Tony Yezer on Tax Avoidance and Incidence

He writes:

"I teach this in urban economics.  However, in this case there is a 4.5% CAP rate (note that is operating revenue net of operating cost including taxes, insurance, etc) and 4% appreciation per year for 8.5% before taxes.  Pretty sweet.  If this asset is so tax-preferred, then how is this possible?  Why don't capital markets arbitrage this away?  Why doesn't the tax expenditure to to the renters.  In urban economics class we learn that the tax expenditure goes to the renters to offset the owner tax expenditure.  So the 8.5% never materializes.  What does happen is that we all (owners and renters) consume more housing space because that is the primary determinant of greenhouse gas emissions by households and we want to maximize those emissions..... Note that the household emissions arise BOTH because the units are larger and contain more stuff AND because commuting distances are longer in less dense cities due to the policy.  I have a JUE paper about all this.    This is not new and it is obvious.  The problem is that no one cares about the incidence of taxes.  I bet that fewer than 2% of the American people know that the corporate income tax falls largely on workers in America.  A society ignorant of the difference between statutory and economic incidence of taxes is likely to make very poor and perverse decisions.  

The most important idea that I include in principles of economics is the difference between statutory and economic incidence.  In the case of GW students, it begins with the idea that taxes on liquor are not paid by the saloon owner or the bartender.  That gets their attention and then we make some progress."

What Tony writes is true, but it also underlines a problem--how do we judge tax fairness based on economic incidence?  That would involve knowing a lot of elasticities that we don't know.  If we think fairness is a critical consideration when making tax policy (and I, for one, do), I don't see how we avoid using statutory incidence, if only as a first approximation to economic incidence.  

I think I support a tax cut...

...for below median income households.

Mitt Romney infamously complained during his presidential campaign that 47 percent of Americans paid nothing for their government benefits.  What he really meant is that 47 percent did not pay federal income tax; they still paid lots of property, sales and FICA taxes.

A story by Jordan Weissman in Slate this morning underscored this fact; indeed, the story, in my view, buried its lede by focussing on the fact that the top one percent pay about 1/6 less in taxes as a share of income when compared with the 1950s.  To me, the most interesting thing was demonstrated in this graph by Piketty, Saez and Zucman:

Taxes as a share of income on the bottom 50 percent of the income distribution have risen about 60 percent (from 15 percent of income to 25 percent).  This falls into the category of facts I didn't know that I should have known.
  

How the very rich legally avoid paying taxes (h/t/ Ed McCaffery)

It is not that difficult--if you have access to capital.  Here are the steps:

(1) Buy an apartment complex for $10,000,000 at a 4.5 percent cap rate with a 35 percent downpayment; finance $6,500,000 with an interest only loan at 3.5 percent that comes due in five years.

(2) Let's say 35 percent of the value of the property is land and the remainder is improvements. Improvements on apartments are depreciated on a straight line basis over 27.5 years.  So taxable income is

450,000-227,500 (interest) - 236,363 = -13,863 or a taxable loss.  

Meanwhile, cash flow is 222,500 per year.  So one gets cash while taking a tax loss.

(3) It gets better.  Suppose when refinancing happens in five years, the property has gained 20 percent in value.  Now one gets a 65 percent LTV loan on a $12,000,000 property--and gets to pull $1,300,000 out of the property.  Suppose NOI has also gone up 20 percent.  Sow now taxable income is 

540,000-273,000-236,363 = 30,636.

Assume that the owner's all in marginal tax rate is 50 percent.  In exchange for a one time $1,300,000 in cash and cash flow of $267,000, the owner pays a little over $15,000 in taxes and 3.5 percent in interest on the extra money.  No matter how one looks at it, this is a tax rate on cash of less than 10 percent.

It keeps going for 27.5 years, at which point the owner can defer taxes via a like-kind exchange. All of this is perfectly legal.  And it explains why salaried workers pay more in taxes than owners of capital.