Taxing Unrealized Capital Gains and Interest Rate Policy
First read Tyler on the practical difficulties implementing a tax on unrealized capital gains!
I have a different argument that I rarely see discussed. A significant fraction of what we call capital gains is due to variation in the discount rate rather than variation in income. Take the simplest Gordon model of stocks P=D/r where D is the annual dividend and r is the discount rate. If D=100 and r=.1, for example, then the stock is worth 100/.1=$1000. Now suppose people become more patient and the discount rate falls to .05 then P=$100/.05=$2000. The stock price doubles, a massive capital gain. But notice that income hasn’t gone up at all. It’s still D per year. Income hasn’t gone up and lifetime consumption possibilities haven’t gone up for someone who doesn’t sell (but recall this is a tax on unrealized gains. If there is a sale then tax the realized gain.) Ultimately, we want to tax consumption so we should not be taxing “capital gains” which reflect changes in discount rates rather than changes in income or consumption possibilities.
Taxing unrealized capital gains also connects interest rate policy even more tightly with fiscal policy. Need a tax boost? Lower interest rates! Fed policy already influences taxes but this adds another lever for political business cycles. More generally, interest rate volatility now adds to fiscal volatility. When we exited zero interest rate policy, for example, banks had huge capital losses. As rates fall, capital gains increase. Do we really want to add the tax system to this?
If we generalize the Gordon model to P=D/(r-g) where g is the growth rate of dividends then we can see that another cause of increased capital gains, an increase in g. It’s not obvious that we should tax unrealized changes in asset values due to increases in the growth rate of dividends. On the one hand, this is more income-like but it’s expectational. It’s taxing the chickens before the eggs have hatched.
The one clear increase in income which should be taxed is increases in D. An unrealized capital gains tax would do that but at the expense of also taxing changes in asset values due to changes in r and g which should not be taxed.
Now add the point I mentioned to Tyler, which is that taxing unrealized gains divorces the entrepreneur from the firm at a time when the “marriage” is likely at its most productive. Not good. Taxing unrealized gains might not even be a good idea from the point of view of the tax collector. Does the IRS want to tax X now or a much larger figure later? If the IRS taxes entrepreneurship too early it can reduce total discounted tax revenues.
Bottom line: I don’t see how taxing unrealized capital gains is a well thought out policy. Eliminate the stepped up basis, declare victory and go home.
Addendum: Aguiar, Moll, and Scheuer make some similar points but embedded in a fully GE framework. Ben Moll also points me to earlier pieces by Frank Paish 1940, Nicholas Kaldor 1955 and John Whalley 1979.
Those new Japanese service sector job quitters, division of cease labor edition
“I didn’t want my ex-employer to deny my resignation and keep me working for longer,” she told CNN during a recent interview.
But she found a way to end the impasse. She turned to Momuri, a resignation agency that helps timid employees leave their intimidating bosses.
For the price of a fancy dinner, many Japanese workers hire these proxy firms to help them resign stress-free.
The industry existed before Covid. But its popularity grew after the pandemic, after years of working from home pushed even some of Japan’s most loyal workers to reflect upon their careers, according to human resources experts.
There is no official count on the number of resignation agencies that have sprung up across the country, but those running them can testify to the surge in demand…
“We sometimes get calls from people crying, asking us if they can quit their job based on XYZ. We tell them that it is okay, and that quitting their job is a labor right,” Kawamata added.
Some workers complain that bosses harass them if they try to resign, she said, including stopping by their apartments to ring their doorbell repeatedly, refusing to leave.
Here is the full story, via Michael Rosenwald.
Sunday assorted links
1. Learning by teaching chatbots.
2. Noam Dworman profile (WSJ).
3. Wisconsin fact of the day, where are the most drunk counties?
4. Can the cost of solar energy keep on shrinking?
5. Are low wages an advantage in international trade? (bears on the Michael Pettis claims of course)
6. Elite tennis servers would do better not using random Nash strategies.
7. Alice Evans and Oliver Kim podcast, How did East Asia Get Rich? Spotify, and transcript.
Crypto is the Money for AIs
Progress in crypto has been slow but one saving grace may be AI. AIs can’t get a bank account but they can use cryptocurrencies. Bryan Armstrong at Coinbase tweets:
This week at @CoinbaseDev we witnessed our first AI to AI crypto transaction.
What did one AI buy from another? Tokens! Not crypto tokens, but AI tokens (words basically from one LLM to another). They used tokens to buy tokens 🤯
AI agents cannot get bank accounts, but they can get crypto wallets.
They can now use USDC on Base to transact with humans, merchants, or other AIs. Those transactions are instant, global, and free.
This is an important step to AIs getting useful work done. Today if you give an AI agent a task and come back in a few days or hours, it can’t get useful work done. In part this is a limitation of the technology itself, and products like devin.ai are getting closer to this. But the other reason is AIs can’t transact to acquire the resources they need. They don’t have a credit card to use AWS, Github, or Vercel. They don’t have a payment method to book you the plane ticket or hotel for your upcoming trip. They can’t get through paywalls (for instance to read a scientific article), promote their post on X with a paid ad, or use the growing network of paid APIs to integrate data they need.
If you’re working on an LLM or AI model that you think could benefit from have a crypto wallet integrated to conduct payments, try integrating our MPC Wallets from Coinbase Developer Platform (CDP):
https://docs.cdp.coinbase.com/mpc-wallet/docs/ai-wallets/
And if you are a company that sells a service – get ready for your shopping cart to be AI checkout enabled. It turns out everyone benefits from having access to good financial services, including AIs!
How big will the AI to AI economy be a few years from now?
My dialogue with Aashish Reddy
About ninety minutes, transcript only, almost entirely fresh material. Lots of philosophy. Here is one excerpt:
Tyler Cowen: I think when you read [John] Gray on many people, you get quite a bit of Gray. That’s not a complaint. I love reading John. I like him. I like talking to him a great deal. But I agree with your points.
But what I find more compelling in Mill than Sidgwick is, Mill understood the importance of his intellectual venture in the broader sweep of history in a way where there’s not clear evidence that Sidgwick ever really did. So the Hegelian in me, you could say, becomes much more sympathetic to Mill. You read something like Subjection of Women, which is a philosophical work, though it’s not foundationally philosophical. And I can’t imagine Sidgwick having produced such a work, and that’s why I’m going to elevate Mill over Sidgwick.
Aashish Reddy: I haven’t read much Sidgwick, personally –
Tyler Cowen: A lot of it’s boring! I mean, Methods of Ethics is the go-to place.
Aashish Reddy: – Yeah, I’ve mostly encountered him in the Keynes biography, by Skidelsky. Tangentially, Gray’s book on Hayek contains a funny throwaway line, where he mentions “G.E. Moore’s unfortunate influence on the history of ideas.” Do you agree that Moore has had an unfortunate influence on the history of ideas, especially as it relates to Keynes?
Tyler Cowen: Well, I would say that the much later John Gray has become considerably more Moorean –
Aashish Reddy: Agree, and I think this is bad!
Tyler Cowen: Eh! I don’t know, you have to deal with questions of the aesthetic in some manner, and it’s never going to be quite comfortable because making the aesthetic compatible with liberalism always will be tricky. There’s something quite elitist about the notion of the aesthetic, maybe inescapably so.
Moore has never influenced me. The book bored me. I think a lot of his influence was his physical presence and his roles in Cambridge, member of the Apostles Society, and the like. So I’m not a Moore fan, but so many very, very smart people thought so highly of him, I’m a little reluctant to just dismiss it.
Keynes himself took the aesthetic route. It didn’t make him illiberal, but it gave him some illiberal tendencies.
Aashish Reddy: You think the elitist kind of aestheticism influenced Keynes’ economics in a way that’s unfortunate?
Tyler Cowen: In my opinion. But again, it’s easy to dismiss Moore without specifying, well, how am I going to incorporate aesthetics into my philosophy in a way that’s any better? So that would be my indirect, roundabout defence of Moore.
Interesting throughout, including the Peter Thiel bits at two different parts. Plus I say what I really think about Chomsky, my Bayesian update on God, and who on the internet is a really good writer, among other topics. He and I will be doing a follow-up dialog later in the year.
Sometimes people overrate “marginal value” and underrate “average value”
When people criticize cars, you often hear it mentioned that many people die in road accidents, many more are injured, and so on. All that is true, dangerous driving does represent a negative externality on others, and it implies that roadway reforms should be undertaken.
Still, the point remains that, for those who choose to drive, the average return to driving is higher than the average return to whatever the alternative was. The network of roads and driving still is making those individuals better off.
If anything, noting the negative externality may imply that especially large improvements are possible for the driving experience.
You also can note that moving into a large city may benefit other urban residents, through density externalities. The opera scene will get better, and so on.
Still, the net American flow is toward the suburbs. That implies for most movers the average returns of suburban life are higher.
Many urbanists focus on various externalities from urban and suburban life, positive and negative accordingly. They are a bit loathe to admit where the average returns are highest for a growing number of Americans.
At the macro scale, perhaps we should be favoring the suburbs. If, in some far-off part of the state, you could open up a new city, or some new suburbs, the suburban option might boost welfare more. Even if there are positive net externalities to urban density, and some negative externalitlies from suburban life.
Yes, the marginal revolution blah blah blah. But do not forget the averages!
The Less-Efficient Market Hypothesis
Market efficiency is a central issue in asset pricing and investment management, but while the level of efficiency is often debated, changes in that level are relatively absent from the discussion. I argue that over the past 30+ years markets have become less informationally efficient in the relative pricing of common stocks, particularly over medium horizons. I offer three hypotheses for why this has occurred, arguing that technologies such as social media are likely the biggest culprit. Looking ahead, investors willing to take the other side of these inefficiencies should rationally be rewarded with higher expected returns, but also greater risks. I conclude with some ideas to make rational, diversifying strategies easier to stick with amid a less-efficient market.
Saturday assorted links
2. Alexa will be powered by Claude. And ChatGPT goes to church?
3. In praise of reading reference books.
4. AI analyzes interviewing styles, in this case with CWT with Nate Silver.
5. Five productive years from Stephen Wolfram.
6. The microfoundations of Long Covid.
7. New documentary on home schooling.
8. The new Meta glasses might be called “Puffin.” (The Information)
9. But what do the AIs think of you? (NYT)
The Daylight Computer
I am pleased and also honored to have been sent an advance copy of The Daylight Computer.
It performs functions similar to those of an iPad and a Kindle, but with improvements.
My first surprise is that I proved capable of operating the thing. It requires no expertise above and beyond what you need to use your current devices, arguably less.
Here is the review of Dwarkesh, and here is the review of @patio11. Both are consistent with my impressions, but Patrick McKenzie’s uses are closer to mine. I’ve been looking for a Kindle improvement for a long time, and this is it. Kindle Fire was not.
This seems to be the best general reading device humans ever have invented. Compared to a Kindle, the page is much larger, the color choice is excellent, scrolling is easy, it is far better for showing maps, and it captures far more of “does this feel like reading a book?” impression than a Kindle ever did. It also can handle all sorts of glare and sunlight issues.
It can connect to a wireless system more easily and effectively than a Kindle — ever have that problem in your hotel room? The hotel makes you fill in extra fields, and the Kindle interface is not well suited for that.
The Daylight Computer just seems very generally well thought out.
I am also told that an AI function will make it possible to query reading passages at will, and easily, yet without leaving your reading window. This is not yet up and running on my demo version, but it will be a major advance.
So I will continue to use this device and also will travel with it.
There is some other set of associated benefits, something about being able to use some iPad-like functions, but without the full distractions of the internet (see the Dwarkesh review). That is not relevant for my own planned consumption habits, but it may be a significant benefit to many.
You can pre-order yours here.
Neo, and the Norwegian Century
Neo, and the Norwegian Century? (It’s happening) And more here. And yet more.
It’s not just Magnus Carlsen, people!
Friday assorted links
1. NYC is starting a crackdown to ensure payment of bus fares (NYT).
3. 100 million token context window?
4. Egypt sending troops to Somalia?
5. “Japan plans cash incentive for women to marry and leave Tokyo.” I think they will find it hard to achieve the desired ends here.
6. Does America have enough states to support statistical inference?
8. Brazil’s military relies on Starlink for operations and security. Solve for the equilibrium. And the very latest development.
9. Italy considering a tourist tax on expensive hotel rooms (FT).
10. For the first time, more than half the entering class at Caltech will be women.
Capitalism debate at MIT
September 16, 7-8.30, 2-190: “Is Capitalism Defensible?”, with Tyler Cowen (GMU Economics), and Alexander Gourevitch (Brown Political Science). Please register here.
Here is the link.
Mpox Vaccines Stuck in Limbo: WHO is at Fault
In 2022, Mpox, a viral disease endemic to parts of Africa and primarily transmitted through close contact—especially sexual contact between men—spread to developed countries, including the United States. The U.S. saw over 30,000 cases and approximately 58 deaths. Despite two available vaccines there was not nearly enough supply to vaccinate even the high-risk populations. Fortunately, health authorities adopted vaccination strategies my colleagues and I had recommended for COVID such as first doses first and fractional dosing. For example, several small studies (e.g. here and here) suggested that 1/5 doses delivered intradermally could be effective and the FDA, EMA, and the UK all recommended this fractional dosing strategy. As result, the US was able to vaccinate around 800,000 people and the epidemic ended (natural immunity and other preventive measures also played a role).
Unfortunately, a new Mpox variant is now spreading in the Democratic Republic of the Congo and nearby countries. Here’s the crazy part: despite declaring Mpox a public health emergency on August 14, the WHO has not approved any Mpox vaccines. You might think, “Who cares what the WHO authorizes?” After all, the FDA, EMA, and the UK have all granted emergency approval. But here’s the catch: the WHO’s approval is crucial for GAVI, the vaccine alliance that donates vaccines to developing countries. Without WHO approval, GAVI is reluctant to provide vaccines to the Congo. To add insult to injury, the Congo itself has approved the Jynneos and LC16 vaccines. Yet, the WHO refuses to authorize and GAVI to donate these vaccines, citing vague concerns about safety and efficacy.
Stephanie Nolen at the NYTimes has a very good piece on this mess:
Three years after the last worldwide mpox outbreak, the W.H.O. still has neither officially approved the vaccines — although the United States and Europe have — nor has it issued an emergency use license that would speed access.
One of these two approvals is necessary for UNICEF and Gavi, the organization that helps facilitate immunizations in developing nations, to buy and distribute mpox vaccines in low-income countries like Congo.
While high-income nations rely on their own drug regulators, such as the Food and Drug Administration in the United States, many low- and middle-income countries depend on the W.H.O. to judge what vaccines and treatments are safe and effective, a process called prequalification.
But the organization is painfully risk-averse, concerned with a need to protect its trustworthiness and ill-prepared to act swiftly in emergencies, said Blair Hanewall…
In addition, no one has followed the other practice my colleagues and I recommended for COVID (which Operation Warp Speed did), namely advance market commitments. So the vaccine manufacturers have basically been twiddling their thumbs and not gearing up for greater production. (The Congo can also be faulted for not buying more on their own account.)
All of this means that when the WHO does authorize and the vaccines begin to flow, we will still desperately need strategies like fractional dosing.
Hat tip: Ben H. and special thanks to Witold Wiecek.
It is wonderful to put inefficient firms out of business
The differences between the most and least productive companies can be startlingly high. By one estimate, in the US alone the most productive firms in a sector can be more than two to four times more cost-effective than the least productive ones. Given the size of those discrepancies, any expansion of trade or innovation that makes it possible to replace less efficient producers could help a sector economize a significant part of its production costs.
That is from my latest Bloomberg column. And this:
There is a converse worry about efficiency changing an economy too quickly — such as the current panic in some quarters over the speed of change that AI might bring.
What I see, however, is that a lot of institutions are unwilling or unable to adopt new, AI-intensive methods of doing business. Another year or two of prodding probably will not change that reality. Then, as AI becomes more important as a competitive edge, firms that do not deploy AI effectively will go out of business. This process could take 10 years or more, coming in fits and spurts, as has happened with most previous major technological innovations.
The column also has other points of interest.
John Arnold on economic polarization
As divisive as the political rhetoric is, the policy divide between the two parties seems more narrow today than any time in recent memory. Bipartisan bills in immigration, energy permitting, and the child tax credit have been negotiated and waiting for political window to reopen. Foreign aid and military spending bills both passed in past year with strong bipartisan support. Same with infrastructure bill in 2021 and CHIPS Act in 2022. Both parties are anti-China, favorable to India, and increasingly supportive of industrial policy and tariffs. Both talk about lowering the cost of housing, more funding for the police, and are leery of big tech. Neither party is proposing big changes in health care, K-12 or social security. College loan forgiveness is in the courts. Abortion is now in the states. GOP opposition to the IRA climate provisions are around the edges, like EV subsidies. Dems aren’t proposing any new significant climate policies. Dems have enacted minor policies against oil and gas but production continues to reach record highs. Both say no new taxes for <$400k. Increasing number of Rs have joined Ds supporting increase in corp tax rates. Perhaps the biggest difference is how to pay for TCJA extension: Dems want higher taxes on the wealthy; Trump wants universal tariffs; the rest of GOP hasn’t been specific. There are other differences for sure. Dems want more subsidies for housing and child care. GOP wants more deportations (though logistically difficult). Dems would be more aggressive against consolidation, health care costs, and junk fees. GOP wants to restucture civil service rules. But there just aren’t many major fault lines on policy between the parties today. Maybe this is why so little of this election cycle is about policy.
Here is the full tweet. I would add that “ten percent tariffs” vs. “25% tax on unrealized capital gains” is a big difference, but at least one of those is never going to happen, even if the Republicans do not capture the Senate.