11/1/19: Capital Gains Tax: Human Capital vs Other Forms of Capital

This is exactly the source of policy-induced wealth inequality in the modern advanced economies: the disparity between labor income tax and capital gains tax that (1) incentivises accumulation of capital gains generating assets; (2) increases wealth inequality arising from non-meritocratic transfers (spousal and inheritance); and (3) reduces gains from meritocratic investment in human capital.

Now, factor this into tax-adjusted returns on various forms of capital: Intangible Capital returns are taxed at a corporate tax level at below the Physical Capital returns tax rates, which fall lower than the Capital Gains tax rate. Meanwhile, returns to the [intangible] Human Capital are taxed at the rates of higher margin Income tax rates. Go figure why wealth inequality is rising (as entrepreneurship is shrinking).

18/4/16: Capital Gains Tax & Investment Distortions: Corporate Data from the U.S.

In our MBAG 8679A: Risk & Resilience:Applications in Risk Management class we have been discussing the links between taxation, optimal corporate capital structuring and investment, including the decisions to pursue M&A as an alternative strategy to disbursing cash to shareholders.

Lars Feld, Martin Ruf, Ulrich Schreiber, Maximilian Todtenhaupt and Johnnes Voget recently published a CESIfo Working paper, titled “Taxing Away M&A: The Effect of Corporate Capital Gains Taxes on Acquisition Activity” (January 26, 2016, CESifo Working Paper Series No. 5738: http://ssrn.com/abstract=2744534). The paper links directly taxation structure to M&A decisions and outcomes.

Per authors, “taxing capital gains is an important obstacle to the efficient allocation of resources because it imposes a transaction cost on the vendor which locks in appreciated assets by raising the vendor’s reservation price in prospective transactions.” Note, this is an argument similar to the effects of limited interest deductions on mortgages and transactions taxes on property in limiting liquidity of real estate.

“For M&As, this effect has been intensively studied with regard to shareholder taxation, whereas empirical evidence on the effect of capital gains taxes paid by corporations is scarce. This paper analyzes how corporate level taxation of capital gains affects inter-corporate M&As.”

Specifically, “studying several substantial tax reforms in a panel of 30 countries for the period of 2002-2013, we identify a significant lock-in effect. Results from estimating a Poisson pseudo-maximumlikelihood (PPML) model suggest that a one percentage point decrease in the corporate capital gains tax rate would raise both the number and the total deal value of acquisitions by about 1.1% per year. We use this result to estimate an efficiency loss resulting from corporate capital gains taxation of 3.06 bn USD per year in the United States.”

I am slightly sceptical about the numerical estimate as the authors do not appear to control for M&A successes. However, since the lock-in mechanism applies to all types of re-investment projects, one can make a similar argument with respect to other forms of capex and investment. One way or the other, this presents evidence of distortionary nature of U.S. capital gains taxation regime.

21/9/2013: Human Capital & Social Mobility: Capital Tax v Education Spending Reforms

A new paper Human Capital, Social Mobility and the Skill Premium (September 18, 2013, CESifo Working Paper Series No. 4388. Available at SSRN: http://ssrn.com/abstract=2327435) by Angelopoulos, Konstantinos and Malley, James R. and Philippopoulos, Apostolis produces fascinating insights into the relationship between human capital, physical capital and skills/wage premium.

The main drivers of the skill/wage premium are commonly recognised to be: 

1. Skills-complementary technical change (SBTC - B standing for 'biased'), "which raises the demand for skilled labour, and the relative supply of skilled versus unskilled labour". Economic policy can influence this channel by increasing R&D and innovation which lead to increased technology contribution to the economic activity and in turn generate demand for complementary skills.
2. "Occupational choice of economic agents, usually focusing on the distinction between entrepreneurs and workers, and its implications for social mobility." Here, economic policy too can have an impact via, say labour markets regulations and interventions, as well as general taxation policies.
3. Direct policy impact via stimulating "capital accumulation via tax reforms" and direct "labour markets …intervention".

In contrast, "although education policies and tax policies have been considered as important determinants of social mobility, their impact on the joint determination of social mobility and the skill premium has generally not been studied."

Human Capital, Social Mobility and the Skill Premium "develops a dynamic general equilibrium model to highlight the role of human capital accumulation of agents differentiated by skill type in the joint determination of social mobility and the skill premium."

The authors find that "the model with endogenous social mobility can capture the empirical co-movements of the skill premium, the relative supply of skilled to unskilled workers and aggregate output in the U.S. data from 1970-2000." The study shows "that the model predictions for these empirical co-movements are improved when we allow for positive externalities from skilled human capital on social mobility." In other words, skill premium for skilled and unskilled workers tends to rise/fall jointly (co-move) and this co-movement is strengthened when increased social mobility of skilled human capital is associated with increased social mobility of unskilled human capital.

The authors' "policy results first show that endogenous social mobility creates additional incentives for the agents which enhance the beneficial effects of policy on aggregate outcomes and wage equality."

"Second, that important dynamic effects of policy on the skill premium are captured by allowing human capital accumulation to affect social mobility. In particular, post reform, the skill premium is higher in the short- to medium-run than in the long-run."

"Third, that although all policy reforms considered lead to an increase in output and social mobility, their implications regarding the skill premium differ. In particular, the skill premium increases after a capital tax cut and decreases after an increase in spending on education for unskilled agents and in spending on education for skilled

agents."

In other words, the authors show that "endogenous social mobility and human capital accumulation are key channels through which the effects of capital tax cuts and increases in public spending on both pre- and post-college education are transmitted."

Note: in my view this tends to support the idea - outlined by me in my TEDx Dublin talk last Saturday - that we are witnessing migration to the age of tech-enabled human capital away from the skills-enabled tech capital. 

"In particular, social mobility creates additional incentives for the agents which enhance the beneficial effects of policy reforms. Moreover, the dynamics of human capital accumulation imply that, post reform, the skill premium is higher in the short-to medium-run than in the long-run."

Note: in the context of my TEDx Dublin theme, the above reinforces my concept of new policy paradigm of C.A.R.E. (policy dimension aimed at establishing a comprehensive economy that is capable of Creating, Attracting, Retaining and Enabling human capital).

"Regarding all three results above, the effects of public spending on education for skilled agents are dependent on the externality that skilled human capital has on social mobility. In particular, a negative externality generally reduces many of the positive effects of this policy reform."

What about a capital tax cut? 

The "improvement in aggregate outcomes" following tax cut "also implies increased wage inequality. The reason is that the policy-induced increase in the capital stock is skill-biased because capital complements skilled labour more than unskilled. Hence, …the skill premium increases with the capital stock post-reform."

However, this "increase in the skill premium works to encourage the accumulation of unskilled human capital, as a means to increase social mobility to capture the higher returns associated with skilled employment. In turn, …the resulting increase in the relative skill supply acts to lower the skill premium. In fact, the reduction in the skill premium starts taking effect 20-30 years after the reform, when the increase in the share of skilled labour is sufficiently strong to counterbalance the increase in the capital stock."

Note: in my TEDx Dublin talk context, the above relates to the changes in underlying drivers for growth I highlighted in the chart - in particular, the lags we are experiencing in terms of the Age of Tech translating with a delay into future wage premium erosion (some might argue we are already witnessing this today). 

Education spending increase for unskilled workers: "As expected, the stock of human capital for unskilled labour increases and this raises output in all models and social mobility in the models that allow for endogenous skill accumulation. In turn, this increase in the relative supply of skill leads to a decline in the skill premium in the medium- to long-run. However, initially, the skill premium increases …because the labour productivity gains, brought about by the increase in human capital, also increase the return to physical capital and thus lead to increased capital stock, which tends to increase the skill premium." 

Over time, "when the relative skill supply has increased sufficiently, the skill premium starts to decline. In this case, in fact, the increase in the share of skilled in the population is sufficiently strong to decrease the skill premium in the long-run."

"The dynamic processes of human capital accumulation and social mobility have non-trivial implications on the …determination of …skill premium-social mobility" co-movements. Long-run: wage inequality is reduced along with increased social mobility. Short-run: wage inequality increases.

Summary: 

(1) In the long-run, "government spending on unskilled education, by increasing the labour productivity of unskilled labour and increasing their skill accumulation, raises output, reduces wage inequality and improves social mobility. However, "the increase in government education spending crowds out private consumption." In the short-run, unskilled education increases lead to increased inequality and social mobility declines.

(2) "…Increases in government spending on the education of the skilled agents has positive effects on output and consumption, as well as encouraging social mobility, despite the reduction in the skill premium. This occurs because, by supporting the productivity of the skilled, the government indirectly increases the potential future benefits of the unskilled, if they succeed in climbing the social ladder. However, these results are sensitive to whether externalities of skilled human capital on social mobility are positive or negative. The former enhance the positive effects on social mobility, wage inequality, and welfare, whereas the latter reverse them for social mobility and wage inequality and lower them for welfare."

(3) "Wage inequality effects of capital tax cuts are significantly dampened by the increase in the relative skill supply, which follows the increased returns to upward social mobility, while, at the same time, the aggregate efficiency effects of the capital tax cut become stronger."

Economics 23/06/2010: Russia scraps CGT

While neo-liberal and free-market Ireland is scrambling to find any new forms of tax to raise against its rapidly depleting household incomes and savings, Russia - an economy also badly impacted by the current crisis - is planning some real reforms.

Speaking at St Petersburg Economic Forum - annual leadership summit held in the Northern Russian city every year in June - Russian President Dmitri Medvedev said that his Government will abolish the capital gains tax on all long-term investments (including foreign direct investment). The measure is seen as a stimulus for non-oil and gas related investment in new technologies, manufacturing and services - areas that Russian Government established as priority for development over the next 10 years.

Russia already sports a flat-rate 13% income tax and a corporate tax of 20% (reduced by 4 percentage points in 2008 from 24%). Regional governments can cut the corporation tax to 16% on their own authority. There is zero tax on royalties from patents, know how and other forms of IP for domestic receipts and a 20% tax on payments from abroad - except where specified otherwise by bilateral treaties. Companies also enjoy an unlimited carry forward on losses.

The Government will also reduce its enterprise holdings by 80% to allow private (domestic and foreign) ownership of many 'strategic' national enterprises currently numbering around 200. "I am cutting the number of strategic companies five times...I have signed a decree to this effect today," Medvedev said.

Russian economy grew by 4% in 5 months between January and end of May 2010 and Medvedev also opened the door for future tax cuts on businesses, but this will be subject to continued economic growth and, presumably, continued displacement of extraction industries at the top of growth pyramid by other sectors.

"We shall return to the issue of a tax burden easening for businesses in the next few years if the global and Russian economies recover in favorable conditions. If everything goes to a favorable scheme," Medvedev said. Before then, there is a need to strengthen country fiscal position which means that some privatizations of the companies previously off the private investors' radar due to state restrictions will be forthcoming.

Medvedev also proposed the government will set up a joint investment fund with state and private investors to develop strategic projects. "...where state money will be augmented with private capital - say, we expect one ruble of state investment to attract three rubles of private investment. I think the idea should be implemented within a year," Medvedev said.