When you go to work, whether you get paid by the hour, or on commission, tips or by salary, you earn every penny of it. The operative word being earned.
When you invest your own sweat equity and/or money to create a company, the operative word being create, you earn every penny of it.
I think Obama is about to make a HUGE misake, if elected, by increasing taxes on EARNED income of 250k or more. 250k does not make you rich, particularly if you live in a city, say New York City, with a huge cost of living. 250k does not make you rich if you are 60 years old, hoping not to get laid off and holding on to your salary long enough to have enough in the bank to retire. 250k does not make you rich if you have 3 kids near or at college age.
The disparity in wealth in this country does not come on the backs of people making 250k, or even 500k or 1mm per year FROM THEIR JOBS. The ever increasing delta between the rich and everyone else does not come from EARNED INCOME at all. It comes from found money.
Found money is when an internet bubble hits and the options you got for 1 dollar are sold for 250. It comes from buying a stock for $1 and seeing it turn into a “10 bagger”. It comes from hitting the lottery. It doesn’t matter whether you were smart or lucky, it is money you FOUND based on good fortune.
When I sold broadcast.com does anyone seriously think I would have cared if the tax on my FOUND money was 10pct or 20pct more ? Hell no. Would I have made any decisions differently, HELL NO.
I dont have access to financial data, or maybe Im just too lazy to find it, to know how much income in this country is found money. Capital gains earned from limited risk capital. Things like stock options awards sold. I dont know what the number is, but its found money and could be taxed higher. If Steve Jobs gives himeself 1mm Apple options at a buck or two apiece, and he sells them for $175 dollars each, would anything about his actions change if that FOUND income were taxed at 20pct higher rate ? Sure Steve Jobs busts his ass to increase the output of Apple Computer. But his ass busting does really change the multiple or base price assigned to the stock. Thats a function of the market and market trends.
Im not the economist, fortunately, but if we can arbitrarily assign taxation to given income levels, we can arbitrarily define what constitutes FOUND MONEY.
I would do the following:
if an individual, in any given year, has short term capital gains of more than 1mm dollars, AND that gain is 200pct or more (remember, for your taxes, you list cost and sales price, so gain percentage would not be difficult to calculate) you pay the existing cap gains tax, plus you get hit with a “You got lucky tax of 30pct”
For long term capital gains, it would be more difficult, but I would tax it at a gain greater than $1mm or a basis equal to the compounded CPI for every year held, against a 300pct increase and reduce the GOT LUCKY percentage to 20pct.. So in the Steve Jobs example, if he had held his stock for 5 years, then sold it at 175mm a share, he would pay tax on 175mm in gains at the current rate, then a GOT LUCKY tax at 20pct of $175mm or $35mm dollars.
Will it piss off rich people like me.. Yep. But it wont affect our behavior at all. At some point you know the difference between FOUND MONEY and EARNED INCOME. That stock that went crazy, the options or warrants you got that vested just at the right time, thats where people get in to the Fuck You money territory, and most if not all recognize that paying taxes at that level is a great problem to have.
The transactions this GET LUCKY tax is most likely to impact
Yes, just like Bethany McLean s upcomimg article on the credit crisis . If Blythe Masters were more attractive , it would make more interesting reading about her chain-smoking , gin swilling , baby dropping ( on head … long after birth .. thx DM ) , cuckolding (not cock holding DM , unless you include plastic in her case ) .
Comment by Dave Moo -
Great post. Good analysis of some of a major flaw in his plans. As an aside, what Obama claims about nobody under 250K having no tax increase isn’t exactly true. He has said he wants all income subject to Social Security tax, not just the first $100K. That tax rate is 12.4% for self employed and 6.2% for employees. If an individual makes $120K his/her taxes could go up by $2,480. Small businesses could really be hurt by his tax plans… he also supports a proposal to make all earnings of a sub-s corporation subject to Social Security tax, not just the salaries. In the case of my dad for example, it would mean 10K in additional tax. As he told me when he explained all of this to me, this would have a similar effect on millions of small businesses.
Don’t get me wrong, I’m not trying to make a political ad here… I toe no party line (though I have strong libertarian leanings) and am not crazy about either of the choices.
Comment by Rebecca -
I’m hard-pressed to see a difference between creating a company and
owning stock in the company. How do you differentiate the two? Why
are Jobs’ stock options “found money” when clearly he has put sweat
equity into Apple?
Perhaps what you are really trying to do is to add a new tax bracket,
which takes effect at the “Geez that’s a lot of money” level.
Comment by anonymous -
Where do dividends fall – earned or found? If classified as earned, what about the companies whose stock prices appreciate because they’ve reinvested their liquid assets into company growth. Wouldn’t this spur executives to pay these earnings out (resulting in a lower tax for shareholders) than to invest them in growth? If classified as found, then we are back to placing a higher tax on the return of an investment.
I can think of several types of income that would be classified as “earned”, including million dollar commissions paid to the brokers who structured the sale of Broadcast.com. But to those who are making $250,00 a year it still smells like “It comes from hitting the lottery. It doesn’t matter whether you were smart or lucky, it is money you FOUND based on good fortune.” If the tax on their commissions was higher would they stop doing the deals?
Just another side to the equation to ponder. Good economics discussion though.
Comment by Amy S -
I love how clearly you point out the failures of taxing earned income.
While I think you are dead-on in the Steve Jobs example, I think there is also an unintended consequence that you are missing here.
When startups, well, start up, they offer equity in lieu of capital that they don’t have. It’s the only lever they have to compete for top talent in business and technology against capitalized competitors.
Those employees choose to offset some earned income with another form of earned income- Options, which have a value in terms of their potential to be exercised at a higher price. Some options will be worthless, some will have mid-range values, and others will shoot the moon. The potential employee evaluates the likelihood and scale of each outcome to determine how much income he is willing to compromise for options.
By dubbing this “Found money” and hitting it with a surcharge, you are limiting the upside- which lowers the potential value of the option, making it require more cash to compete for top talent.
That will have a negative effect on investment, innovation, income, and disposable income which will trickle down to consumer demand and corporate profit.
Comment by Noah Roth -
Dear Mark,
While I do agree with the concept of taxing found money based on a certain amount, i would like to point out the fact, that found money was based ( the money you used to invest) on already taxed money, thus the idea takes advantage of people who know better than just putting money in the pillow case. If i reinvest my earned money, i help the economy, regardless of what i reinvest it in. If i reinvest in a start up, and hit the jack pot – and it does not happen very often- i should be rewarded for my risk and willingness to put my savings back into the economy. similarly if i give it to the bank, they can use that to finance the growth of a company or a family in the form of loans. This is why i think that while the idea is noble, it is nevertheless unfair.
robert
Comment by Robert -