tag:blogger.com,1999:blog-4039434.post3507998307186534351..comments2024-02-26T06:46:53.171-05:00Comments on Rajiv Sethi: Returns to Information and Returns to CapitalRajivhttp://www.blogger.com/profile/13667685126282705505noreply@blogger.comBlogger4125tag:blogger.com,1999:blog-4039434.post-42460779362796100032012-01-31T15:29:16.764-05:002012-01-31T15:29:16.764-05:00Rajiv, I was thinking of a situation where a perso...Rajiv, I was thinking of a situation where a person buys a business and then invests their own time and money into restructuring the business, creating business plans, etc. The same amount of time or entrepreneurial expertise would be applied to the business in the no tax or 50% tax world, but returns are lower in the 50% tax world.<br /><br />I see this as more accurately reflecting Romney's activities. After all, if Romney is only investing capital in a business, he would earn the same return (given the same risk) regardless of where he invested it. Takeovers only make sense in a world where people can invest things other than capital into improving a business.<br /><br />The other way you can think of it is, yes a tax on capital only causes a one off fall in the value of capital the moment it is put in place (or anticipated), and from then on capital earns the same risk free rate plus risk premium. But this includes human capital that people will apply to a business in the future and earn a return. Thus a tax on capital causes a one off drop in the net present value in human capital, making people worse off. The difference between human and regular capital is the former is only ever rented out (for a wage) and never sold outright. <br /><br />This way of thinking seems strange though. It means wage earners are hit by a capital tax as well, because they are simply suppliers of unsellable human capital. So Romney is right to say a capital tax increases his effective tax rate, but it does so to wage earners too so he does actually have a relatively low tax rate. HmmmTalohttps://www.blogger.com/profile/16161577235394876155noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-58226446799156034552012-01-31T11:55:06.469-05:002012-01-31T11:55:06.469-05:00Talo, in both the no tax and 50% tax world, the in...Talo, in both the no tax and 50% tax world, the investor makes a 100% return on their investment. The amount required to buy a business in the no-tax world is enough to buy two such businesses in the 50% tax world. If the investor is constrained by time or other resources and can only deal with one business at a time, your argument applies and the tax is costly. If the investor is constrained by capital then there's no difference in the two worlds.<br /><br />JKH, yes, context matters a lot and returns to seed capital will be affected by the tax. Most capital gains are not on seed capital though. Perhaps I should have left Romney and Buffet out of the picture... I'm really interested in the more general issue of (alleged) double taxation. Will think about it some more.Rajivhttps://www.blogger.com/profile/13667685126282705505noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-25272228226919917192012-01-31T11:14:30.862-05:002012-01-31T11:14:30.862-05:00The above comment seems about right to me.
Part o...The above comment seems about right to me.<br /><br />Part of the challenge is getting the right context for the analysis of counterfactuals.<br /><br />Consider the position of somebody starting up a business from scratch, and investing seed capital. Then consider two scenarios, corresponding to status quo taxation versus an increase in the tax rate payable on both capital gains and dividends.<br /><br />The fact is that the after-tax return on book equity is going to be lower for the second case, other things equal. And it’s going to be lower to the degree that the venture becomes non-viable at the outset, other things equal. So there won’t be any further consideration of how the market values such an investment going forward, or what the return is from one period to the next under either tax/valuation scenario, because there won’t be any such investment. The original book value economics are what determines the original viability of the investment and its return – not a running comparison under two different tax rates with corresponding start and end date valuations.<br /><br />Now consider the position of somebody who’s already started up a business from scratch, with original status quo tax treatment of capital income. Suppose the tax rate on capital gains and dividends is now increased. Then the value of the investment will decline as a result. The fact that somebody else can now buy the investment cheaper and realize comparable returns going forward is moot. The original investor has been screwed.<br /><br />Romney is in the position of an original investor. The projected after-tax return on original book equity is what determined the economics at the outset, and that depended on avoidance of full double taxation. The fact that somebody else might be able to buy the investment from him now and in doing so adjust to either tax/valuation scenario in setting his offered price, is moot. It was the status quo tax treatment that made the original book value investment viable as a return on book equity proposition. Without it – with full double taxation – it would not have been viable, other things equal, because the projected after-tax ROE would have been too low.JKHhttps://www.blogger.com/profile/13340378835600547262noreply@blogger.comtag:blogger.com,1999:blog-4039434.post-47099974885300408432012-01-30T17:53:32.300-05:002012-01-30T17:53:32.300-05:00Things are different if you think Romney makes mon...Things are different if you think Romney makes money from improving businesses.<br /><br />I'm going to pretend the business is an annuity cause I'm not familiar with the formula you used, but I don't think it matters. Say a business earns $1 a share (pre tax) each period and the interest rate is 10%. Each share is worth $10 in the no tax world, but in a 50% tax world each is only worth $5.<br /><br />Romney buys the business and uses his managerial skills to improve the businesses profitability such that it can double its dividend payment every period. After Romney joins each share is worth $20 in the no tax world and $10 in the 50% tax world.<br /><br />Thus in a no tax world Romney earns $10 per share, but only $5 per share in the 50% tax world.<br /><br />A person who buys then sells capital is unaffected by a corporate tax rate because both buy and sell price are lowered by the same proportion. However if you create capital yourself by starting or improving a business, you are made worse off by the tax.<br /><br />I guess you could think of entrepreneurs as having "potential capital" stored inside them, and any tax on capital lowers the value of this potential capital making them worse off.Talohttps://www.blogger.com/profile/16161577235394876155noreply@blogger.com