Posts tagged ‘Asymmetrical Information’

Estate Tax Confusion

It is not surprising that that a debate like the one over estate taxes that attracts so many class warfare fanatics should miss the point on a lot of issues.  However, the estate tax debate has been handled in the media perhaps worse than even other tax debates, which is a pretty low bar to try to crawl under.  The reason I say this is that the most serious "end the estate tax" type proposals out there have two parts, only one of which I have ever seen mentioned in the press:

  1. End the federal tax on estates (this, of course, is the part that gets the press)
  2. End the stepping-up of the cost basis of financial assets at death (this part never gets mentioned)

This 2nd piece of the proposal may seem arcane to some -- let me explain.  Most large estates (ie, the ones that estate tax supporters are concerned about) are dominated by financial assets (e.g. stocks, bonds).  These financial assets, typically held for years, tend to have a cost basis far below their current market value.  An example might be shares of Microsoft held for 10 years that were purchased for only a small fraction of the current price.  The cost basis of a financial asset is generally its purchase price plus commissions and other transaction charges.

Lets take a gentleman who dies and whose estate is made up entirely of $10 million worth of Coca-Cola stock bought years ago for just $5 million.  The estate all goes to his one daughter.  Under estate law, two things would happen.  The estate pays a large tax on the $10 million, and the remainder flows through to his daughter.  Lets say taxes take half, and his daughter now has $5 million of stock with an original price of $2.5 million.  The other thing that happens is the basis of assets is stepped up to current market value.  That means that as far as the IRS is concerned, his daughter owns stock worth $5 million with a basis of $5 million.  If she immediately sold the stock, she would have no capital gains tax.

There are a couple of good arguments against the estate tax.  From an efficiency standpoint, it diverts large pools of capital from private investments into the hands of the Federal Government, where only the most ardent statist would argue that it is better spent.  Also, billions and billions of dollars are spent every year with lawyers, accountants and financial planners to find ways to dampen the impact of the estate tax.  This is all wasted, unproductive effort that would immediately be redirected to more productive uses if the estate tax were eliminated.

From a fairness standpoint, the estate tax acts as a second tax on income that has already been taxed before.  In our example, though the $5 million capital gain is getting taxed for the first time in the estate, the $5 million original costs, which must have come from taxed income at one time, is getting taxed for at least a second time.  The other fairness problem becomes visible if we change the name of the stock from Coca-Cola to "Dad's private company."  For family businesses, ownership is not as easily divisible - you can't sell half or two-thirds that easily in part because there is not much market for minority shares of small family businesses.  What therefore happens in practice is that the daughter must sell the family business to pay the taxes.

The estate tax reform plan outlined above eliminates both these latter problems.  Under these rules, the daughter would inherit the full $10 million of stock, but, unlike today, her basis would remain the same as her dad's -- in this case, $5 million.  She would not pay any tax until she sold any of the assets.  And then she would pay capital gains taxes using the lower basis of her father's.

This results in two beneficial outcomes:  a)  taxes are only charged on the part of estates that have not already faced income taxes and b)  taxes are only paid when the individuals who inherit choose to make an asset sale and convert assets to cash.  The timing of assets sales drive taxes, whereas today, in all too many cases, taxes drive the timing of asset sales.  (By the way, supporters of the estate tax also argue that it is good because the estate tax incentivizes charitable giving.  The argument is that the tax is so confiscatory, and that the government so well-known as a black hole for money, that rich people decide it is better to give it away than to let the government take it all.  This is an odd argument for statists to make, but they do.  Note that in this estate tax proposal, the daughter would inherit a lot of low-basis stocks.  The same charitable giving incentives exist for low-basis stocks, since the IRS will give you credit for the market value as a deductible gift but you don't have to pay the capital gains).

Asymmetrical Information has been on this case for a while:

There is no case for saying, as the New York Times inexplicably does, that "Repeal would shield
the estates of the very wealthiest Americans from the tax." It does not. It
does, however, defer taxation. Because basis will no longer be 'stepped-up'
after death (except for a $1.3 million exemption) they will simply be taxed like
all other capital gains - at the time those gains are realized.

Stepped-up basis is one of the four legs of the estate-planning stool along
with the life insurance tax exemption, minority discount valuations and the division of income and
principal interests (such as the "estate
freeze
"). It is not entirely clear that beneficiaries of large estates are
better off after repeal when the full toolkit of estate planning techniques is
taken into account - unless capital gains tax is done away with altogether and
the states stop taxing estates. Neither is likely to happen.

Given the large estates I've seen avoid taxes, I am skeptical of analyses
that suggest an enormous impact to revenues from this repeal. I don't believe
they factor in the new potential revenues from carryover basis outside the
traditional estate tax shelter vehicles. Certainly, the capital gains rate is
lower than the estate rate, but when estate tax shelter vehicles dwindle away,
more assets will ultimately be subject to capital gains taxation. Based on what
estate planning professionals tell me, it will be a wash in many cases and more
expensive in some significant estates. In other words, with respect to the
Estate Tax, we may still be in the fat part of the Laffer curve, where a lower statutory rate may yield higher
revenues over time (due to avoidance behavior, not a lack of work
incentives).

This post also cites a study that says that increased capital gains taxes on inherited assets could offset estate tax losses to the government.  That seems aggressive, assuming a lot of assets are getting passed in vehicles (trusts?) that avoid or limit estate taxes, but the offset is there never-the-less and is something you will never ever see in a newspaper article about the estate tax.

I haven't paid attention to the current Congressional proposals out there, but the post goes on to argue that Congress, as is its wont, has chosen the worst of both worlds while maximizing rent-seeking opportunities.

postscript: By the way, shame on all of those accountants, lawyers, and others in the estate planning profession.  They all tell their clients that the estate tax is confiscatory, and can go on for hours with a client about various things that are unfair in the system.  But at the same time they run to Congress begging them to keep the whole tottering complex system in place to protect the rent they extract from inefficiencies in the system

Harvard Paradox

Asymmetrical Information comments on Greg Mankiw by observing:

Harvard scores lowest in student satisfaction *and* enjoys the highest yield (%
of students admitted who attend) of any leading American university. How can the
same institution be so desirable and so disliked at the same time?

The data presented for is for the undergraduate school and my experience is with the graduate school of business, but I think some of my experience can still help answer this question.

At the time I attended, I was sure that the Harvard Business School (HBS) was the best place for me to attend.  I still think that is true.  First, it had (and has) a great reputation with both people hiring for jobs and the general public.  The Harvard diploma has power, power that hasn't lessened even 20 years later.  Second, it had a style that worked well for me personally.  I sat in on classes at other business schools, but HBS classes had an interactive, and often combative, style that I loved and thrived in.  Yes there was work, but the workload never was worse than my undergraduate school.  I would not change my decision.

That being said, while I have showered my undergraduate school with cash, Harvard has not gotten one dime from me.  Because as an institution, it sucked.  It had an incredible arrogance to it, often stating publicly that its customer was NOT the students, but was the businesses who hired its graduates and society at large.  And this was the attitude at the business school, which I was often told was the most student-friendly part of Harvard.  My college roommate Brink Lindsey apparently had a similar experience at Harvard Law, as he was part of a group that founded N.O.P.E., which stood for Not One Penny Ever (to Harvard).

At every turn, one ran into petty, stupid stuff that did nothing to contribute to the educational experience but were frustrating as hell.  The faculty was often arrogant and the administrative and housing staff uncaring. 

At the risk of sounding petty, I will share two examples.  These are small things, but are representative of hundreds of similar experiences over two years. 

  • At winter break the first year, we were all given a "gift" of a coffee table book about Harvard.  Then, next spring, we all found a $100 charge on our spring term bill for this "gift"
  • My Harvard dorm room had a broken heater in my second year.  It got so cold that ice formed on the inside of the windows.  After weeks of trying, we finally got a maintenance guy to come out.  He set a thermometer down in the center of the room and stared at it for ten minutes.  Then he picked it up and started to leave.  "Why are you leaving?" I asked.  He replied "Because its 53 degrees in here.  State law does not require us to fix the heating until it falls below 50."  I finally had to go to Walmart and buy several space heaters.  Several weeks later I was ticketed by the campus police for having a fire hazard -- too many space heaters.

I do not think it an exaggeration to say that had Harvard scoured every post office in the country for employees, it could not manage to provide worse customer service day-to-day.

And I think this is the answer to the paradox.  If you can tolerate the faculty arrogance, you can get a great education, but Universities are more than just a school.  For most students, Harvard is also their landlord, their only restaurant choice, their local police force, etc. etc.  And for all these other functions, they are terrible.

Ballooning Health Care Costs

Jane Gault at Asymmetrical Information is on a roll with a series of posts about the problems with the Medicare system.  Check out her posts on the rising costs of the prescription drug benefit,  the media bias when programs are cut, and the rising cost of Medicaid.

The problem in the world of health care costs is actually very simple:  patients have the incentive to over-consume services and providers have the incentive to over-provide services.  Patients consume as many services as possible because some other entity is generally footing the bills, such that the marginal cost to the patient of extra services is generally nil (if you don't believe this, imagine a world where a 3rd party paid for your car - would you choose the same care you drive today?)  Providers tend to over-provide in part for the same reason, and in part as a defensive response to the threat of torts.  As a result, costs go through the roof, and those who pay (government, insurance companies, employers) respond by rationing, which pisses everyone off.

This disconnect between the entity paying the bills and the entity selecting the care cannot endure.  The fix in the future is guaranteed to be one where the decision maker on the selection of care is the same person who is paying for the care.  The only choice we have in designing the system is whether that entity making the decisions is the government (as preferred by statists of all stripes) or the patient. 

We need a system where people pay their own everyday medical bills, with insurance in place for catastrophic needs (which is basically how we take care of our cars).  You could probably incentivize this tomorrow by making personal medical expenses tax deductible while at the same time making employer-provided medical insurance taxable just like every other kind of compensation.  Not only would this fix the incentives problem in the system, but would also eliminate the portability issue associated with employer-provided coverage.

Unfortunately, people have a huge mental block where paying for their own medical care is concerned.  My wife is a great example.  When I became self-employed, she was shocked that I did not get dental insurance.  I tried to explain that we would just use the insurance to pay for checkups and a filling here-or-there, and it would probably cost more than just paying the expenses ourselves.  But for her, medical bills are paid by insurance, not by individuals, and it actually felt wrong for her to pay her own doctor's bill (we have a big annual deductible on our medical insurance too so it acts mainly as catastrophic coverage).  This is not an isolated attitude - it is why many people equate "not insured" today with "not getting medical care".

Postscript:  There is nothing magical about the system of employer-paid medical insurance we have today.  Many large employers implemented paid health benefits as a way to evade government wage freezes during the NRA of the 30's and later in World War II.  In the tight labor market of WWII, government mandated maximum wages could not lure enough workers, so free health benefits were thrown into the compensation mix since only cash wages were frozen.  The system is perpetuated today by a tax code that does not tax health insurance as it does all other parts of the compensation package.

UPDATE:  Or, we could just try this

UPDATE#2:  A small example of the mindset:  Carly Fiorino get $42 million as a parting gift from HP, but still insists that HP privide her medical insurance.  With $42 million, she couldn't pay for it herself? (via gongol)

The Check is NOT in the Mail

I have not asked my wife yet, but she certainly must be proud today to be a Harvard (B-school) alumna today, given recent comments by Harvard President Larry Sommers:

The president of Harvard University prompted criticism for suggesting that innate differences between the sexes could help explain why fewer women succeed in science and math careers.

My gut feel, though, without having talked to her, is that the annual giving check is probably not in the mail.

By the way, I do think there are innate differences in the sexes - it is almost impossible not to see this having raised kids of both genders.  It is also fun to joke about women and math skills - I joke with my wife all the time.  However, I am not speaking as the representative of the leading university in the country.  Mr. Sommer's remark is pure supposition, without any real research behind it (he admits as much).  That said, given that he is in charge of an educational institution whose job is to push people of both sexes up to and beyond their potential, it was a stupid statement from the wrong person.

Is this hypocritical on my part - criticizing Mr. Sommers for something I have done myself?  No.  Here is an analogy:  Its may be fun for all of us to joke about French military prowess, or lack thereof (Q:  Why are the streets of Paris lined with trees?  A: Because the Germans like to march in the shade) but it would be absolutely wrong for the president or the state department to do so in any public venue, because they are representing our country in an official capacity.  Mr Sommers is representing Harvard University, and to suggest publicly that half his student body is biologically incapable of being successful in a substantial part of his University's course work is stupid and irresponsible.

UPDATE:

Virginia Postrel comes to Sommers defense here and here.  She argues that Sommers did indeed have quite a bit of good analysis behind him, and that those of us who criticize him are being politically correct and hindering academic inquisitiveness.    Hmmm, maybe.  I have a lot of respect for Ms. Postrel, so if she says I am missing something, I am willing to think about it some more.  However, I will say that all I saw in the write-ups was data that women are underrepresented in math and science related careers (duh) and speculation but no evidence that this may go beyond socialization to biology. 

I still have trouble buying the biology thing.  For two reasons:

  • The distribution of careers data is loaded with social factors that are really, really hard to control for.  Based on the same data, you might come to the conclusion that blacks are biologically less suited to be corporate CEO's or that men are less suited to being nurses or flight attendants.
  • We are in the middle of a radical change with women and education.  A wave of women more comfortable with educational and intellectual achievement in general is moving through the system.  It is therefore dangerous to read data ahead of the wave - say with 30 and 40 year olds, since everything will change when the wave rolls through. 

How do I know there is such a wave?  If you graduated high school 20 or more years ago, look at the picture of the honor society in the yearbook.  Likely as not, the picture will be mostly boys.  Now go to just about any high school and look on the wall.  Taking my kids to chess tournaments and the like, I have been in a lot of high schools lately, and it is not at all unusual that the pictures of the honor society are ALL girls - not more girls than before, but all girls.  Then, take a look at college enrollment and the huge influx of women there.  Yes, for various reasons, these women may still not be choosing careers in the sciences, but you can't tell me that they are somehow biologically less prepared to do math.

UPDATE#2:  I really did not intend for this to be such a long post, but there is another good defense of Sommers here at Asymmetrical Information.  Apparently most of the left is explaining the "gap" with bias rather than biology.  Which is funny, because I thought much less about bias but rather personal choice - that for a variety of reasons women were not choosing math/science careers.  Anyway, the post from McCardle had this humorous observation:

Interesting, isn't it, how many of the liberals proclaiming that it's utterly ridiculous to think that a department running 95% leftists might be, consciously or unconsciously, discriminating against those of a more right wing persuasion, find it completely obvious that if a physics department is 80% male, that must be because they're discriminating

lol, anyway, no more.  I have decided to cut Sommers some slack, in part because I obviously don't have all the facts, and in part because I am sympathetic to him since I know for a fact that Harvard University is somewhat less governable than, say, Haiti. 

On Social Security Reform

One of the less remarked on casualties of 9/11 and the war on terror is any progress on a number of issues that GWB looked like he might tackle (e.g. social security and tort reform).    While the war is far from over, and I have had mixed feelings about some part of it (e.g. here), the infrastructure seems to be in place to fight the war while also tackling some new domestic issues.

Jane Galt, over at Asymmetrical Information, has a nice post about new momentum in the Bush administration to tackle social security.  It is unlikely that Bush could draw any more hatred than he already has, so he might be the right person to finally grab the third rail.

UPDATE #1

Marginal Revolution tackles social security and links to other good sources.

Princess Bride Day

Two election-related Princess Bride posts in one day.

From Vodkapundit - "Incomceiveable"

From Asymmetrical Infromation - "Iocane powder"

I think the Princess Bride is one of the 10 most quotable movies of all time, at least for guys (Caddyshack being #1).  So here is my Princess Bride reference for the election:

Rove (election night, 7PM EST): I admit it, Kerry is leading us in the exit polls
McAuliff: Then why are you smiling?
Rove:  Because I know something you don't know.
McAuliff: And what is that?
Rove: I... am not left-handed.

UPDATE

Jane Galt & Co. have their servers down at Asymmetrical Information.  Here's hoping they are back soon.