Two things I’m seeing right now are driving me nuts.
The first is the talking point that assumes that the $3.5 trillion (or, if Joe Manchin gets his way, $200) reconciliation bill will be inflationary. Manchin expressed this fear, and so did Bret Stephens, and it’s everywhere in conservative media. I can’t say that the bill won’t be inflationary; the inflationary impact depends on many factors, including ones that are TBD. But clearly, many people believe “spending causes inflation”, and it’s not nearly that simple.
The second thing I’m seeing is progressive whinging over the fact that an Elizabeth Warren-style wealth tax almost certainly won’t1 be part of the bill. Wealth taxes have become the preferred policy of many on the left despite the fact that they don’t work well, might be unconstitutional, and there are better alternatives. One workable and obvious way to achieve some of the goals of a wealth tax is to close the “step-up in basis” loophole. I wrote an explainer about this (and other tax stuff) back before I had any subscribers, so most of you haven’t seen it, but I sort-of liked the bit about step-up in basis, so I’m repurposing it here.
Spending Does Not Necessarily Cause Inflationary Pressure
Inflation happens when demand exceeds supply. Many buyers + few sellers = higher prices. It’s fundamentally the same principle that causes a Mark Rothko painting to get bid up to $87 million: Rothko is far too dead to produce new paintings, but there are legions of rich suckers who want a Rothko, so they bid the price up to $87 million even though if you want a painting of a square I’ll paint you a fucking square. Look:
There’s justifiable (and also unjustifiable) concern about inflation right now, because it’s up after being low for a very long time. In the broadest sense, the causes are clear: Supply lines are pinched because of Covid, and we’ve had more than $5 trillion in Covid-related stimulus spending. The first thing reduces supply, the second gooses demand. Unsurprisingly, inflation is up, and we don’t yet know if it’s a temporary blip or a long-term trend (I’m on Team Blip but we’ll see).
So: If the $5 trillion-plus in spending is an inflationary pressure (and it is), then wouldn’t the (roughly) $1 trillion dollar infrastructure bill and the (maybe) $3.5 trillion reconciliation bill also encourage inflation? Not necessarily, because there’s a big difference between spending that’s “paid for” and spending that’s borrowed.
I put scare quotes around “paid for” because, in a sense, all spending gets “paid for” eventually. There’s a saying in economics: “There’s no such thing as a free continental breakfast, you’re obviously just rolling it into the price, so nice try, Hampton Inn, but I went to MIT” (sometimes abbreviated as “there’s no such thing as a free lunch”). The $5 trillion in Covid spending didn’t materialize from the ether; we essentially borrowed it, and we’ll have to pay it back and also manage possible effects like higher inflation and interest rates. Now: A person like me would argue that we absolutely did the right thing, that dealing with debt and inflationary pressures are by far the lesser evil compared to the low demand/deflationary spiral that we risked entering due to Covid. In my opinion, the early returns on that $5 trillion are damn good. But the point is: That spending wasn’t “paid for”, it was borrowed, so it’s an inflationary pressure (set against the deflationary pressures of Covid but I digress).
That makes it qualitatively different from the spending that Congress is considering right now. An annoying asterisk: The infrastructure bill is sort of paid for; the bill allegedly “finds” revenue sources, but many of those sources are basically bullshit. This is the nonsense you’re forced into when one party has an ideological aversion to any new taxes. At any rate: We should probably think of the infrastructure bill as partly paid for and partly borrowed. It’s the more inflationary of the two bills, even though it’s the one that moderates and Republicans like.
The reconciliation bill, unlike the infrastructure bill, raises taxes; it generates actual revenue. Time will tell if it legitimately raises enough revenue to pay for the spending, but there’s reason to believe that it might. In order for Democrats to pass the bill with 50 votes, they have to adhere to the so-called “Byrd Rule”, named after the ‘60s rock group that everyone in the Senate agrees basically invented the psychedelic sound and are chronically underrated.
The Byrd Rule requires that a bill not increase deficits after ten years. Of course, there are accounting gimmicks that allow for minor fudging — “cost” is a concept like “loving your children” that, when you really think about it, is difficult to pin down. But we can expect the bill to be basically revenue-neutral after ten years. Which is to say: Basically not inflationary after that time, because spending is matched by taxes, so the effect of one cancels out the other. Of course, it’s not actually quite that simple (it never is), because the nature of taxation or spending might have effects on supply or demand, but the size and nature of those effects are currently unclear and I see no reason to believe that they’ll be large and inflationary. At any rate, if there’s an inflationary effect, it won’t simply be because the government spent money, which is the relationship that Joe Manchin and the New York Post seem to believe exists.
There’s also the question of what happens within the ten year timeframe, but again: There’s nothing I see (yet) that would indicate significant inflationary pressure. The taxes kick in right away, and the big-ticket items aren’t front-loaded. This all makes perfect sense; the Covid bills were stimulus bills, this bill is a long-term investment. If the taxes-for-spending tradeoffs are real, and there aren’t sector-specific impacts that distort supply or demand in the short term (which we won’t know until the bill is closer to finished), then there’s no reason to view the bill as inflationary. Despite what people like World’s Worst Non-Economist Steven Moore believe, it’s entirely possible to pass a large spending bill that has no substantial inflationary impact.
The Step-Up in Basis Loophole Explained Using Nightmarish Baby Dolls
You often see analyses of how billionaires pay extremely low tax rates. These analyses are frequently very stupid, because they count taxes that haven’t come due yet as taxes that are “unpaid”. But there’s some truth to them: The very wealthy make their money mostly from asset appreciation, not income, and our taxes on assets aren’t very effective. We tax capital gains at a low rate (the reconciliation bill will probably raise that a bit), inherited assets are subject to our extremely generous estate tax system (the bill will make that system slightly less ridiculous), and there are other loopholes available to any billionaire willing to shell out 70 bucks for H&R Block (if I was Bezos I’d do it!).
The most obvious and egregious of those loopholes is the “step-up in basis” scam, which I will now illustrate using this monstrosity:
That little hellspawn — which to me looks like nothing other than a baby who has killed an Ewok and is wearing its skin — is an Anne Geddes doll. Long ago, I was married to a woman whose mother owned dozens of those things. They were freakish little gremlins — ostensibly babies dressed as animals — and it turns out that combining two cute things is like multiplying negative numbers, because those dolls were acid-induced nightmares straight from the fiery sphincter of hell. Some of the babies were sleeping, which made them look very...how do I put this?...dead. Or at least drunk — the best case scenario is that this baby hedgehog has really tied one on:
Now: That marriage didn’t last. I do not stand to inherit a fortune in plastic-baby-dressed-as-a-bumblebee wealth. But imagine that I had stayed married, and imagine that the 2020s ends up being a decade that sees a surge in demand for creepy rubber infants in animal pelts. So, in this hypothetical — every element of which I find nightmarish, but we’ll soldier on — the $1,000 worth of Anne Geddes dolls my mother-in-law bought in the ‘90s is worth $10,000 when she passes away in, say, 2030. And let me tell you: The second I get my hands on those things, they are going out the fucking door! They’re getting liquidated, INSTANTLY - I’m not turning my house into a menagerie of dead-eyed Island of Doctor Moreau babies. If some sick fuck wants to pay me $10,000 for those, be my guest.
So, basically: Somebody — either me or my mother-in-law’s estate, depending on how you look at it — just made $9,000. That should be subject to capital gains tax (if we ignore exemptions that shield the middle class from any of this and I am because this is just an example). But the step-up in basis loophole allows me to tell the IRS: “I actually inherited $10,000 worth of passed-out babies, which I then sold for $10,000, netting me a profit of $0.” My taxable income is zero. Nobody paid any tax on my mother-in-law’s savvy cosplaying baby doll investment. This loophole gives rich people an incentive to hold on to assets until they die. Dying is always a smart move if you’re rich; I don’t know if Jeffrey Epstein committed suicide or was murdered, but either way it was a tax-avoidance master stroke and I’m sure his accountant was thrilled.
Biden’s attempt to close this loophole will probably get dropped from the final bill. I think that sucks; I think closing this loophole is a no-brainer. Most of the bill’s revenue will probably come from corporate taxes that I’m luke-warm about, because that’s how Americans like our taxes: Hidden and less progressive than they could be.
And Elizabeth Warren-style “two percent annual surcharge” tax is definitely not going to happen, but Ron Wyden has proposed an annual tax on derivatives and carried interest. That’s a wealth tax of sorts, and in my opinion it’s infinitely more workable than what Warren proposed (because the tax would be on assets whose value is easy to determine). But a discussion of the wisdom of this “mark-to-market” proposal will have to wait for another day; I just wanted to point out that something like a wealth tax is being considered, though it’s not the Warren/Saez/Zucman thing.
I love this discussion, as it hits all the right notes for me.
All income is income, and should be taxed when realised. It should also be indexed to inflation. No exceptions for inheritances or investment partnerships (hedge funds, VCs, etc.). When you get cash income, you pay a tax on it, indexed for inflation. Yes, it’s not easy to value illiquid assets or determine their cost basis when that was in the distant past, but those are mostly one-time effects that will cease to be an issue once everyone realizes the need for properly assessing and recording the values of all assets.
I’d also completely eliminate the deductibility of interest on debt - corporate debt and mortgage. It will cause a re-alignment of the credit markets when it happens, but once that is done, it will reduce one more distortion from the economy while disincentivising some forms of risky behaviour. And yes, you’d need to grandfather some of this stuff in, but that’s doable over the course of 5-10 years (during which time CPAs and tax preparers will be busy as heck).
One year, the IRS sent me $4000 more than I was expecting in my tax refund. It turned out that someone at the IRS entered my capital gains incorrectly, so that it went from a couple hundred dollars to something like $20,000. When they thought I'd made a big chunk of my income from capital gains instead of my job, the taxes I owed decreased by $4000. I was so angry.