Friday, February 7, 2014

Differential Capital Gains Taxes and Euvoluntary Institutions

In yesterday's post, I floated the absurd proposal that progressive taxation on Treasury securities was isomorphic to progressive taxes on house-rents as described by Adam Smith in Book V of WoN.

To the best of my knowledge, nobody bit. I guess I should, since it gnawed at me a little this morning.

A surtax on interest income means that anyone liable for the tax would only be willing to buy at a discount. The weighted cost of Treasury capital would rise. But that's only for folks with the tax liability. At auction, Treasuries would first go to small cap and foreign (of any size) buyers and then to the large institutional investors. Hedge and mutual funds would divest. Pension funds would divest. Bond "vigilantes" and zero hedgies would earn enough to buy several archipelagos in comfortable climates. To call my tax proposal "disruptive" is a hilarious understatement.

But is it inflationary? Deflationary? I'm not that kind of economist, so I find myself perpetually agnostic on the interaction between interest rates, the quantity of money in circulation, and the price level. Indeed, I'm not entirely sure I quite understand what each of those things truly mean beyond the flickering shadows they cast on the gneiss that surrounds me. Interest rates can be modeled by ad hoc equations, approximated by regressions, but the yield curve itself doesn't jump off a blackboard, it comes from the uncrackable eggs of investors' minds. And sure, there's money in circulation, but like I mentioned yesterday, money is just a proxy for underlying stuff-n-junk. I find M2 measures and the various die fleders similarly epistemologically troubling.

Macro no giod P, I guess.

Still, flights of fancy about tax policy is a fun (pursuant to a very liberal definition of the word) exercise in thinking about the nature of public finance and its relation to monetary and tax policy. How would my proposal count? It certainly affects the ability of the Treasury to issue bonds, and it's not wholly unreasonable that changing borrowing costs should count as fiscal policy, right? But the relative price change domestic-to-foreign would release a bunch of foreign-held liquidity back into the US, increasing the cash in circulation. But that cash could be stowed away as excess reserves, or put back into munis or commercial paper or whatever, so that might be a wash. But also the FOMC loses a hell of a lot of discretion if they're competing with the IRS for control over real yields. See how quickly this scenario gets just absurdly complicated?

I think my observation yesterday was a good one: interest income is an idle rent. But to reason from this directly to a policy position elides necessary reasoning. How great would it be if economists would retain the rigorous circumspection needed to avoid this type of logical error in general? A boy can sure dream.

Some transitional gains traps are mouse-sized, snapping shut on the necks of cab drivers and dairy farmers. Others are wrought from steel bars and can trap village-menacing, man-eating tigers. Luckily, the Second Law of Public Finance is (probably) true: with enough time, all spending is discretionary. And discretion is a virtue. And statesmen are virtuous.


It's sort of funny anyway. The underlying asset of a Treasury instrument is tax revenue. Taxing tax revenue has a certain ironic elegance to it, don't you think? It's a self-stirring bowl of porridge. Eh.

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Do you have suggestions on where we could find more examples of this phenomenon?