Our modern institutions, the banks and the corporation, arose in a period when business was very capital intensive, you had to build big factories to compete. But recently, large areas of business have been changed by technology to require far less capital. Not all of them, building chip factories has not, but look at say the media business, it used to cost a huge amount to build printing plants for newspapers, but this is all starting to go away, taking with it the rationale for the large corporation which used to have to be that big to finance the capital.
Silicon Valley is funding the smaller scale firms of the new economy, but that does not require huge amounts of money; meanwhile Wall Street is mostly large amounts of leveraged capital that does not have productive use in the real economy any more, so it tends to feed into asset price bubbles.
> Whenever someone criticizes “Wall Street,” someone else tries to defend Wall Street by saying that without it we wouldn’t have Silicon Valley and all of its wonders.
Criticizing Wall Street is a very broad term and its defense is equally general. No person who knows anything about markets will say corporations, stock exchanges, or liquidity shouldn't exist. The author is replying to someone who is broadly defending Wall Street's role in VC, private equity, IPOs, and debt. This is a diversion from what the problem with Wall Street really is. I have no problems or complaints about the actual functions and goals of markets. My problems with Wall Street are things that nobody tries to defend but nobody seems to stop:
1) Revolving-Door: Between the top banks, Federal Reserve, and US Treasury. Ex-CEO of GS should not be allowed to dictate or enforce monetary policy. Similarly ex-management of big pharma should not be allowed to run FDA. I saw an OccupyWallStreet sign that expressed this beautifully: Separation of Corporation and State.
2) Capital Gains tax: Income tax is progressive. Why not Capital Gains tax above 15%? I understand the whole I'm taking a "risk" factor. But will pg really shutdown YC if long-term CG is higher? Short-term CG is already same as Income Tax: http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United... - but long-term is just 1 year. This means, instead of giving a CEO a salary of $10m (taxable at 35%), you just give him $10m in stock that he can collect after 12 months. After the first year has rolled by, it is no different from a regular paycheck. I'd say 99.9% of people cannot afford $0 income for a year but those who can, pay significantly lower taxes. And there are other ways to treat short-term gains as long-term. So why not make long-term to actually be long-term, like 5 years?
3) Funny Quant business: My friends and professors in college suggested that I switch my major from CompSci/Econ to Operations Research/Math because banks on Wall Street were looking for kids like me who loved numbers. The more I looked into it, the more disgusted I felt. Yes, I can comprehend why improving a linear optimization algo. by 0.01% can result in $5m in profits so as a business, it makes perfect sense to hire the smartest people you can find to work on these problems. The issue I have with this is that these operations serve no capital market purpose. I know they're not illegal and I know they're not directly harmful. But they are also not necessary and they indirectly harm everyone because the banks find them as bigger sources of profit than their investment operations. It's like an MD selling power bracelets - not illegal, not directly harmful but you know that if they keep this up and make a lot more money this way, they have less incentive to dispense regular medical advice which is harmful.
Additionally, with regards to the quant business, that they compete for engineering and software development talent probably diverts good people away from the product, research, and service side of the economy.
I never quite bought into the concept of treating long-term capital gains in a special way. In fact, a glance at http://en.wikipedia.org/wiki/Capital_gains_tax suggests that only Hungary, India and United States have a notion of special taxation for long-term capital gains (it's 12 months in India and USA and 3 years in Hungary).
Treating LTCG as income would simplify tax preparation, but any time this gets brought up, the politicians bring up the small business owners who are unfairly penalized for selling their business.
> small business owners who are unfairly penalized for selling their business.
If you work for little profit and low salary for 10 years and finally managed to sell your business for $200k gains, I can understand why you don't want to pay 33% just for that one year, especially since you no longer have a source of income until you create another business or get a job. Paying 33% instead of 15% seems unfair. I personally fit into the same dilemma where in 2011 my wife and I will have high income but I won't be making anywhere close in 2012 when I go full-time on my app/startup.
I believe there can be solutions to this such that SMBs are not harmed while at the same time, making sure top 0.01% doesn't qualify for it. Changing the brackets for LTCG can work (15% for < $250k, 20% for < $500k, 33% for < $1m, 35% otherwise). Tax deferment could be another solution.
Problem is that SMBs are used as a shield to defend the ones with Cayman Island and Swiss Bank accounts. It's not about being anti-corporation or anti-government. It's about being pro-fair.
If you work for little profit and low salary for 10 years and finally managed to sell your business for $200k gains, I can understand why you don't want to pay 33% just for that one year, especially since you no longer have a source of income until you create another business or get a job. Paying 33% instead of 15% seems unfair.
Can you elaborate on why this is unfair? From a simplistic point of view, this hypothetical person worked for 10 years and ended up with a gain of 200k (assuming income in other years was negligible). Why is it unfair to tax this gain - which can be thought of as receiving the income for 10 years in one shot - at normal income rates?
Is it because if it was normal income, the 20k/year amount would not be taxed at 33%?
> Is it because if it was normal income, the 20k/year amount would not be taxed at 33%?
Correct. If you make 15k taxable income for 4 years (i.e. 60k), you'd pay 10% in taxes filing married = 6k/year. If you make 60k in a single year (after 3 years of no income), you'd pay 10% of 17k, and 15% on 43k. That's over $2k in difference. Double the year, add more risk and zeros to the income/gains figures and you'll see why raising taxes on capital gains will take away the incentive to start a business. So it is fair to give SMBs a break. I just don't want to extend this break to investment bankers and hedge fund managers making $30m/year, regardless of how useful their services are. They should pay the same taxes as anyone with salary of $30m.
There is an easy fix though, allow them to use low/ no tax years to offset the gain amount. Anyone using it as a big wage will still be in the same tax bracket as usual.
But let's say you knew your LTCG would be taxed as income. It seems you would've either
1) opted in for a larger salary over the last few years to realize the income under a bracket that you're comfortable with, and drive the sale price of a business down
2) come up with a structure where you can split up the proceeds over several tax years (selling 50% on Dec 31st and 50% on Jan 1st comes to mind, but there're probably better ways to optimize this)
I agree. Both 1 and 2 are possible. However 1) is unknown because of the inherent risk. You can't give yourself a large salary just in case business sells. 2) is probably possible already (sorry, not a tax accountant) but might be costly/friction.
First, if your payoff after 10 years is $200k, then perhaps you chose poorly :-)
Second, if you know those are the rules, why would it be unfair? Don't do it if you don't want it. Phase out long term capital gains 20% over 5 years, and we're done!
Canada has a lifetime capital gains exemption of $750,000, which makes the small business argument moot. In families operating many small businesses, you'll find that the children are majority owners of the companies so that their exemption will be used in the event of a sale.
> 2) Capital Gains tax: Income tax is progressive. Why not Capital Gains tax above 15%?
What's your goal?
During the campaign, Obama was asked if he'd raise the capital gains tax rate even if the result was less revenue. He said yes.
What is your answer to that question? What goal are you trying to accomplish with the capital gains tax?
And no, you don't get to assert that an unspecified "higher" rate or one with a different term would raise more money. You get to do the analysis. (I'm not claiming that the current rate is tax-revenue maximizing.)
Note that there might well be other goals. One is growing the economy. Another is "fairness". There is little chance that maximining more than one at a time is possible.
The thing about raising capital gains tax rates is that it will reduce the efficient flow of capital from lower performing investments to higher performing ones.
Let's say I am invested in stock A, rate of return is (a). Stock B looks like a better investment, returning (b). I have some gains in A (ag); if I sell A to reinvest in B, I pay capital gains tax (t) on the gain, reducing my investment in B by the same amount.
It is only worthwhile to make the switch if I make enough more in B to cover the loss in capital that was taxed away. In mathematical terms,
(A + ag) * (1 + a)^n < (A + ag * (1 - t)) * (1 + b)^n
The larger t is, the higher b has to be to compensate for it, or the larger the number of years (n) have to be.
This is the reason why people invest in unproductive tax shelters - the tax rates make them financially better investments, although they are worse for the economy. One thing Reagan did was eliminate many tax shelters in exchange for lowering the marginal rates, this had the economically productive effect of shifting capital out of tax shelters into more productive endeavors.
1) Reagan lowered capital gains and put up barriers for tax shelters at the same time. Because it occurred at the same time there is no way to decouple whether lowering the marginal tax rate or creating barriers for tax shelters caused money to flow from tax shelters. (most likely there is an academic paper out there on this, but I do not have one)
2) Increasing the tax rate may cause people to stay in some securities sometimes, but for the vast majority of institutional investors this increase in tax rate will have no effect on decision making since the majority of investors in these funds are 401K investments that are not taxable.
For the taxable investors, this becomes an issue, but the vast majority of funds still have a lot of churn which indicates that your formula doesn't matter.
The tax increase is not targeted as much at standard fundamental equity or even scientific equity as much as it is targeted at VC, other non-VC PE and probably the largest segment Real Estate.
I'm not endorsing the tax increase, rather I am stating that the approach you used to say it shouldn't exist really isn't proven by the market.
In my opinion, the best reason to oppose the tax increase would be to say that it may temporarily decrease real estate transaction volumes and may permanently decrease RE churn which will reduce a lot of income for fee based services like RE brokerage, bankers, title companies etc. Further putting pressure on an already depressed job market.
Saying risk capital worked before a liquid second market existed is like saying food distribution worked before the supermarket. I agree that Wall Street financiers seem to focus too much on using secondary (and tertiary) effects to simply amass wealth, and i worry that that actually has a negative overall effect on society. But without a liquid secondary market, the primary market is significantly stymied!
The art of investment banking has been around for centuries, and by no means started with Wall Street. If you look back many hundred years, the Church had outlawed usury (charging interest on loans), effectively meaning lenders had no more incentive to lend to people who needed it.
To solve this problems, some of the first derivatives were invented (yes, some derivatives have a purpose). A lender would trade money to a farmer in exchange for, say, a flock of sheep (although the farmer would keep the sheep). Their repurchase agreement would state that after a year, the farmer would buy the sheep back from the lender, but any baby sheep would still belong to the lender because they were born while the sheep were in the lender's possession.
SV might do fine with WS, but I really do believe finance and tech work well, hand in hand.
>If you look back many hundred years, the Church had outlawed usury (charging interest on loans)
Correction: Usury was the charging of interest on an unproductive loan. If the principle of the loan was meant to buy food for a family, then the lender could not charge interest. If the principle was meant to start a business then the charging of interest was not usury.
The big problem was that, for a long time, theologians followed Aristotle on the question if money, itself, was "fruitful" or not. Aristotle said that it wasn't. In the later Middle Ages, theologians made a distinction between money and the uses of money. That distinction led to the conclusion I gave in the previous paragraph.
Okay, I'm nitpicking, but this medieval usury issue is a pet peeve of mine.
Silicon Valley is funding the smaller scale firms of the new economy, but that does not require huge amounts of money; meanwhile Wall Street is mostly large amounts of leveraged capital that does not have productive use in the real economy any more, so it tends to feed into asset price bubbles.
Its a big long term shift in the balance.