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(Mods, let me know if I need to delete this and repost in Small Questions Sunday.)
The US Supreme Court (SCOTUS) hears Moore v United States today. According to SCOTUSBlog, at issue is "Whether the 16th Amendment authorizes Congress to tax unrealized sums without apportionment among the states". Since that's not very helpful, I'll quote The Atlantic's summary instead:
Mother Jones, NPR, CBS, and Foreign Policy (of all the friggin' places) are running articles breathlessly proclaiming DOOM! for the US tax code, or at least the ability of Democrats to pass wealth tax laws. This Forbes article seems to be a pretty good explanation of what's at issue but I'll admit that I'm not well-versed enough in tax law to understand the full ramifications of what a Moore victory would mean for the ability of the federal government to raise revenue. On the other hand, I can't say I'm sad about the idea of a wealth taxes getting a bullet to the head. What am I missing or not considering as I read about this from the various outlets?
All else equal, all wealth should be taxed equally (say, flat 1%/y) , not income from wealth. Current tax laws encourage bubbles and poor investing. Just buy a garbage bond or shitcoin and uncle sam will barely touch it, but god helps you if you invest in a company actually making money. And don’t give me the hard-luck grandma story.
It’s like a poll tax on wealth, and like a poll tax, it’s very tax efficient. The problem with income tax is that it discourages economically beneficial behaviour, like working or good investing. Every time you engage in it, the state wants a piece, and possibly, an even bigger piece, the better you are at it. So the state, counter-productively, eggs you on to be a bum and to stack your wealth under the mattress (ignoring inflation). Your lazy bum money should be taxed at least as much as superstar cancer-curing money.
Hmm - I haven't heard this take before. Let me do some quick math, courtesy of the Markowitz model. Suppose you have two investment options:
Let e be your risk aversion and let x be the the proportion of your portfolio you are investing in stocks
U = xA + (1-x)i - exxB
dU/dx = A - i - 2exB
x = (A - i) / (2eB)
Capital gains scales returns by k and variance by k^2 (where k = 1 - tax_rate):
x = (kA - ki) / (2ekkB) = (A - i) / (2ekB)
As taxes go up, k shrinks from 1 towards 0, which makes x increase. Therefore, capital gains taxes cause increased risk tolerance.
A wealth tax reduces returns by k:
x = ((A-k) - (i-k)) / (2ekkB) = (A - i) / (2ekB)
This is the same, so a wealth tax doesn't affect risk tolerance.
I don't think this can be true. The chief academic argument against capital gains taxes is that they impose a 100% tax on consumption in the far future, which is maximally distortionary. The same is true of a wealth tax.
I personally think that if society had no welfare, a flat income tax would be either not distortionary or push people to work more. Note: historically people worked much more and (e.g.) wages being 4x lower because your country is poor is equivalent to a 75% flat tax today.
I have an elegant mathematical model illustrating this result, but I think I've force-fed this forum with enough math already.
Where is “p”? I’m gonna need a template for these equations, like an article who uses similar ones (the wikipedia markowitz model wasn’t helpful). Or more letter definitions.
So a 99 % capital gains tax results in everyone investing in stocks?
I call bullshit on that. A 100% tax on everything right now is more distortionary.
But we have welfare, and the income tax isn’t flat. You’re very theoretical today.
Ignoring the motivating effect of hunger, of course.
Sorry. I ended up using "x" in the actual math. I've edited the post to be correct
You might find the Modern portfolio theory article more useful or even his original paper (scihub). If you want a quick explanation
Obviously, the usual caveat applies: all models are wrong, some are useful.
[ Edit: in case it wasn't clear, I'm saying a wealth tax is better than a capital gains tax in that it doesn't distort risk-taking while a capital gains tax does]
Yeah. Note: people would probably save less, but what the people are saving would be invested in stocks rather than bonds in this model.
Sure. I mean that according to ivory-tower theory, even a 1% capital gains tax now is equivalent to a 100% tax on far-future consumption. A 1% tax on labor income or current-consumption doesn't have that pathology.
Right, my main point is that, contrary to textbooks, I don't think poll taxes are actually non-distortionary. I think a poll tax (and its opposite: welfare) is distortionary.
What do you mean?
I think there’s an error here. The k subtracts itself in the numerator, so the two k’s stay in the denominator, unlike in the cap gains equation.
Vast layers of misunderstandings keep peeling off, yet your position remains as inscrutable as ever. Didn't you (wrongly, see above) determine that the equation was the same : ' x = (A - i) / (2ekB)' for both? So why is risk tolerance increased for cap gains tax and not for the wealth tax?
I want to distort risk-taking, I think we would all tremendously benefit from a 90% reduction in financial risk aversion of the average citizen. By the lights of MPT, shouldn’t we collectively expect a higher return on all our investments if risk aversion went down?
I think that discredits the model. They’re not going to take all the equity risk for 1% of the equity premium, they’re supposed to be loss averse.
This is a useless extrapolation theory.
Welfare is not the opposite of a poll tax, it’s a progressive tax that goes into the negative. Regardless, how is a poll tax distortionary?
I never responded to this. The point you're missing is that a 99% capital gains tax also reduces the risk. An investment that returns 10±30% now returns 0.1%±0.3%.
That's not what risk is. If the company he invests in goes bankrupt, that's not helped by the 99% capital gains tax. That is the risk he cares about, not the variance on his profits. But let's not get into that.
It does. He then gets to deduct those losses on his taxes, resulting in recouping 99% of his lost value.
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I want to also take this opportunity to wax poetic on financial markets and risk.
Most economic risk in society has nothing to do with financial markets - think things like
etc.
Finance, as a market, serves two purposes:
So, for instance,
Why are the investors better positioned to take these risk? Two reasons: they have money (duh) and they can diversify by buying a basket of somewhat independent risk.
So, when functioning properly, financial markets reduce the cost of risk to society.
That being said, "functioning properly" is key and, due to the principal–agent problem and plain old human error, there are significant sources of imperfection.
Much of that imperfection probably pushes investors to take too much risk: generally speaking if a trader does well, they make oodles of cash, while if they do poorly the worse they can be is fired. Note, however, that absent a specific scenario (see next paragraph), that cost of that risk is still paid by the company funding the trader, so it is internalized to the company and we, as the broader society, don't really need to care too much about it. When a trading firm's net worth hits zero and it closes, we still don't really care - the costs of that firms' sins were laid at that firm's feet.
The specific exception to this is when a company's net worth hits negative, which can only happen if a firm takes leverage. Even in leveraged firms, this is not too common, since as any firm worth its salt will start winding down positions automatically as its overall wealth goes towards zero (the specific terms are "funding risk" and "unwinding"). Robinhood, for instance, will do this for you automatically (or, rather, force you to do it).
Even if a firm's net worth hits negative, someone was lending the firm money and that firm bears the costs, so, again, you and me (as outsiders) shouldn't really care. So, the actual exception is a firm that
This gives us the three things to target in seeking solutions:
But none of these imply a wealth tax or capital gains tax. Neither tax policy discourage leverage (borrowed money is deducted from wealth and, at least today, margin interest is tax deductible). Neither have any bearing on unwind strategies or target firms that impose systematic risk.
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Yeah, my bad. It should read
x = ((A-k) - (i-k)) / (2eB) = (A - i) / (2eB)
So, my conclusion remains: the wealth tax doesn't affect the allocation into stocks, while the capital gains tax does. This also explains your second point: the two conclusions are no longer the same.
Do you believe venture capitalists and the startups they fund are net-bad for society? I think they're (a) net-positive and (b) the platonic ideal of high-risk-taking, so I don't think we want to discourage risk-taking in general. I do think you can argue that leverage should be discouraged more, but I don't think a capital-gains-versus-wealth tax is the appropriate tool to do that, even if you insist on using taxes rather than regulations. For instance, you can remove the interest tax deduction.
I don't see how MPT implies this. This sounds like you're "reasoning from a price change" - i.e. what matters isn't that risk is reduced - what matters is how it was reduced.
Hence my use of the term "ivory tower" :p
Just to make sure we're on the same page - you're saying welfare is a "progressive tax that goes into the negative". A poll tax is a fixed sum demanded regardless of income.
You can decompose any tax system as the union of
In this sense, welfare and poll taxes are opposites:
Well, if you want math - suppose my utility function is
U = ln(wage * labor) - labor
dU/dLabor = 1/labor - 1
∴ labor = 1
With a poll tax
U = ln(wage * labor - poll_tax) - labor
dU/dLabor = wage/(wage * labor - poll_tax) - labor
∴ labor = 1 + poll_tax / wage
So, in this model, a poll tax would cause me to work more.
If you want a story: consider someone who barely makes enough to survive - a poll tax would force them to work more hours to continue surviving.
And it keeps going, more layers of misunderstandings.
So your math was incorrect, but luckily you interpreted it wrong, so by being doubly wrong you went all the way to being right again?
And what happened to the k’s now, why did you remove them from the denominator? You previously used them to justify “As taxes go up, k shrinks from 1 towards 0, which makes x increase. Therefore, capital gains taxes cause increased risk tolerance. “
By that logic, and assuming the equations are worth a damn, the wealth tax also causes increased risk tolerance. More even, since you have two k’s in the denominator going to zero.
Another misunderstanding. Man, I am in favour of risk, from the beginning. Between low-risk/low-return and high-risk/high-return, I choose high every time. Personally, and macroeconomically. I said people should be less risk averse, ie, take more risk. I could rail against insurance companies and the giant societal loss they represent all day. They prey on the irrational fears of people to the tune of trillions of dollars annually. But that’s besides the point.
To be 100% clear, no, I do not believe VC and startups are net-bad for society at all.
I am not talking about a reduction in risk, but a reduction in risk aversion. An investor with less risk aversion (ie, willing to take more risk) could expect higher returns, correct? I’m just applying this to all investors in the economy.
Yes, and yes.
Your progressive tax depends on your income. When your income is low enough, instead of paying the tax, you get welfare. So it’s the ‘negative side’ of the progressive tax. Your progressive tax becomes a payment to you.
The poll tax is not distortionary, because nothing you do matters. You can work or not work, you’re still on the hook for the same poll tax, 100 dollars or whatever. The progressive tax( including welfare), takes from you if you work and gives to you if you don’t. Whether that is good or bad is another issue, but it definitely distorts your behaviour more.
Any tax in this model is distortionary. We’re talking relative distortionaryness.
That’s what I referred to above : “ignoring the motivating effects of hunger”.
This whole section is my bad. My reading comprehension clearly needs work. Mea culpa.
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No. I did the math on a piece of paper correctly and copied it wrong.
Because a wealth tax doesn't affect the variance of post-tax returns.
I've been arguing this whole time that
So it does, indeed, follow that, relative to a capital gains tax, a wealth tax increases risk tolerance.
Incorrect. A flat tax (without any poll tax or welfare) is non-distortionary in that model.
Edit:
U = ln((1 - tax_rate) * wage * labor) - labor
U = ln(1 - tax_rate) + ln(wage) + ln(labor) - labor
dU/dLabor = 1/labor - 1
so labor = 1
all independent of tax_rate
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