the person worked for the money. Then they wanted a percentage of what that money generated as it worked for the owner. Now there are some who want MORE of what that money generates. The question is how much is fair or what percentage is fair? The money is not made in same way. One is from work and the other is from investment income generated from previous money made from work and also that had already been taxed. Why should they both be taxed the same way?

My other point is ...I'd bet a million dollars that the person paying 15% tax on money generated from investment is already paying far more net dollars in tax over the course of their life than those that do not have cap gain or dividend income. He/she has already and will probably continue to contribute far more to our economic situation than someone that doesn't have that type of income.

Taxing cap gains and dividends like the current income tax levels will...do a number on the desire or many to invest as they do now. Greed took us down during the housing crisis. Government greed under the redistribution guise may be the next thing to take us down. I say guise....because how do we really know what this is truly about.
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Old 01-10-2012, 12:13 AM   #15
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Oh that Professor Ronald McKnut is such a genius:
Quote:
Because wealth will generally present a much larger tax base than income, tax rates can be kept low and still raise substantial revenue.


I suggest a different taxation scheme - Implement a 99% income tax on the Professor's salary and the big fat monthly pension amount he will probably get when he retires. And a 99% tax on the cost of all insurance provided to him at no or reduced cost. I'm looking out for him, it will be for his own good. If the people who support foundations reduce giving due to his "idea", then there will be less research grant money coming the way of academia. This will have a negative effect on many in the university world. Then his fellow professors will get angry and beat the snot out of him.
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Old 01-10-2012, 12:49 AM   #16
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I view a wealth tax the same way I view "sin" taxes on alcohol and tobacco. Those things you wish to destroy, you tax instead of outlawing them. As in all "new" taxes, the hard part is getting them started. Once you have them in place, it's pretty easy to up the rates or lower the exemptions. What we DON'T need (IMHO) is one more tax to play with. We don't have too little taxation, we have too much spending (again, IMHO).
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Old 01-10-2012, 05:41 AM   #17
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Originally Posted by Chuckanut View Post
Would it not make more sense to simply tax all income at the same rates? Why should a working stiff pay 25% on his income when a guy who makes 10x more in capital gains only pays 15%? Are not both contributing to our economic health? Enlighten me, please.
to quote another poster, +1 here. I'm not militant about hitting those on the board that have LBYM and saved to retire, but how about the guy that gets restricted stock grants of millions and then only pays 15% on the millions he/she makes when exercising them? Why and I paying 28% when the CEO pays only 15% or less?

Over the years I've done some tax prep work for soldiers and others for free. Most of these don't pay much or any income tax and we know Buffett pays about 15%. Flat 25% makes sense to me.
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Old 01-10-2012, 05:49 AM   #18
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From the WSJ article,
Quote:
The basic problem is that defining "income" becomes progressively more difficult as income and wealth rise.
There is no difficulty defining income. He goes on to define it quite well

Quote:
But wealthy people live much more off returns from their asset holdings. They receive capital gains, stock options, interest and dividends; and carried interest for owners of hedge funds
The author asserts but does not show why taxing this income is difficult, nor does he share why wealth would be any easier to tax.

Quote:
They may receive imputed rental income from multiple homes and major consumer durables such as automobiles, art collections or yachts, which the federal income tax misses altogether.
It is a stretch to call these items income.
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Old 01-10-2012, 06:33 AM   #19
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I think most people would "hide a significant portion under the mattress" so they didn't have to report and would qualify under the 3 mil exemption.
I'm sure this is done now in those countries with a wealth tax.
In the past, I read from a survivalism site that some people already put their money in rolls into large PVC pipes, and glue two caps on to make each PVC tube/canister both air and water proof, then deep bury them in some secret locations on their properties. I thought that's a joke, but now I have better understanding why some people would do it.
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Old 01-10-2012, 07:05 AM   #20
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PVC pipes stuffed with cash, heading to Canada? All because some professor has a cockamamie scheme? Worry about real things like the EU tanking triggering a double dip, loosing your health insurance after Obamacare is repealed...
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