WEBVTT 00:00:00.000 --> 00:00:01.961 align:middle line:90% [SQUEAKING] 00:00:01.961 --> 00:00:03.909 align:middle line:90% [RUSTLING] 00:00:03.909 --> 00:00:05.370 align:middle line:90% [CLICKING] 00:00:05.370 --> 00:00:09.825 align:middle line:90% 00:00:09.825 --> 00:00:12.200 align:middle line:84% PROFESSOR: So we're going to continue with our discussion 00:00:12.200 --> 00:00:14.527 align:middle line:90% of chapter 22. 00:00:14.527 --> 00:00:16.860 align:middle line:84% Remember, we're talking about-- this part of the course, 00:00:16.860 --> 00:00:19.600 align:middle line:84% we're talking about behavioral responses of taxation. 00:00:19.600 --> 00:00:22.900 align:middle line:84% And we talked in chapter 21 about how labor supply responds 00:00:22.900 --> 00:00:24.280 align:middle line:90% to taxation. 00:00:24.280 --> 00:00:27.480 align:middle line:84% And then we started chapter 22 discussing how 00:00:27.480 --> 00:00:29.520 align:middle line:90% savings response to taxation. 00:00:29.520 --> 00:00:33.080 align:middle line:84% And we talked about the canonical intertemporal choice 00:00:33.080 --> 00:00:36.000 align:middle line:84% model where people have two periods, 00:00:36.000 --> 00:00:37.560 align:middle line:90% working life and retirement. 00:00:37.560 --> 00:00:41.000 align:middle line:84% And they decide how to allocate their savings across them. 00:00:41.000 --> 00:00:43.120 align:middle line:84% Then we turn-- we mentioned that that's not 00:00:43.120 --> 00:00:44.300 align:middle line:90% the only model of savings. 00:00:44.300 --> 00:00:47.100 align:middle line:84% And in fact, there's a lot of evidence for alternative models, 00:00:47.100 --> 00:00:50.080 align:middle line:84% such as behavioral motivations for savings 00:00:50.080 --> 00:00:53.240 align:middle line:84% and precautionary motivations for savings. 00:00:53.240 --> 00:00:56.123 align:middle line:84% We then talked about how inflation affects the tax rate. 00:00:56.123 --> 00:00:58.040 align:middle line:84% And now I want to come to the main application 00:00:58.040 --> 00:01:00.700 align:middle line:84% of this chapter, which is tax incentives for retirement 00:01:00.700 --> 00:01:01.580 align:middle line:90% savings. 00:01:01.580 --> 00:01:05.099 align:middle line:84% There's a general feeling in the US that we don't save enough. 00:01:05.099 --> 00:01:08.380 align:middle line:84% If you go back to your basic macro, your basic macro growth 00:01:08.380 --> 00:01:10.300 align:middle line:84% models, one of the key determinants of growth 00:01:10.300 --> 00:01:11.320 align:middle line:90% is capital. 00:01:11.320 --> 00:01:13.147 align:middle line:84% And what drives capital is savings. 00:01:13.147 --> 00:01:14.980 align:middle line:84% And a general feeling is that we as a nation 00:01:14.980 --> 00:01:17.380 align:middle line:84% are not achieving our potential because our savings 00:01:17.380 --> 00:01:18.680 align:middle line:90% rate is too low. 00:01:18.680 --> 00:01:20.420 align:middle line:84% And one way the government addresses 00:01:20.420 --> 00:01:24.820 align:middle line:84% that is through offering subsidies to saving 00:01:24.820 --> 00:01:27.860 align:middle line:84% for retirement, to making sure that besides Social 00:01:27.860 --> 00:01:29.940 align:middle line:84% Security-- remember Social Security, if anything, 00:01:29.940 --> 00:01:30.920 align:middle line:90% lowers savings. 00:01:30.920 --> 00:01:32.460 align:middle line:90% It crowds out savings. 00:01:32.460 --> 00:01:34.980 align:middle line:84% The idea is, how we get people to save on their own 00:01:34.980 --> 00:01:36.820 align:middle line:90% for their retirement? 00:01:36.820 --> 00:01:42.500 align:middle line:84% And we do so through four different tools, OK? 00:01:42.500 --> 00:01:46.160 align:middle line:90% The first is employer pensions. 00:01:46.160 --> 00:01:48.940 align:middle line:90% 00:01:48.940 --> 00:01:53.140 align:middle line:84% Pensions are plans your employer provides where essentially they 00:01:53.140 --> 00:01:58.200 align:middle line:84% put aside some money, and it becomes-- it's you can then 00:01:58.200 --> 00:01:59.960 align:middle line:90% access that when you retire. 00:01:59.960 --> 00:02:02.420 align:middle line:84% There's two kinds, actually, of pensions. 00:02:02.420 --> 00:02:06.600 align:middle line:84% One kind, the kind is-- the traditional pension is actually 00:02:06.600 --> 00:02:08.600 align:middle line:90% defined benefit pension. 00:02:08.600 --> 00:02:12.920 align:middle line:84% That is a Social Security-- it's an unfunded-- 00:02:12.920 --> 00:02:17.920 align:middle line:84% unfunded Social Security-like system, 00:02:17.920 --> 00:02:21.260 align:middle line:84% where the benefit you get is unrelated to what you put in. 00:02:21.260 --> 00:02:23.600 align:middle line:84% The benefit you get is a function of your earnings, 00:02:23.600 --> 00:02:25.880 align:middle line:84% and how long you've been at the firm, and your age. 00:02:25.880 --> 00:02:28.600 align:middle line:84% But it's not a function of how much you actually put in. 00:02:28.600 --> 00:02:30.420 align:middle line:90% So that's unfunded. 00:02:30.420 --> 00:02:32.320 align:middle line:84% Now, government laws, unlike Social Security, 00:02:32.320 --> 00:02:34.680 align:middle line:84% where it's a true Ponzi scheme, government laws 00:02:34.680 --> 00:02:37.280 align:middle line:84% that dictate firms are supposed to be putting aside money 00:02:37.280 --> 00:02:40.360 align:middle line:84% to pay that when it's due, although some firms don't 00:02:40.360 --> 00:02:41.820 align:middle line:90% sufficiently fund it. 00:02:41.820 --> 00:02:43.860 align:middle line:90% So it's not really unfunded. 00:02:43.860 --> 00:02:46.320 align:middle line:84% But the key thing is it's defined-- it's let's 00:02:46.320 --> 00:02:49.880 align:middle line:90% call it federal quasi-funded. 00:02:49.880 --> 00:02:51.380 align:middle line:84% In theory, it's funded in practice. 00:02:51.380 --> 00:02:52.140 align:middle line:90% Some firms don't do it. 00:02:52.140 --> 00:02:53.515 align:middle line:84% But the main thing is the benefit 00:02:53.515 --> 00:02:55.700 align:middle line:84% is not a function of what you saved. 00:02:55.700 --> 00:02:58.540 align:middle line:84% It's a function of things like what you earned. 00:02:58.540 --> 00:02:59.560 align:middle line:90% Those are going away. 00:02:59.560 --> 00:03:01.282 align:middle line:90% There's not many of those left. 00:03:01.282 --> 00:03:02.740 align:middle line:84% The main way pensions work today is 00:03:02.740 --> 00:03:05.100 align:middle line:84% what's called defined contribution pensions. 00:03:05.100 --> 00:03:06.980 align:middle line:84% That's literally your employer says 00:03:06.980 --> 00:03:10.435 align:middle line:84% there's money being put aside periodically for you 00:03:10.435 --> 00:03:11.560 align:middle line:90% that's going to an account. 00:03:11.560 --> 00:03:15.100 align:middle line:84% You can see the account, and you see how it grows. 00:03:15.100 --> 00:03:17.070 align:middle line:90% OK? 00:03:17.070 --> 00:03:23.000 align:middle line:90% And that's one kind of pension. 00:03:23.000 --> 00:03:25.740 align:middle line:84% And most importantly, the money that your employer 00:03:25.740 --> 00:03:29.140 align:middle line:84% puts in these accounts, in these defined contribution accounts, 00:03:29.140 --> 00:03:30.760 align:middle line:90% is non-taxable income. 00:03:30.760 --> 00:03:34.820 align:middle line:84% So just like when your employer spends on health insurance, 00:03:34.820 --> 00:03:37.280 align:middle line:90% you're not taxed on that income. 00:03:37.280 --> 00:03:39.860 align:middle line:84% When your employer contributes to your DC account, 00:03:39.860 --> 00:03:42.460 align:middle line:90% that is non-taxable income. 00:03:42.460 --> 00:03:46.260 align:middle line:84% Now, when you retire and take the money out of the account, 00:03:46.260 --> 00:03:48.420 align:middle line:90% you are then taxed on it. 00:03:48.420 --> 00:03:51.340 align:middle line:84% So it's not that it avoids taxes. 00:03:51.340 --> 00:03:52.493 align:middle line:90% It delays taxes. 00:03:52.493 --> 00:03:53.660 align:middle line:90% And we'll come back to this. 00:03:53.660 --> 00:03:54.300 align:middle line:90% Very important. 00:03:54.300 --> 00:03:55.100 align:middle line:90% Yeah? 00:03:55.100 --> 00:03:55.640 align:middle line:90% AUDIENCE: Is that the 401k? 00:03:55.640 --> 00:03:56.480 align:middle line:84% PROFESSOR: I'm going to get there. 00:03:56.480 --> 00:03:56.820 align:middle line:90% It's not. 00:03:56.820 --> 00:03:58.778 align:middle line:84% It's different and critical-- critical concept. 00:03:58.778 --> 00:04:00.880 align:middle line:84% I'm going to get there in one second. 00:04:00.880 --> 00:04:03.527 align:middle line:84% So this is-- everyone talks about 401k's. 00:04:03.527 --> 00:04:05.360 align:middle line:84% But in fact, this is still an important part 00:04:05.360 --> 00:04:06.460 align:middle line:90% of the pension landscape. 00:04:06.460 --> 00:04:09.200 align:middle line:84% Some employers, like MIT, I've got a 401k and I've got a DC 00:04:09.200 --> 00:04:10.080 align:middle line:90% plan. 00:04:10.080 --> 00:04:12.760 align:middle line:84% So these are still-- these are important plans. 00:04:12.760 --> 00:04:16.200 align:middle line:84% And they're tax subsidized, not tax avoidant. 00:04:16.200 --> 00:04:18.200 align:middle line:84% They're tax subsidized because you do pay taxes. 00:04:18.200 --> 00:04:20.325 align:middle line:84% But you don't pay until you actually retire and get 00:04:20.325 --> 00:04:21.440 align:middle line:90% the money. 00:04:21.440 --> 00:04:25.280 align:middle line:90% That's as opposed to 401k's. 00:04:25.280 --> 00:04:28.680 align:middle line:84% A 401k is also-- that's the section of the tax code that 00:04:28.680 --> 00:04:29.720 align:middle line:90% authorizes it. 00:04:29.720 --> 00:04:31.940 align:middle line:84% That is also a defined contribution plan. 00:04:31.940 --> 00:04:34.268 align:middle line:84% And the difference is you decide how much to put in 00:04:34.268 --> 00:04:35.560 align:middle line:90% and what's done with the money. 00:04:35.560 --> 00:04:38.800 align:middle line:84% With the DC plan, your employer says, you work at MIT. 00:04:38.800 --> 00:04:41.500 align:middle line:84% We're contributing 3% earnings to this account, 00:04:41.500 --> 00:04:42.880 align:middle line:90% and we're investing it. 00:04:42.880 --> 00:04:45.840 align:middle line:84% With a 401k plan, they say you're now eligible for a 401k 00:04:45.840 --> 00:04:46.560 align:middle line:90% plan. 00:04:46.560 --> 00:04:49.280 align:middle line:84% You can decide how much of your earnings to set aside 00:04:49.280 --> 00:04:51.910 align:middle line:84% and where to invest it in this government-- 00:04:51.910 --> 00:04:54.330 align:middle line:90% in this employer-sponsored tool. 00:04:54.330 --> 00:04:57.290 align:middle line:84% [INAUDIBLE] a traditional defined contribution to 401k is 00:04:57.290 --> 00:05:00.770 align:middle line:84% who makes the decisions and who controls the money. 00:05:00.770 --> 00:05:04.110 align:middle line:84% Now, with a 401k, there's a limit. 00:05:04.110 --> 00:05:10.130 align:middle line:84% You can only contribute up to about $20,000 into a 401k. 00:05:10.130 --> 00:05:13.450 align:middle line:84% And sometimes firms will match those contributions. 00:05:13.450 --> 00:05:15.830 align:middle line:84% Sometimes firms will say for the first several thousand, 00:05:15.830 --> 00:05:17.538 align:middle line:84% for example, for every dollar you put in, 00:05:17.538 --> 00:05:19.290 align:middle line:90% we'll put a dollar in. 00:05:19.290 --> 00:05:22.970 align:middle line:90% But the bottom line is that-- 00:05:22.970 --> 00:05:29.290 align:middle line:84% the bottom line is that it's a defined contribution plan where 00:05:29.290 --> 00:05:30.810 align:middle line:84% you decide how much to contribute 00:05:30.810 --> 00:05:32.590 align:middle line:84% and you decide how it's invested. 00:05:32.590 --> 00:05:35.050 align:middle line:84% And sometimes employers might match it. 00:05:35.050 --> 00:05:37.010 align:middle line:90% OK? 00:05:37.010 --> 00:05:39.410 align:middle line:84% Now, apart from that, there are also 00:05:39.410 --> 00:05:42.030 align:middle line:84% what's called individual retirement accounts. 00:05:42.030 --> 00:05:44.530 align:middle line:84% Not the Irish Republican Army, but the individual retirement 00:05:44.530 --> 00:05:49.170 align:middle line:84% accounts, which are recognizing the fact that the majority 00:05:49.170 --> 00:05:52.970 align:middle line:84% of workers in America do not have a 401k in their job. 00:05:52.970 --> 00:05:53.470 align:middle line:90% OK? 00:05:53.470 --> 00:05:54.612 align:middle line:90% You're all trained. 00:05:54.612 --> 00:05:55.570 align:middle line:90% You all know that term. 00:05:55.570 --> 00:05:57.830 align:middle line:84% I mean, it's amazing how well the-- it's probably 00:05:57.830 --> 00:06:00.910 align:middle line:84% the best known section of the tax code. 00:06:00.910 --> 00:06:05.810 align:middle line:84% But in fact, most jobs don't provide a 401k or a pension. 00:06:05.810 --> 00:06:08.163 align:middle line:84% So as a result, if your job does not offer that, 00:06:08.163 --> 00:06:10.830 align:middle line:84% you can take advantage of what's called an individual retirement 00:06:10.830 --> 00:06:14.530 align:middle line:84% account, which is literally the same thing as a 401k, 00:06:14.530 --> 00:06:17.020 align:middle line:84% but you literally-- it's not your employer doing it. 00:06:17.020 --> 00:06:17.770 align:middle line:90% It's you doing it. 00:06:17.770 --> 00:06:18.570 align:middle line:90% Yeah? 00:06:18.570 --> 00:06:20.710 align:middle line:84% AUDIENCE: For the employers that [INAUDIBLE] 401k, 00:06:20.710 --> 00:06:24.590 align:middle line:84% what incentivizes them to match the-- 00:06:24.590 --> 00:06:26.430 align:middle line:90% PROFESSOR: Oh, great question. 00:06:26.430 --> 00:06:30.130 align:middle line:84% Actually, it's a sub-provision of this section of the tax law, 00:06:30.130 --> 00:06:37.110 align:middle line:84% which states that if your 401k does not sufficiently represent 00:06:37.110 --> 00:06:39.977 align:middle line:84% your whole workforce, you lose the tax benefit. 00:06:39.977 --> 00:06:41.810 align:middle line:84% So basically, the concern is only the rich-- 00:06:41.810 --> 00:06:44.350 align:middle line:84% if only your rich employees take the 401k, 00:06:44.350 --> 00:06:45.850 align:middle line:84% then it doesn't get the tax benefit. 00:06:45.850 --> 00:06:46.950 align:middle line:84% It's got to be that all employees-- 00:06:46.950 --> 00:06:49.750 align:middle line:84% that a broad cross-section of employees take advantage of it. 00:06:49.750 --> 00:06:52.010 align:middle line:84% So the match rate, which employers pitch as them being 00:06:52.010 --> 00:06:54.810 align:middle line:84% nice, is them making sure that low-income people actually take 00:06:54.810 --> 00:06:57.330 align:middle line:84% advantage-- lower-- that it's not just the executives that 00:06:57.330 --> 00:06:59.270 align:middle line:84% take advantage of the 401k, but everyone does. 00:06:59.270 --> 00:07:01.490 align:middle line:84% It's a way of bribing people to get in 00:07:01.490 --> 00:07:04.770 align:middle line:84% so they don't run afoul of the discrimination provision. 00:07:04.770 --> 00:07:06.090 align:middle line:90% Yeah? 00:07:06.090 --> 00:07:09.610 align:middle line:84% AUDIENCE: It sounds like the tax benefits are not noticeably 00:07:09.610 --> 00:07:11.510 align:middle line:84% different between the 401k and the IRA. 00:07:11.510 --> 00:07:13.270 align:middle line:90% PROFESSOR: Well, no. 00:07:13.270 --> 00:07:15.170 align:middle line:90% I haven't gotten IRA yet. 00:07:15.170 --> 00:07:16.750 align:middle line:84% I haven't talked about the IRA yet. 00:07:16.750 --> 00:07:19.145 align:middle line:84% The tax benefits between the 401k and the DC, you mean? 00:07:19.145 --> 00:07:19.770 align:middle line:90% AUDIENCE: Yeah. 00:07:19.770 --> 00:07:20.590 align:middle line:84% PROFESSOR: OK, I haven't talked-- 00:07:20.590 --> 00:07:20.870 align:middle line:90% OK. 00:07:20.870 --> 00:07:22.328 align:middle line:84% I haven't talked about the IRA yet. 00:07:22.328 --> 00:07:22.850 align:middle line:90% Yeah? 00:07:22.850 --> 00:07:24.975 align:middle line:84% AUDIENCE: What incentivizes the companies to manage 00:07:24.975 --> 00:07:26.370 align:middle line:90% your money well in DC? 00:07:26.370 --> 00:07:27.510 align:middle line:90% PROFESSOR: In the DC plan? 00:07:27.510 --> 00:07:31.170 align:middle line:90% Well, I mean basically-- 00:07:31.170 --> 00:07:33.250 align:middle line:84% I mean, nothing except there is they 00:07:33.250 --> 00:07:34.590 align:middle line:90% have fiduciary responsibility. 00:07:34.590 --> 00:07:36.970 align:middle line:84% So legally they can be sued if they don't. 00:07:36.970 --> 00:07:39.970 align:middle line:84% And so I think it's more just kind of that they 00:07:39.970 --> 00:07:41.290 align:middle line:90% have a responsibility to do. 00:07:41.290 --> 00:07:43.533 align:middle line:84% AUDIENCE: So which performs better, 401k-- 00:07:43.533 --> 00:07:44.450 align:middle line:90% like maybe on average? 00:07:44.450 --> 00:07:46.117 align:middle line:84% Like a DC, they would invest [INAUDIBLE] 00:07:46.117 --> 00:07:47.632 align:middle line:90% one smarter or less smart? 00:07:47.632 --> 00:07:49.090 align:middle line:84% PROFESSOR: That's a great question. 00:07:49.090 --> 00:07:52.430 align:middle line:84% And there's huge variation between-- obviously, 00:07:52.430 --> 00:07:55.630 align:middle line:90% 401k's are more risky. 00:07:55.630 --> 00:07:59.510 align:middle line:84% People generally take more risks than firms do. 00:07:59.510 --> 00:08:02.455 align:middle line:84% People are not as necessarily thoughtful about how they invest 00:08:02.455 --> 00:08:04.830 align:middle line:84% their own money as-- we talked about with Social Security 00:08:04.830 --> 00:08:06.650 align:middle line:84% privatization, that people might-- 00:08:06.650 --> 00:08:09.310 align:middle line:84% but I'm not sure what the average rate of return of a DC 00:08:09.310 --> 00:08:10.650 align:middle line:90% for a 401k is. 00:08:10.650 --> 00:08:11.150 align:middle line:90% Enoch? 00:08:11.150 --> 00:08:13.358 align:middle line:84% AUDIENCE: I don't know if someone already asked this. 00:08:13.358 --> 00:08:15.270 align:middle line:84% But what incentivizes employers to match? 00:08:15.270 --> 00:08:16.930 align:middle line:84% PROFESSOR: Oh, that was the question was just asked. 00:08:16.930 --> 00:08:19.750 align:middle line:84% It's basically so that you don't run afoul of nondiscrimination 00:08:19.750 --> 00:08:23.770 align:middle line:84% provisions by bribing your lower income employees to participate. 00:08:23.770 --> 00:08:24.270 align:middle line:90% OK. 00:08:24.270 --> 00:08:28.190 align:middle line:84% So what an IRA is it's an individual account. 00:08:28.190 --> 00:08:30.790 align:middle line:84% First of all, you're only eligible if you're 00:08:30.790 --> 00:08:31.730 align:middle line:90% lower-middle income. 00:08:31.730 --> 00:08:34.270 align:middle line:84% So if your income is below about $100,000, 00:08:34.270 --> 00:08:37.897 align:middle line:84% you can take advantage of the IRA. 00:08:37.897 --> 00:08:39.730 align:middle line:84% Here's the key thing, is IRA-- first of all, 00:08:39.730 --> 00:08:41.950 align:middle line:84% you can contribute up to a certain amount, 00:08:41.950 --> 00:08:44.490 align:middle line:90% currently about $6,000. 00:08:44.490 --> 00:08:47.450 align:middle line:84% So you contribute up to $6,000 every year. 00:08:47.450 --> 00:08:48.630 align:middle line:90% What is an IRA? 00:08:48.630 --> 00:08:52.130 align:middle line:84% It's actually just a label for a savings account. 00:08:52.130 --> 00:08:54.370 align:middle line:84% Anything in the world can be an IRA. 00:08:54.370 --> 00:08:56.230 align:middle line:84% You can have a bank account that's an IRA. 00:08:56.230 --> 00:08:57.750 align:middle line:90% You can have gold that's an IRA. 00:08:57.750 --> 00:08:59.370 align:middle line:90% You can have stocks in an IRA. 00:08:59.370 --> 00:09:02.950 align:middle line:84% It's just a label you put on a particular form of savings. 00:09:02.950 --> 00:09:05.810 align:middle line:84% You say this chunk of money is my IRA. 00:09:05.810 --> 00:09:09.470 align:middle line:84% Once you say that, any money in there is treated like a 401k 00:09:09.470 --> 00:09:11.970 align:middle line:84% in the sense that when you put it in, you can deduct it from 00:09:11.970 --> 00:09:15.050 align:middle line:84% your taxes if your income is below $100,000. 00:09:15.050 --> 00:09:16.950 align:middle line:84% You can deduct it from your taxes. 00:09:16.950 --> 00:09:19.730 align:middle line:84% And then when you take it back out, it's taxed. 00:09:19.730 --> 00:09:22.410 align:middle line:84% So once again, all these things have the feature that they're 00:09:22.410 --> 00:09:24.090 align:middle line:90% not taxed on the way in. 00:09:24.090 --> 00:09:26.250 align:middle line:90% They're taxed on the way out. 00:09:26.250 --> 00:09:27.050 align:middle line:90% OK? 00:09:27.050 --> 00:09:31.770 align:middle line:84% You cannot take money out of your IRA or your 401k until you 00:09:31.770 --> 00:09:32.750 align:middle line:90% reach a certain age. 00:09:32.750 --> 00:09:34.090 align:middle line:90% It's 59 and 1/2. 00:09:34.090 --> 00:09:35.430 align:middle line:90% So these are retirement plans. 00:09:35.430 --> 00:09:37.650 align:middle line:84% You can't access the money till you're 59 and 1/2. 00:09:37.650 --> 00:09:40.550 align:middle line:84% And you have to start taking it out by age 70. 00:09:40.550 --> 00:09:42.550 align:middle line:84% So these are not designed to shield your bequest 00:09:42.550 --> 00:09:43.630 align:middle line:90% to your kids. 00:09:43.630 --> 00:09:48.150 align:middle line:84% So basically, 401k's and IRAs, the idea is basically 00:09:48.150 --> 00:09:52.630 align:middle line:84% we're going to let you defer taxation on these accounts. 00:09:52.630 --> 00:09:55.670 align:middle line:84% But you have to start taking them out. 00:09:55.670 --> 00:09:57.978 align:middle line:84% And we're not letting you get them until 59 and 1/2. 00:09:57.978 --> 00:09:59.770 align:middle line:84% But you have to start taking out at age 70. 00:09:59.770 --> 00:10:01.590 align:middle line:84% There's actually an actuarial schedule 00:10:01.590 --> 00:10:04.790 align:middle line:84% that says-- it has what's called minimum distributions to make 00:10:04.790 --> 00:10:06.630 align:middle line:84% sure that you don't just leave it sitting in there until you 00:10:06.630 --> 00:10:09.338 align:middle line:84% die, to try to make you actually use it while you're still alive. 00:10:09.338 --> 00:10:10.030 align:middle line:90% OK? 00:10:10.030 --> 00:10:11.990 align:middle line:90% So that's how an IRA works now. 00:10:11.990 --> 00:10:16.350 align:middle line:84% In fact, richer people can still use IRAs. 00:10:16.350 --> 00:10:18.208 align:middle line:84% You just don't get the tax deduction. 00:10:18.208 --> 00:10:20.250 align:middle line:84% Now, you might say, well, why the hell would you? 00:10:20.250 --> 00:10:21.250 align:middle line:90% I'll tell you why in a minute. 00:10:21.250 --> 00:10:21.750 align:middle line:90% Yeah? 00:10:21.750 --> 00:10:24.990 align:middle line:90% AUDIENCE: [INAUDIBLE]. 00:10:24.990 --> 00:10:26.830 align:middle line:84% PROFESSOR: I mean, your kids get your IRA. 00:10:26.830 --> 00:10:28.370 align:middle line:90% Your kids get your IRA. 00:10:28.370 --> 00:10:32.590 align:middle line:84% But then-- so we inherit-- my wife inherited her mother's IRA. 00:10:32.590 --> 00:10:35.350 align:middle line:84% And now she has to spend it at the rate at which her mother 00:10:35.350 --> 00:10:36.830 align:middle line:90% would have had to spend it. 00:10:36.830 --> 00:10:40.230 align:middle line:84% So we inherit both her mother's IRA and her mother's schedule, 00:10:40.230 --> 00:10:42.450 align:middle line:90% which it has to be spent. 00:10:42.450 --> 00:10:43.430 align:middle line:90% Yeah? 00:10:43.430 --> 00:10:45.513 align:middle line:84% AUDIENCE: [INAUDIBLE] actually use the money? 00:10:45.513 --> 00:10:46.930 align:middle line:84% I just took it out of the account? 00:10:46.930 --> 00:10:47.770 align:middle line:84% PROFESSOR: Just take it out of the account. 00:10:47.770 --> 00:10:48.090 align:middle line:90% Do whatever. 00:10:48.090 --> 00:10:48.670 align:middle line:90% They don't track. 00:10:48.670 --> 00:10:49.950 align:middle line:84% You could put it into another account. 00:10:49.950 --> 00:10:51.825 align:middle line:84% You just have to take it out of that account. 00:10:51.825 --> 00:10:52.513 align:middle line:90% Good question. 00:10:52.513 --> 00:10:54.930 align:middle line:84% That's a very important question for later in the lecture. 00:10:54.930 --> 00:10:55.730 align:middle line:90% OK? 00:10:55.730 --> 00:10:56.830 align:middle line:90% So that's IRAs work. 00:10:56.830 --> 00:10:58.890 align:middle line:84% Finally, the last thing we have is 00:10:58.890 --> 00:11:05.210 align:middle line:84% what's called a SEP IRA, which is for self-employed people. 00:11:05.210 --> 00:11:07.650 align:middle line:84% If you're self-employed, it's essentially like a 4-- 00:11:07.650 --> 00:11:10.650 align:middle line:84% it's essentially an IRA that you can 00:11:10.650 --> 00:11:12.950 align:middle line:84% pay into out of your self-employment earnings. 00:11:12.950 --> 00:11:15.890 align:middle line:84% The reason it's different is the limit here is $57,000 instead 00:11:15.890 --> 00:11:17.370 align:middle line:90% of $6,000. 00:11:17.370 --> 00:11:20.410 align:middle line:84% So if you're self-employed, you can put up to 25% 00:11:20.410 --> 00:11:23.550 align:middle line:84% of your earnings into essentially a 401-- 00:11:23.550 --> 00:11:26.285 align:middle line:84% it's essentially a 401k, but for a self-employed person. 00:11:26.285 --> 00:11:27.410 align:middle line:90% It's just not quite a four. 00:11:27.410 --> 00:11:28.510 align:middle line:90% It's called the SEP IRA. 00:11:28.510 --> 00:11:30.135 align:middle line:84% It's basically a way to set money aside 00:11:30.135 --> 00:11:33.050 align:middle line:84% if you're self-employed in a tax-preferred manner. 00:11:33.050 --> 00:11:33.650 align:middle line:90% Yeah? 00:11:33.650 --> 00:11:35.850 align:middle line:84% AUDIENCE: Are the numbers of the SEP IRA is such that they are 00:11:35.850 --> 00:11:37.558 align:middle line:84% essentially equivalent to being a 401k? 00:11:37.558 --> 00:11:38.850 align:middle line:90% PROFESSOR: It's basically 401k. 00:11:38.850 --> 00:11:41.110 align:middle line:84% It's basically 401k for self-employed people. 00:11:41.110 --> 00:11:44.080 align:middle line:90% OK, now here's the key point. 00:11:44.080 --> 00:11:45.830 align:middle line:84% With all these things, what I mentioned is 00:11:45.830 --> 00:11:47.830 align:middle line:90% you don't avoid taxation. 00:11:47.830 --> 00:11:49.590 align:middle line:90% You just delay taxation. 00:11:49.590 --> 00:11:50.490 align:middle line:90% So what's the point? 00:11:50.490 --> 00:11:51.430 align:middle line:90% What's the value? 00:11:51.430 --> 00:11:54.310 align:middle line:90% Well, the value comes from-- 00:11:54.310 --> 00:11:58.488 align:middle line:90% the value comes from-- 00:11:58.488 --> 00:11:59.030 align:middle line:90% oh, you guys. 00:11:59.030 --> 00:12:00.870 align:middle line:90% You missed table 22-2. 00:12:00.870 --> 00:12:02.497 align:middle line:90% OK. 00:12:02.497 --> 00:12:03.830 align:middle line:90% Or maybe you put it in the back. 00:12:03.830 --> 00:12:07.790 align:middle line:84% No, 23-1-- no, you just missed it. 00:12:07.790 --> 00:12:10.850 align:middle line:84% OK, I'll write the table on the board. 00:12:10.850 --> 00:12:14.430 align:middle line:90% So the value comes from-- 00:12:14.430 --> 00:12:17.350 align:middle line:84% the tax advantage comes-- the value comes from the fact 00:12:17.350 --> 00:12:21.750 align:middle line:84% that, essentially, the present discounted value of money 00:12:21.750 --> 00:12:25.670 align:middle line:84% means that taxes paid later are more valuable than taxes 00:12:25.670 --> 00:12:28.590 align:middle line:84% paid earlier, or they cost you less than taxes paid earlier. 00:12:28.590 --> 00:12:31.370 align:middle line:84% So the key point is that-- there's an example in the book, 00:12:31.370 --> 00:12:34.290 align:middle line:90% but I'll just go through it. 00:12:34.290 --> 00:12:39.290 align:middle line:84% The point is that if I earn money today, pay taxes on it 00:12:39.290 --> 00:12:42.730 align:middle line:84% and save it, then when I take it back out, 00:12:42.730 --> 00:12:45.130 align:middle line:84% I'm going to have less than if I earn money today, 00:12:45.130 --> 00:12:47.410 align:middle line:84% save it, and then pay taxes on it. 00:12:47.410 --> 00:12:49.250 align:middle line:90% Why is that? 00:12:49.250 --> 00:12:52.208 align:middle line:84% Well, that's because I earn the money on the amount that 00:12:52.208 --> 00:12:53.250 align:middle line:90% would have paid in taxes. 00:12:53.250 --> 00:12:55.833 align:middle line:84% I earn interest the amount that would have been paid in taxes. 00:12:55.833 --> 00:12:59.930 align:middle line:84% So I earn $100 bucks today, keep $50 and save it. 00:12:59.930 --> 00:13:01.930 align:middle line:90% Then I get the interest on $50. 00:13:01.930 --> 00:13:05.050 align:middle line:84% If I keep all $100 and save it, I get the interest all $100. 00:13:05.050 --> 00:13:07.690 align:middle line:84% And then while I pay taxes, I get-- essentially, 00:13:07.690 --> 00:13:09.870 align:middle line:90% it's who gets to hold the money. 00:13:09.870 --> 00:13:12.370 align:middle line:84% If I pay my taxes today, the government gets the money today 00:13:12.370 --> 00:13:14.730 align:middle line:84% and gets to earn all the interest on that money forever. 00:13:14.730 --> 00:13:16.350 align:middle line:84% If I hold the money in my account, 00:13:16.350 --> 00:13:18.290 align:middle line:90% I get to earn the interest. 00:13:18.290 --> 00:13:21.410 align:middle line:84% And then I pay taxes later, which is a better deal 00:13:21.410 --> 00:13:23.610 align:middle line:84% Indeed, the rough facts are if you 00:13:23.610 --> 00:13:25.330 align:middle line:84% have an individual retirement account 00:13:25.330 --> 00:13:30.032 align:middle line:84% and hold for 30 years with a 25% tax rate, 00:13:30.032 --> 00:13:32.490 align:middle line:84% then if you put the money in a regular bank account, an IRA 00:13:32.490 --> 00:13:35.300 align:middle line:84% account, you end up with twice as much in the IRA account-- 00:13:35.300 --> 00:13:36.480 align:middle line:90% twice as much. 00:13:36.480 --> 00:13:36.980 align:middle line:90% Why? 00:13:36.980 --> 00:13:39.600 align:middle line:84% Because you got to earn the interest on the taxes. 00:13:39.600 --> 00:13:41.940 align:middle line:84% The other guy got had to pay the whole time. 00:13:41.940 --> 00:13:44.200 align:middle line:84% So essentially, the intuition is you-- 00:13:44.200 --> 00:13:47.020 align:middle line:84% and that's what's called inside build-up. 00:13:47.020 --> 00:13:50.140 align:middle line:84% And that's why, in fact, people will actually 00:13:50.140 --> 00:13:51.405 align:middle line:90% use nondeductible IRAs. 00:13:51.405 --> 00:13:53.780 align:middle line:84% Like I said, you can have an IRA if you're above $100,000 00:13:53.780 --> 00:13:54.320 align:middle line:90% in income. 00:13:54.320 --> 00:13:56.362 align:middle line:84% You just don't get to deduct the initial payment. 00:13:56.362 --> 00:13:58.343 align:middle line:84% But you still to get all the-- all the tax 00:13:58.343 --> 00:13:59.760 align:middle line:84% you would have paid along the way, 00:13:59.760 --> 00:14:01.500 align:middle line:84% you still get to avoid till the end. 00:14:01.500 --> 00:14:04.340 align:middle line:84% And that ends up being the bigger part of the savings. 00:14:04.340 --> 00:14:06.980 align:middle line:84% So even though you don't get the initial deduction, 00:14:06.980 --> 00:14:08.443 align:middle line:84% every year when you earn interest, 00:14:08.443 --> 00:14:09.860 align:middle line:84% you don't pay tax on it that year. 00:14:09.860 --> 00:14:11.580 align:middle line:90% You pay tax at the end. 00:14:11.580 --> 00:14:13.878 align:middle line:84% So you to get the interest on your taxes 00:14:13.878 --> 00:14:15.420 align:middle line:84% you would have paid on your interest. 00:14:15.420 --> 00:14:18.100 align:middle line:84% So it's a smaller amount, but it's still beneficial. 00:14:18.100 --> 00:14:21.627 align:middle line:84% And so that's why tax subsidies actually 00:14:21.627 --> 00:14:23.960 align:middle line:84% are valuable, even though you're just avoiding taxation. 00:14:23.960 --> 00:14:25.540 align:middle line:84% It's better to avoid taxation because then you 00:14:25.540 --> 00:14:26.940 align:middle line:84% get to earn the interest on the money 00:14:26.940 --> 00:14:28.640 align:middle line:84% rather than the government earning interest on the money. 00:14:28.640 --> 00:14:29.300 align:middle line:90% Yeah? 00:14:29.300 --> 00:14:32.288 align:middle line:84% AUDIENCE: So once you get through-- 00:14:32.288 --> 00:14:34.080 align:middle line:84% as your wealth increases, you can no longer 00:14:34.080 --> 00:14:35.973 align:middle line:84% deduct what you contribute to your IRA. 00:14:35.973 --> 00:14:38.640 align:middle line:84% But you can still contribute to your IRA, is what you're saying? 00:14:38.640 --> 00:14:39.960 align:middle line:90% PROFESSOR: Yes, contribute. 00:14:39.960 --> 00:14:42.557 align:middle line:84% And you get the tax break on the accumulated interest 00:14:42.557 --> 00:14:43.140 align:middle line:90% along the way. 00:14:43.140 --> 00:14:46.118 align:middle line:84% Rather than paying tax every single year, you pay at the end. 00:14:46.118 --> 00:14:48.660 align:middle line:84% So you get to hold the money and earn interest along the way. 00:14:48.660 --> 00:14:50.480 align:middle line:90% Does that make sense to folks? 00:14:50.480 --> 00:14:52.320 align:middle line:84% OK, so that's why this is a tax-- that's 00:14:52.320 --> 00:14:56.053 align:middle line:84% why delaying taxes-- taxes delayed are taxes avoided. 00:14:56.053 --> 00:14:58.720 align:middle line:84% Taxes delayed are taxes avoided because taxes paid in the future 00:14:58.720 --> 00:15:00.380 align:middle line:84% mean that you get to earn the interest along the way, 00:15:00.380 --> 00:15:02.547 align:middle line:84% rather than the government earning it along the way. 00:15:02.547 --> 00:15:08.098 align:middle line:84% OK, so this brings us to one of my-- 00:15:08.098 --> 00:15:08.640 align:middle line:90% I don't know. 00:15:08.640 --> 00:15:10.598 align:middle line:84% It's hard to have a number in this day and age. 00:15:10.598 --> 00:15:12.720 align:middle line:84% One of my least favorite public servants, 00:15:12.720 --> 00:15:14.980 align:middle line:84% the former Senator from Delaware, William Roth. 00:15:14.980 --> 00:15:17.313 align:middle line:84% Now, why is William Roth one of my least favorite public 00:15:17.313 --> 00:15:17.880 align:middle line:90% servants? 00:15:17.880 --> 00:15:21.320 align:middle line:84% Because William Roth introduced what's called the Roth IRA. 00:15:21.320 --> 00:15:22.920 align:middle line:90% Now, what is the Roth IRA? 00:15:22.920 --> 00:15:25.680 align:middle line:84% The Roth IRA is the opposite of IRA. 00:15:25.680 --> 00:15:29.060 align:middle line:84% What it is is you pay taxes now when you put the money away, 00:15:29.060 --> 00:15:31.820 align:middle line:84% but you don't pay taxes when you take it back out. 00:15:31.820 --> 00:15:33.720 align:middle line:84% Now, according to logic I just gave you, 00:15:33.720 --> 00:15:35.400 align:middle line:90% that would be kind of stupid. 00:15:35.400 --> 00:15:35.900 align:middle line:90% Why? 00:15:35.900 --> 00:15:38.380 align:middle line:84% I just said the whole advantage of these things 00:15:38.380 --> 00:15:40.400 align:middle line:84% is paying taxes in the future, not today. 00:15:40.400 --> 00:15:43.540 align:middle line:84% So why would someone find a Roth IRA attractive? 00:15:43.540 --> 00:15:45.410 align:middle line:90% Why would someone do that? 00:15:45.410 --> 00:15:47.160 align:middle line:84% I'm sure you guys have thought about this. 00:15:47.160 --> 00:15:49.340 align:middle line:84% You guys, why would someone do that? 00:15:49.340 --> 00:15:50.225 align:middle line:90% Yeah? 00:15:50.225 --> 00:15:52.100 align:middle line:84% AUDIENCE: If you think tax rates could go up. 00:15:52.100 --> 00:15:54.308 align:middle line:84% PROFESSOR: If you think tax rates are going to go up, 00:15:54.308 --> 00:15:56.160 align:middle line:84% it's a way of betting against tax increase. 00:15:56.160 --> 00:15:58.348 align:middle line:84% Or if you think your tax rate's going to go up. 00:15:58.348 --> 00:15:59.640 align:middle line:90% So you're betting against that. 00:15:59.640 --> 00:16:03.460 align:middle line:84% So it's-- literally does not promote savings at all. 00:16:03.460 --> 00:16:06.360 align:middle line:84% It's just a way to rip off the government. 00:16:06.360 --> 00:16:07.940 align:middle line:84% It's just a way, if you think taxes 00:16:07.940 --> 00:16:10.700 align:middle line:84% are going to go up-- so if you have a regular IRA versus a Roth 00:16:10.700 --> 00:16:12.820 align:middle line:84% IRA, all you're doing is saying, well, I'm 00:16:12.820 --> 00:16:14.900 align:middle line:84% going to let you choose the one that 00:16:14.900 --> 00:16:18.460 align:middle line:84% allows you to bet in which way tax rates are going to go 00:16:18.460 --> 00:16:20.180 align:middle line:90% and lower savings that way. 00:16:20.180 --> 00:16:21.140 align:middle line:90% OK? 00:16:21.140 --> 00:16:23.140 align:middle line:90% Why did we do this? 00:16:23.140 --> 00:16:28.780 align:middle line:84% We did this because of the CBO, who I praise generally. 00:16:28.780 --> 00:16:30.160 align:middle line:90% But here's the problem. 00:16:30.160 --> 00:16:33.880 align:middle line:84% The CBO scores revenues over-- has budget scoring over 00:16:33.880 --> 00:16:34.660 align:middle line:90% a 10-year period. 00:16:34.660 --> 00:16:36.577 align:middle line:84% When Roth was done, it was a five-year period. 00:16:36.577 --> 00:16:37.920 align:middle line:90% Now it's 10 years. 00:16:37.920 --> 00:16:41.480 align:middle line:84% Let's say I wanted to promote savings by introducing an IRA. 00:16:41.480 --> 00:16:43.760 align:middle line:90% How's that going to look? 00:16:43.760 --> 00:16:46.240 align:middle line:84% That's going to look like a big tax loss 00:16:46.240 --> 00:16:49.880 align:middle line:84% now, because I'm giving you a tax break and a tax increase 00:16:49.880 --> 00:16:52.120 align:middle line:90% in 30 years when you retire. 00:16:52.120 --> 00:16:54.320 align:middle line:90% What about a Roth IRA? 00:16:54.320 --> 00:16:57.800 align:middle line:84% That looks like a big tax increase now and a tax loss 00:16:57.800 --> 00:16:58.740 align:middle line:90% 30 years from now. 00:16:58.740 --> 00:17:01.480 align:middle line:84% Well, if I'm balancing a 10-year budget, what do I care about? 00:17:01.480 --> 00:17:03.000 align:middle line:90% I care about now. 00:17:03.000 --> 00:17:04.839 align:middle line:84% So by introducing the Roth IRA, it 00:17:04.839 --> 00:17:07.378 align:middle line:84% was simply a shenanigan to give people 00:17:07.378 --> 00:17:09.920 align:middle line:84% tax breaks without looking like it was costing the government 00:17:09.920 --> 00:17:11.000 align:middle line:90% money. 00:17:11.000 --> 00:17:12.740 align:middle line:84% So what the Roth IRA did, was by saying, 00:17:12.740 --> 00:17:15.115 align:middle line:84% we're still letting people save for retirement by letting 00:17:15.115 --> 00:17:16.462 align:middle line:90% them pay the taxes up front. 00:17:16.462 --> 00:17:18.420 align:middle line:84% We're not actually saving the government money. 00:17:18.420 --> 00:17:19.480 align:middle line:84% We're actually costing the government money, 00:17:19.480 --> 00:17:21.079 align:middle line:90% if tax rates are going to go up. 00:17:21.079 --> 00:17:24.720 align:middle line:84% But it looks like, in the first 10 years, we're making money. 00:17:24.720 --> 00:17:25.359 align:middle line:90% OK? 00:17:25.359 --> 00:17:27.420 align:middle line:90% Indeed, it's worse than that. 00:17:27.420 --> 00:17:27.980 align:middle line:90% OK? 00:17:27.980 --> 00:17:31.460 align:middle line:84% President Bush wanted to cut the tax rate on-- 00:17:31.460 --> 00:17:33.420 align:middle line:84% President Bush II, George W. Bush 00:17:33.420 --> 00:17:36.560 align:middle line:84% wanted to cut tax rates on income-- on capital income. 00:17:36.560 --> 00:17:39.180 align:middle line:84% I'll talk about that later today or next lecture. 00:17:39.180 --> 00:17:40.860 align:middle line:90% But he didn't have the money. 00:17:40.860 --> 00:17:44.637 align:middle line:84% So what he did is he boosted the incentives for Roth IRAs. 00:17:44.637 --> 00:17:46.220 align:middle line:84% When he boosted the incentives, people 00:17:46.220 --> 00:17:48.580 align:middle line:84% started putting more money into them, which meant more 00:17:48.580 --> 00:17:51.080 align:middle line:90% taxes now, less taxes later. 00:17:51.080 --> 00:17:53.460 align:middle line:84% And it looked like he'd created revenue. 00:17:53.460 --> 00:17:56.500 align:middle line:84% So he paid for a tax cut with a tax cut. 00:17:56.500 --> 00:17:59.300 align:middle line:84% He paid for a tax cut today by getting people 00:17:59.300 --> 00:18:00.800 align:middle line:84% to put more money in Roth IRA today. 00:18:00.800 --> 00:18:03.100 align:middle line:84% So the reason I'm very upset about this, you can tell, 00:18:03.100 --> 00:18:05.500 align:middle line:84% is it's not materially adding value to the savings 00:18:05.500 --> 00:18:06.720 align:middle line:90% decision in America. 00:18:06.720 --> 00:18:08.965 align:middle line:84% It's just a shenanigan to leverage people 00:18:08.965 --> 00:18:10.340 align:middle line:84% to bet on which way tax rates are 00:18:10.340 --> 00:18:13.420 align:middle line:84% going to go and avoid the consequences of cutting taxes-- 00:18:13.420 --> 00:18:14.640 align:middle line:90% of these tax subsidies. 00:18:14.640 --> 00:18:16.000 align:middle line:90% So lecture over. 00:18:16.000 --> 00:18:17.717 align:middle line:84% But that's kind of why I'm not a fan of-- 00:18:17.717 --> 00:18:18.800 align:middle line:90% I mean, I have a Roth IRA. 00:18:18.800 --> 00:18:19.300 align:middle line:90% Sure. 00:18:19.300 --> 00:18:20.280 align:middle line:90% I mean, Karl Marx-- 00:18:20.280 --> 00:18:22.655 align:middle line:84% Karl Marx, when asked why he lived in a nice house, said, 00:18:22.655 --> 00:18:25.200 align:middle line:84% "When the proletariat takes over, I'll move." 00:18:25.200 --> 00:18:26.480 align:middle line:90% [LAUGHTER] 00:18:26.480 --> 00:18:29.720 align:middle line:84% But the bottom line is it's really-- 00:18:29.720 --> 00:18:32.320 align:middle line:84% it's not a very good deal for the government. 00:18:32.320 --> 00:18:40.680 align:middle line:84% Now, how do taxes-- how do the subsidized retirement 00:18:40.680 --> 00:18:42.780 align:middle line:84% accounts impact savings decisions? 00:18:42.780 --> 00:18:45.680 align:middle line:84% Well, let's go back to our standard intertemporal choice 00:18:45.680 --> 00:18:46.340 align:middle line:90% model. 00:18:46.340 --> 00:18:48.360 align:middle line:90% And let's go to figure 22-3. 00:18:48.360 --> 00:18:51.320 align:middle line:84% Now, you remember in the original figure 00:18:51.320 --> 00:18:53.580 align:middle line:84% we had a budget constraint without taxes. 00:18:53.580 --> 00:18:55.160 align:middle line:90% And the slope was 1 minus R-- 00:18:55.160 --> 00:18:58.100 align:middle line:84% 1 plus R. Then we [INAUDIBLE] with taxes, 00:18:58.100 --> 00:19:00.680 align:middle line:84% and that's now the red budget-- the lower budget [INAUDIBLE] 00:19:00.680 --> 00:19:04.160 align:middle line:84% in this diagram, 1 plus R times 1 minus tau. 00:19:04.160 --> 00:19:06.020 align:middle line:84% That was the budget constraint with taxes. 00:19:06.020 --> 00:19:09.900 align:middle line:84% So let's say with taxes, you're at point A. OK? 00:19:09.900 --> 00:19:13.000 align:middle line:90% That's your after-tax decision. 00:19:13.000 --> 00:19:15.140 align:middle line:84% Now, what is a retirement account doing? 00:19:15.140 --> 00:19:17.900 align:middle line:84% It is lowering your effective capital tax rate, 00:19:17.900 --> 00:19:19.760 align:middle line:90% but it's not taking it to 0. 00:19:19.760 --> 00:19:21.620 align:middle line:90% Remember, we're delaying taxes. 00:19:21.620 --> 00:19:23.740 align:middle line:90% We're not getting rid of them. 00:19:23.740 --> 00:19:27.100 align:middle line:90% So let's add a term, rho. 00:19:27.100 --> 00:19:28.020 align:middle line:90% What is rho? 00:19:28.020 --> 00:19:29.320 align:middle line:90% Or that's the p. 00:19:29.320 --> 00:19:31.220 align:middle line:90% What is rho? 00:19:31.220 --> 00:19:33.540 align:middle line:84% Rho is basically the percent by which 00:19:33.540 --> 00:19:35.340 align:middle line:84% your tax burden is lowered by delaying 00:19:35.340 --> 00:19:38.020 align:middle line:90% when you have to pay taxes. 00:19:38.020 --> 00:19:43.060 align:middle line:84% So rho is some number greater than 0 and less than 1. 00:19:43.060 --> 00:19:44.140 align:middle line:90% OK? 00:19:44.140 --> 00:19:45.700 align:middle line:90% Or some greater than 0, less-- 00:19:45.700 --> 00:19:47.500 align:middle line:90% greater than 0 and less than 1. 00:19:47.500 --> 00:19:50.820 align:middle line:84% So basically if rho was 1, that would be just 00:19:50.820 --> 00:19:52.780 align:middle line:90% we're not taxing you. 00:19:52.780 --> 00:19:54.398 align:middle line:90% Then it would just cancel out. 00:19:54.398 --> 00:19:55.940 align:middle line:84% Then this new budget constraint would 00:19:55.940 --> 00:19:58.380 align:middle line:84% be the same as the original non-tax budget constraint. 00:19:58.380 --> 00:20:01.380 align:middle line:84% If rho's less than 1, it's raising the return 00:20:01.380 --> 00:20:04.740 align:middle line:84% to savings, but not as much as if we just got rid of taxation. 00:20:04.740 --> 00:20:07.180 align:middle line:90% People understand that? 00:20:07.180 --> 00:20:07.702 align:middle line:90% OK. 00:20:07.702 --> 00:20:09.160 align:middle line:84% What did it do to saving decisions? 00:20:09.160 --> 00:20:10.860 align:middle line:90% Well, once again, we don't know. 00:20:10.860 --> 00:20:14.980 align:middle line:84% It depends on whether income or substitution effects dominate. 00:20:14.980 --> 00:20:16.640 align:middle line:84% If substitution effects dominate, 00:20:16.640 --> 00:20:19.855 align:middle line:84% we are raising the price of first period consumption. 00:20:19.855 --> 00:20:21.480 align:middle line:84% Assumption why are we raising the price 00:20:21.480 --> 00:20:22.880 align:middle line:90% of first period consumption? 00:20:22.880 --> 00:20:25.360 align:middle line:84% Because we're making savings more attractive by tax 00:20:25.360 --> 00:20:27.160 align:middle line:90% preferring it. 00:20:27.160 --> 00:20:28.095 align:middle line:90% We tax first savings. 00:20:28.095 --> 00:20:29.720 align:middle line:84% We raise the price of first consumption 00:20:29.720 --> 00:20:32.120 align:middle line:84% that leads to less first period consumption. 00:20:32.120 --> 00:20:34.160 align:middle line:90% That would be like point B. 00:20:34.160 --> 00:20:37.000 align:middle line:84% On the other hand, we are making you richer 00:20:37.000 --> 00:20:40.080 align:middle line:84% because we are giving you a tax break. 00:20:40.080 --> 00:20:43.320 align:middle line:84% When you're rich, you consume more of everything, including 00:20:43.320 --> 00:20:44.820 align:middle line:90% first period consumption. 00:20:44.820 --> 00:20:46.820 align:middle line:84% So that forces you the other way. 00:20:46.820 --> 00:20:47.346 align:middle line:84% And then we're going to say we're 00:20:47.346 --> 00:20:48.580 align:middle line:84% going to increase first period consumption. 00:20:48.580 --> 00:20:50.997 align:middle line:84% Which one dominates depends on whether substitution income 00:20:50.997 --> 00:20:52.360 align:middle line:90% effects dominate. 00:20:52.360 --> 00:20:53.860 align:middle line:90% OK? 00:20:53.860 --> 00:20:58.120 align:middle line:84% So it is uncertain whether tax subsidy retirement 00:20:58.120 --> 00:21:01.560 align:middle line:84% savings actually increase retirement savings or not. 00:21:01.560 --> 00:21:05.120 align:middle line:84% Now, general economics, we tend to think substitution effects 00:21:05.120 --> 00:21:05.620 align:middle line:90% dominate. 00:21:05.620 --> 00:21:07.327 align:middle line:84% That's kind of our pattern of being. 00:21:07.327 --> 00:21:09.160 align:middle line:84% So generally, the assumption would be, look, 00:21:09.160 --> 00:21:12.140 align:middle line:84% if you tax somebody's retirement savings, you'll get more of it. 00:21:12.140 --> 00:21:13.440 align:middle line:90% That seems kind of-- 00:21:13.440 --> 00:21:15.140 align:middle line:84% that doesn't seem so strange to say, 00:21:15.140 --> 00:21:17.500 align:middle line:84% even though it's theoretically not necessarily correct. 00:21:17.500 --> 00:21:19.900 align:middle line:84% It seems not crazy that you would assume that. 00:21:19.900 --> 00:21:22.080 align:middle line:90% But you can't stop there. 00:21:22.080 --> 00:21:23.620 align:middle line:90% It's more complicated. 00:21:23.620 --> 00:21:27.780 align:middle line:84% Because all of the systems I've mentioned, 401k's, and IRAs, 00:21:27.780 --> 00:21:32.580 align:middle line:84% and SEP IRAs, all have a limit on how much you can put 00:21:32.580 --> 00:21:34.220 align:middle line:90% into your retirement account. 00:21:34.220 --> 00:21:37.300 align:middle line:84% And that makes the analysis one step more complicated. 00:21:37.300 --> 00:21:43.180 align:middle line:84% Let's go to figure 22-4, and let's consider an IRA with 00:21:43.180 --> 00:21:45.900 align:middle line:90% a $6,000 limit. 00:21:45.900 --> 00:21:51.140 align:middle line:84% What that says is someone who currently saves nothing 00:21:51.140 --> 00:21:57.060 align:middle line:84% at point B, they get a higher rate of return to their savings 00:21:57.060 --> 00:21:58.298 align:middle line:90% with an IRA than without. 00:21:58.298 --> 00:22:00.340 align:middle line:84% The red button constraint's above the blue budget 00:22:00.340 --> 00:22:01.740 align:middle line:90% constraint. 00:22:01.740 --> 00:22:07.100 align:middle line:84% But once they've saved $6,000, there is no marginal change. 00:22:07.100 --> 00:22:09.580 align:middle line:90% They're back to 1 minus tau. 00:22:09.580 --> 00:22:11.180 align:middle line:84% So the slope of the budget constraint 00:22:11.180 --> 00:22:15.060 align:middle line:84% returns to the parallel line it was before-- 00:22:15.060 --> 00:22:16.590 align:middle line:84% parallel to the line it was before. 00:22:16.590 --> 00:22:18.007 align:middle line:84% Very important to understand this. 00:22:18.007 --> 00:22:18.870 align:middle line:90% This is tricky. 00:22:18.870 --> 00:22:23.310 align:middle line:84% For the first $6,000 of savings, we've changed the slope. 00:22:23.310 --> 00:22:26.732 align:middle line:84% We've made the rate of return to savings higher. 00:22:26.732 --> 00:22:29.190 align:middle line:84% But once you're past $6,000, we haven't-- the slope returns 00:22:29.190 --> 00:22:31.270 align:middle line:84% to the old slope, but you are richer. 00:22:31.270 --> 00:22:33.010 align:middle line:84% You still have $6,000 more dollars. 00:22:33.010 --> 00:22:35.790 align:middle line:84% So it's just a parallel shift up to the budget constraint. 00:22:35.790 --> 00:22:39.430 align:middle line:84% So up to point C super W2, it's a change 00:22:39.430 --> 00:22:40.910 align:middle line:84% in slope of the budget constraint. 00:22:40.910 --> 00:22:44.390 align:middle line:84% To the left of point CW2, it's just a parallel shift up 00:22:44.390 --> 00:22:46.143 align:middle line:90% by $6,000, just $6,000 richer. 00:22:46.143 --> 00:22:47.810 align:middle line:84% But there's nothing else that's changed. 00:22:47.810 --> 00:22:50.590 align:middle line:84% You just got $6,000 and you're not-- 00:22:50.590 --> 00:22:52.790 align:middle line:84% I'm sorry, you're not $6,000 richer. 00:22:52.790 --> 00:22:56.630 align:middle line:84% You're $6,000 times the slope of the budget constraint richer 00:22:56.630 --> 00:22:58.150 align:middle line:90% it's just shifted it up. 00:22:58.150 --> 00:23:01.110 align:middle line:90% OK, questions about that? 00:23:01.110 --> 00:23:02.930 align:middle line:84% Well, let's think about what this does. 00:23:02.930 --> 00:23:05.013 align:middle line:84% And let's go to one of the more complicated graphs 00:23:05.013 --> 00:23:07.630 align:middle line:90% in the book, figure-- 00:23:07.630 --> 00:23:10.050 align:middle line:90% the next figure, figure 22-5. 00:23:10.050 --> 00:23:11.822 align:middle line:90% And we have two people here. 00:23:11.822 --> 00:23:13.530 align:middle line:84% We have the low saver and the high saver. 00:23:13.530 --> 00:23:16.712 align:middle line:84% We have the grasshopper and the ant. 00:23:16.712 --> 00:23:19.170 align:middle line:84% You guys know the old story of the grasshopper and the ant? 00:23:19.170 --> 00:23:20.730 align:middle line:84% The grasshopper is the low saver. 00:23:20.730 --> 00:23:22.530 align:middle line:90% The ant's the high savor. 00:23:22.530 --> 00:23:24.730 align:middle line:84% The grasshopper is someone who wasn't 00:23:24.730 --> 00:23:28.850 align:middle line:84% saving much before this system got introduced. 00:23:28.850 --> 00:23:34.250 align:middle line:84% So let's say they were at point A. They were saving $1,000. 00:23:34.250 --> 00:23:39.290 align:middle line:90% They were saving $1,000. 00:23:39.290 --> 00:23:40.365 align:middle line:90% What happens to them? 00:23:40.365 --> 00:23:41.990 align:middle line:84% Well, they are like the previous graph. 00:23:41.990 --> 00:23:45.948 align:middle line:84% They're like the previous case of figure 22-3. 00:23:45.948 --> 00:23:47.990 align:middle line:84% There's an income effect and substitution effect. 00:23:47.990 --> 00:23:50.050 align:middle line:84% It's not clear which way it goes. 00:23:50.050 --> 00:23:52.430 align:middle line:90% They are the standard case. 00:23:52.430 --> 00:23:55.330 align:middle line:84% We've just changed the marginal rate of return to savings. 00:23:55.330 --> 00:23:59.250 align:middle line:84% That is, the income effect and substitution effect is unclear. 00:23:59.250 --> 00:24:01.930 align:middle line:90% But what about the ant? 00:24:01.930 --> 00:24:07.530 align:middle line:84% The ant was already saving $7,000. 00:24:07.530 --> 00:24:09.590 align:middle line:84% What happens to their savings and why? 00:24:09.590 --> 00:24:12.630 align:middle line:90% 00:24:12.630 --> 00:24:15.130 align:middle line:84% Well, think about it in terms of working period consumption. 00:24:15.130 --> 00:24:17.550 align:middle line:84% What happens to their working period consumption and why? 00:24:17.550 --> 00:24:19.050 align:middle line:84% I mean, you see in the graph, what the answer is. 00:24:19.050 --> 00:24:20.092 align:middle line:90% But what's the intuition? 00:24:20.092 --> 00:24:23.870 align:middle line:90% 00:24:23.870 --> 00:24:27.110 align:middle line:84% By the way, the fact that the new intercept-- yeah, 00:24:27.110 --> 00:24:29.055 align:middle line:90% is that the kink is irrelevant. 00:24:29.055 --> 00:24:30.430 align:middle line:84% The point is that the new inter-- 00:24:30.430 --> 00:24:32.750 align:middle line:84% B is to the right of and A, and unambiguously 00:24:32.750 --> 00:24:34.470 align:middle line:90% to the right of A. And why? 00:24:34.470 --> 00:24:39.340 align:middle line:84% Why is B unambiguously to the right of A in the bottom figure? 00:24:39.340 --> 00:24:41.590 align:middle line:84% Well, it's just basic substitution and income effects, 00:24:41.590 --> 00:24:42.090 align:middle line:90% guys. 00:24:42.090 --> 00:24:42.810 align:middle line:90% What's going on? 00:24:42.810 --> 00:24:45.950 align:middle line:90% 00:24:45.950 --> 00:24:49.210 align:middle line:84% For a person like the person in panel B, what's going on? 00:24:49.210 --> 00:24:51.830 align:middle line:90% 00:24:51.830 --> 00:24:56.910 align:middle line:84% AUDIENCE: Well, I guess for the $6,000 that they're saving, 00:24:56.910 --> 00:24:58.590 align:middle line:90% they have lower consumption. 00:24:58.590 --> 00:25:00.382 align:middle line:84% PROFESSOR: Well, for $6,000 they're saving, 00:25:00.382 --> 00:25:03.470 align:middle line:84% they got a tax break, which makes them richer, 00:25:03.470 --> 00:25:06.350 align:middle line:90% which has an income effect. 00:25:06.350 --> 00:25:08.550 align:middle line:84% Income effect, [? substitute ?] income effect. 00:25:08.550 --> 00:25:09.170 align:middle line:90% OK? 00:25:09.170 --> 00:25:10.530 align:middle line:90% An income effect. 00:25:10.530 --> 00:25:12.290 align:middle line:84% Income effect makes them richer, which 00:25:12.290 --> 00:25:15.170 align:middle line:84% makes them want more first period consumption. 00:25:15.170 --> 00:25:16.830 align:middle line:90% There's no substitution effect. 00:25:16.830 --> 00:25:18.500 align:middle line:84% The slope hasn't changed for them. 00:25:18.500 --> 00:25:20.750 align:middle line:84% They're on the parallel part of the budget constraint. 00:25:20.750 --> 00:25:23.450 align:middle line:84% So it's unambiguous for the person 00:25:23.450 --> 00:25:25.650 align:middle line:84% who is already saving more than the kink 00:25:25.650 --> 00:25:27.810 align:middle line:90% that it lowers their savings. 00:25:27.810 --> 00:25:29.230 align:middle line:84% So think about this for a second. 00:25:29.230 --> 00:25:32.370 align:middle line:84% We've just put in this big tax break that 00:25:32.370 --> 00:25:34.332 align:middle line:84% has an ambiguous effect on some people, 00:25:34.332 --> 00:25:36.290 align:middle line:84% and an unambiguously negative effect on savings 00:25:36.290 --> 00:25:37.555 align:middle line:90% for another people. 00:25:37.555 --> 00:25:38.930 align:middle line:84% So it's actually pretty ambiguous 00:25:38.930 --> 00:25:42.250 align:middle line:84% that it's going to increase US savings, right? 00:25:42.250 --> 00:25:44.850 align:middle line:84% So think about it in terms of the marginal, inframarginal. 00:25:44.850 --> 00:25:50.090 align:middle line:84% The inframarginal is we have taken this person. 00:25:50.090 --> 00:25:53.378 align:middle line:84% We've taken the ant and given them a bunch of money. 00:25:53.378 --> 00:25:55.670 align:middle line:84% The question is, are we getting more savings out of it? 00:25:55.670 --> 00:25:57.950 align:middle line:84% Well, from ant, we're certainly getting less. 00:25:57.950 --> 00:26:00.690 align:middle line:84% And the grasshopper is not clear. 00:26:00.690 --> 00:26:04.030 align:middle line:84% So the marginal effect could be zero or even negative. 00:26:04.030 --> 00:26:07.790 align:middle line:84% We might be spending a bunch of money and getting less savings. 00:26:07.790 --> 00:26:08.290 align:middle line:90% OK? 00:26:08.290 --> 00:26:10.270 align:middle line:90% Do people understand that? 00:26:10.270 --> 00:26:12.670 align:middle line:84% That is not at all obvious that putting in a tax 00:26:12.670 --> 00:26:14.128 align:middle line:84% break-- first of all, the tax break 00:26:14.128 --> 00:26:15.503 align:middle line:84% itself is not obvious [INAUDIBLE] 00:26:15.503 --> 00:26:16.770 align:middle line:90% substitution income effects. 00:26:16.770 --> 00:26:20.430 align:middle line:84% Then you had the cap, and that makes it even less obvious. 00:26:20.430 --> 00:26:22.310 align:middle line:90% What's going on with the ant? 00:26:22.310 --> 00:26:23.790 align:middle line:90% What's actually happening here? 00:26:23.790 --> 00:26:26.190 align:middle line:84% What's happening here is since they were-- remember, 00:26:26.190 --> 00:26:27.170 align:middle line:90% what is an IRA? 00:26:27.170 --> 00:26:29.430 align:middle line:90% It's just a label on an account. 00:26:29.430 --> 00:26:32.650 align:middle line:84% So what Mr. Ant in the second graph is doing is saying, 00:26:32.650 --> 00:26:35.450 align:middle line:84% I already got $7,000 in my tax savings account. 00:26:35.450 --> 00:26:38.030 align:middle line:84% I'm just going to slap the label IRA on that. 00:26:38.030 --> 00:26:41.430 align:middle line:84% Simply slapping the label, I've made money. 00:26:41.430 --> 00:26:44.150 align:middle line:84% I was going to save it anyway, so I've made money 00:26:44.150 --> 00:26:45.270 align:middle line:90% by slapping label IRA. 00:26:45.270 --> 00:26:48.070 align:middle line:84% Because now I save it at a lower tax rate-- effectively lower tax 00:26:48.070 --> 00:26:48.690 align:middle line:90% rate. 00:26:48.690 --> 00:26:52.430 align:middle line:84% He's just reshuffled the money from non-IRA savings 00:26:52.430 --> 00:26:54.710 align:middle line:90% to IRA savings. 00:26:54.710 --> 00:26:58.030 align:middle line:84% So the problem with capped savings 00:26:58.030 --> 00:27:01.030 align:middle line:84% incentives plans is for those above the cap, all they do 00:27:01.030 --> 00:27:03.470 align:middle line:84% is promote reshuffling of savings 00:27:03.470 --> 00:27:08.570 align:middle line:84% that we're going to do anyway into these new accounts. 00:27:08.570 --> 00:27:10.850 align:middle line:84% So in this standard intertemporal substitution 00:27:10.850 --> 00:27:14.410 align:middle line:84% model, it's highly ambiguous whether a capped retirement 00:27:14.410 --> 00:27:16.690 align:middle line:84% subsidy would actually increase savings or lower it. 00:27:16.690 --> 00:27:17.950 align:middle line:90% Questions about that? 00:27:17.950 --> 00:27:19.290 align:middle line:90% Yeah? 00:27:19.290 --> 00:27:21.930 align:middle line:84% AUDIENCE: If he shuffles into IRA, but IRA returns more, 00:27:21.930 --> 00:27:25.650 align:middle line:84% wouldn't he have the same amount when he retires? 00:27:25.650 --> 00:27:28.610 align:middle line:84% PROFESSOR: He'll have hell of more when he retires. 00:27:28.610 --> 00:27:29.390 align:middle line:90% He's richer. 00:27:29.390 --> 00:27:31.282 align:middle line:84% That's what caused the income effect. 00:27:31.282 --> 00:27:33.490 align:middle line:84% He's taking money out of an account that was earning, 00:27:33.490 --> 00:27:35.690 align:middle line:90% what, R times 1 minus tau. 00:27:35.690 --> 00:27:38.410 align:middle line:84% And he's moved to an account that's earning R times 1 minus 00:27:38.410 --> 00:27:40.890 align:middle line:84% tau minus P for the first $6,000. 00:27:40.890 --> 00:27:45.010 align:middle line:84% So his first $6,000 of savings is now taxed less. 00:27:45.010 --> 00:27:45.910 align:middle line:90% So he's richer. 00:27:45.910 --> 00:27:47.250 align:middle line:90% It's a good thing to do for him. 00:27:47.250 --> 00:27:49.170 align:middle line:84% AUDIENCE: [INAUDIBLE] Richer, now, or he's 00:27:49.170 --> 00:27:50.120 align:middle line:90% richer in the future? 00:27:50.120 --> 00:27:51.870 align:middle line:84% PROFESSOR: Well, no, he's lifetime richer. 00:27:51.870 --> 00:27:52.703 align:middle line:90% He's not richer now. 00:27:52.703 --> 00:27:53.590 align:middle line:90% He's lifetime richer. 00:27:53.590 --> 00:27:54.270 align:middle line:90% Lifetime richer. 00:27:54.270 --> 00:27:55.110 align:middle line:90% Yeah? 00:27:55.110 --> 00:27:59.650 align:middle line:84% AUDIENCE: Look, I'm just a little confused. 00:27:59.650 --> 00:28:04.805 align:middle line:84% The income effect pushes one towards present consumption? 00:28:04.805 --> 00:28:05.430 align:middle line:90% PROFESSOR: Yes. 00:28:05.430 --> 00:28:06.250 align:middle line:90% AUDIENCE: Why is that? 00:28:06.250 --> 00:28:06.890 align:middle line:90% PROFESSOR: Why is that? 00:28:06.890 --> 00:28:07.530 align:middle line:90% Because you're richer. 00:28:07.530 --> 00:28:08.970 align:middle line:84% When you're richer, you want more of everything. 00:28:08.970 --> 00:28:10.550 align:middle line:90% AUDIENCE: But wouldn't you-- 00:28:10.550 --> 00:28:12.310 align:middle line:90% doesn't that also mean-- 00:28:12.310 --> 00:28:13.950 align:middle line:84% future consumption is also good when 00:28:13.950 --> 00:28:16.470 align:middle line:84% you want to consume more future [INAUDIBLE]? 00:28:16.470 --> 00:28:17.390 align:middle line:90% PROFESSOR: Well, sure. 00:28:17.390 --> 00:28:18.650 align:middle line:90% You want more of both. 00:28:18.650 --> 00:28:22.032 align:middle line:84% But the point is that the way you can get-- remember-- 00:28:22.032 --> 00:28:24.490 align:middle line:84% just remember, if you go back one of the other graphs here, 00:28:24.490 --> 00:28:27.568 align:middle line:84% remember when we tax capital, that lowered-- regardless 00:28:27.568 --> 00:28:29.610 align:middle line:84% of what you did to your first period consumption, 00:28:29.610 --> 00:28:31.170 align:middle line:84% it lowered second period consumption. 00:28:31.170 --> 00:28:32.590 align:middle line:84% Likewise, when we subsidize capital, 00:28:32.590 --> 00:28:34.870 align:middle line:84% it raises secondary consumption, even if first period consumption 00:28:34.870 --> 00:28:35.530 align:middle line:90% rises. 00:28:35.530 --> 00:28:38.630 align:middle line:84% You don't rise it so much that it falls in the second period. 00:28:38.630 --> 00:28:41.935 align:middle line:84% But the point is, I have now made you richer. 00:28:41.935 --> 00:28:43.810 align:middle line:84% You want more consumption in the first period 00:28:43.810 --> 00:28:44.770 align:middle line:90% and the second period. 00:28:44.770 --> 00:28:46.687 align:middle line:84% But remember, the only variable you care about 00:28:46.687 --> 00:28:47.750 align:middle line:90% is the first period. 00:28:47.750 --> 00:28:48.930 align:middle line:90% The second period drops out. 00:28:48.930 --> 00:28:49.770 align:middle line:90% And here's why. 00:28:49.770 --> 00:28:52.067 align:middle line:84% Because once you decide in the first period, 00:28:52.067 --> 00:28:54.150 align:middle line:84% that's going to feed through to the second period. 00:28:54.150 --> 00:28:56.670 align:middle line:84% And when you basically say, I'm rich, [INAUDIBLE] first period 00:28:56.670 --> 00:28:57.910 align:middle line:84% consumption, you're not going to take so much 00:28:57.910 --> 00:29:00.110 align:middle line:84% more you make yourself poorer in the second period. 00:29:00.110 --> 00:29:02.390 align:middle line:84% You say, I've got money to split. 00:29:02.390 --> 00:29:04.790 align:middle line:84% So [INAUDIBLE] them spend that money by saving less, 00:29:04.790 --> 00:29:06.970 align:middle line:84% not saving so much less that by consumption actually 00:29:06.970 --> 00:29:08.095 align:middle line:90% falls in the second period. 00:29:08.095 --> 00:29:09.473 align:middle line:90% But I can have it both ways. 00:29:09.473 --> 00:29:10.890 align:middle line:84% I consume more in the first period 00:29:10.890 --> 00:29:12.307 align:middle line:84% and have more in the second period 00:29:12.307 --> 00:29:15.690 align:middle line:90% because I'm getting a benefit. 00:29:15.690 --> 00:29:17.290 align:middle line:84% Because essentially, the government 00:29:17.290 --> 00:29:18.990 align:middle line:84% is handing-- this guy at the bottom, 00:29:18.990 --> 00:29:22.590 align:middle line:84% the government is handing him a check for a few thousand 00:29:22.590 --> 00:29:23.990 align:middle line:90% dollars. 00:29:23.990 --> 00:29:24.490 align:middle line:90% OK? 00:29:24.490 --> 00:29:26.782 align:middle line:84% What he's going to say is I'm going to take that check, 00:29:26.782 --> 00:29:28.587 align:middle line:90% spend $1,500 now, $1,500 later. 00:29:28.587 --> 00:29:30.170 align:middle line:84% His first period consumption's gone up 00:29:30.170 --> 00:29:32.087 align:middle line:84% and his second period consumption has gone up, 00:29:32.087 --> 00:29:34.850 align:middle line:90% but he's saving less. 00:29:34.850 --> 00:29:37.010 align:middle line:84% AUDIENCE: Is there-- that leaves open 00:29:37.010 --> 00:29:42.143 align:middle line:84% the possibility of saving zero more though, right? 00:29:42.143 --> 00:29:42.810 align:middle line:90% PROFESSOR: Yeah. 00:29:42.810 --> 00:29:44.850 align:middle line:84% Yeah, he could-- he's going to save-- 00:29:44.850 --> 00:29:46.910 align:middle line:84% this person's going to unambiguously save less. 00:29:46.910 --> 00:29:49.290 align:middle line:84% It could be-- the income effect could be zero. 00:29:49.290 --> 00:29:50.770 align:middle line:90% He could have no effect. 00:29:50.770 --> 00:29:54.570 align:middle line:84% But the bottom line is the way he raises, unless he doesn't 00:29:54.570 --> 00:29:56.410 align:middle line:84% care about first period consumption, 00:29:56.410 --> 00:29:58.890 align:middle line:84% he's going to consume more in the first period. 00:29:58.890 --> 00:30:00.270 align:middle line:90% So let's put it this way. 00:30:00.270 --> 00:30:03.790 align:middle line:84% The government has just handed me a check for $3,000. 00:30:03.790 --> 00:30:04.750 align:middle line:90% AUDIENCE: [INAUDIBLE]. 00:30:04.750 --> 00:30:07.310 align:middle line:90% PROFESSOR: So let me finish. 00:30:07.310 --> 00:30:09.950 align:middle line:90% I was saving $7,000 already. 00:30:09.950 --> 00:30:12.750 align:middle line:84% The government just handed me a check for $3,000. 00:30:12.750 --> 00:30:14.618 align:middle line:84% Unless I don't care at all about today, 00:30:14.618 --> 00:30:16.910 align:middle line:84% I'm not just putting that away and have it be $10,000-- 00:30:16.910 --> 00:30:19.612 align:middle line:84% and have $3,000 more in the future and no more today. 00:30:19.612 --> 00:30:20.570 align:middle line:90% Say, great, I'm richer. 00:30:20.570 --> 00:30:22.237 align:middle line:84% I'll spend some today and some tomorrow. 00:30:22.237 --> 00:30:24.660 align:middle line:84% So by spending more today, my savings falls from $7,000 00:30:24.660 --> 00:30:25.770 align:middle line:90% to $6,000. 00:30:25.770 --> 00:30:28.550 align:middle line:84% But I've got $3,000, so I'm still better off in both 00:30:28.550 --> 00:30:30.008 align:middle line:90% periods. 00:30:30.008 --> 00:30:30.550 align:middle line:90% AUDIENCE: OK. 00:30:30.550 --> 00:30:31.495 align:middle line:90% PROFESSOR: Yeah? 00:30:31.495 --> 00:30:33.870 align:middle line:84% AUDIENCE: If your consumption is higher the first period, 00:30:33.870 --> 00:30:36.270 align:middle line:84% why do we care about having lower savings? 00:30:36.270 --> 00:30:37.530 align:middle line:84% PROFESSOR: Well, why do we about lower savings? 00:30:37.530 --> 00:30:39.470 align:middle line:84% Because ultimately, what was the whole motivation? 00:30:39.470 --> 00:30:41.178 align:middle line:84% Was that we care about the capital stock. 00:30:41.178 --> 00:30:42.210 align:middle line:90% We talked last time. 00:30:42.210 --> 00:30:44.270 align:middle line:84% We care about the level of savings in the US. 00:30:44.270 --> 00:30:46.270 align:middle line:84% Why do we have this subsidy in the first place 00:30:46.270 --> 00:30:47.500 align:middle line:90% just to raise consumption? 00:30:47.500 --> 00:30:49.250 align:middle line:84% Why are we giving a tax break three times? 00:30:49.250 --> 00:30:51.390 align:middle line:84% Why don't we just give people checks? 00:30:51.390 --> 00:30:54.990 align:middle line:84% And we have a tax subsidy for retirement savings. 00:30:54.990 --> 00:30:57.590 align:middle line:84% That's the whole idea is we're trying to promote savings here. 00:30:57.590 --> 00:30:58.110 align:middle line:90% Why are we doing it? 00:30:58.110 --> 00:31:00.735 align:middle line:84% If we're not promoting savings, why the hell are we doing this? 00:31:00.735 --> 00:31:03.318 align:middle line:84% We're spending a ton of money on this to give the guys checks. 00:31:03.318 --> 00:31:04.818 align:middle line:84% Think about it, once again, in terms 00:31:04.818 --> 00:31:07.040 align:middle line:84% of the inframarginal, marginal effect of a tax break. 00:31:07.040 --> 00:31:08.680 align:middle line:84% I'm giving away government tax revenues 00:31:08.680 --> 00:31:10.280 align:middle line:90% by giving you this tax break. 00:31:10.280 --> 00:31:13.440 align:middle line:84% If I'm not promoting savings, why the hell am I doing that? 00:31:13.440 --> 00:31:14.220 align:middle line:90% I got to ask. 00:31:14.220 --> 00:31:15.200 align:middle line:84% I mean, maybe I'm doing it because I 00:31:15.200 --> 00:31:16.980 align:middle line:84% like this way of giving people money. 00:31:16.980 --> 00:31:17.840 align:middle line:84% But you at least ought to evaluate 00:31:17.840 --> 00:31:20.173 align:middle line:84% these other things I could do with the government money. 00:31:20.173 --> 00:31:21.825 align:middle line:90% Does that make sense? 00:31:21.825 --> 00:31:22.700 align:middle line:90% It's a good question. 00:31:22.700 --> 00:31:23.460 align:middle line:90% Keep asking questions. 00:31:23.460 --> 00:31:24.320 align:middle line:90% It's really hard. 00:31:24.320 --> 00:31:25.580 align:middle line:90% So if it's not clear. 00:31:25.580 --> 00:31:26.120 align:middle line:90% Keep asking. 00:31:26.120 --> 00:31:26.680 align:middle line:90% Yeah? 00:31:26.680 --> 00:31:28.400 align:middle line:84% AUDIENCE: For the high-favor person, 00:31:28.400 --> 00:31:29.520 align:middle line:84% you're paying them for doing something 00:31:29.520 --> 00:31:30.580 align:middle line:90% that they are already doing? 00:31:30.580 --> 00:31:31.205 align:middle line:90% PROFESSOR: Yes. 00:31:31.205 --> 00:31:32.940 align:middle line:90% That's the inframarginal effect. 00:31:32.940 --> 00:31:33.960 align:middle line:84% AUDIENCE: And then they're richer off? 00:31:33.960 --> 00:31:34.820 align:middle line:84% PROFESSOR: Then they're richer off. 00:31:34.820 --> 00:31:37.153 align:middle line:84% And because you're doing that, they're then saving less. 00:31:37.153 --> 00:31:38.640 align:middle line:90% So it's like a double whammy. 00:31:38.640 --> 00:31:41.000 align:middle line:84% You're paying them for something they're already doing. 00:31:41.000 --> 00:31:42.720 align:middle line:84% So it's cost your government revenue. 00:31:42.720 --> 00:31:44.460 align:middle line:84% And imagine-- think of it this way. 00:31:44.460 --> 00:31:47.240 align:middle line:84% Imagine everyone was like the second graph. 00:31:47.240 --> 00:31:49.800 align:middle line:84% Imagine we said, we're going to give a tax break, but only 00:31:49.800 --> 00:31:51.020 align:middle line:90% on the first $100. 00:31:51.020 --> 00:31:52.880 align:middle line:84% And everybody saved more than $100. 00:31:52.880 --> 00:31:55.360 align:middle line:90% Not true, but imagine they did. 00:31:55.360 --> 00:31:59.660 align:middle line:84% Then we'd literally be saying we are giving a tax break 00:31:59.660 --> 00:32:02.500 align:middle line:90% to lower savings in America. 00:32:02.500 --> 00:32:05.660 align:middle line:84% So we would have a inframarginal effect, which 00:32:05.660 --> 00:32:08.860 align:middle line:84% is all the money we would have collected on the first $100, 00:32:08.860 --> 00:32:10.760 align:middle line:84% and a negative marginal effect, and a margin. 00:32:10.760 --> 00:32:13.160 align:middle line:84% So it literally would be a self-defeating tax break. 00:32:13.160 --> 00:32:17.740 align:middle line:84% We'd be paying money to accomplish less than nothing. 00:32:17.740 --> 00:32:19.340 align:middle line:90% Does that make sense? 00:32:19.340 --> 00:32:20.020 align:middle line:90% All right. 00:32:20.020 --> 00:32:24.780 align:middle line:84% Now, now it gets more complicated. 00:32:24.780 --> 00:32:27.480 align:middle line:84% It gets more complicated because, I mentioned last time, 00:32:27.480 --> 00:32:30.540 align:middle line:84% this is not the only model of savings. 00:32:30.540 --> 00:32:34.180 align:middle line:84% Imagine a world where savings is done partly for this reason, 00:32:34.180 --> 00:32:36.600 align:middle line:84% but partly for precautionary reasons. 00:32:36.600 --> 00:32:38.100 align:middle line:84% Partly because you want to make sure 00:32:38.100 --> 00:32:40.820 align:middle line:84% you have money to save if your car breaks down 00:32:40.820 --> 00:32:41.960 align:middle line:90% or if you get sick. 00:32:41.960 --> 00:32:44.740 align:middle line:90% 00:32:44.740 --> 00:32:46.380 align:middle line:90% I would argue-- 00:32:46.380 --> 00:32:50.380 align:middle line:84% I will argue that that actually causes 00:32:50.380 --> 00:32:53.380 align:middle line:90% IRAs to increase savings more. 00:32:53.380 --> 00:32:54.960 align:middle line:84% That offsets the negative effects 00:32:54.960 --> 00:32:56.085 align:middle line:90% we were just worried about. 00:32:56.085 --> 00:32:57.320 align:middle line:90% And why? 00:32:57.320 --> 00:32:58.960 align:middle line:84% If part of the reason people save 00:32:58.960 --> 00:33:01.560 align:middle line:84% is they have money for their car breaking down, 00:33:01.560 --> 00:33:04.500 align:middle line:84% why does that reduce the reshuffling I just talked about? 00:33:04.500 --> 00:33:08.000 align:middle line:90% 00:33:08.000 --> 00:33:08.800 align:middle line:90% Why does-- yeah? 00:33:08.800 --> 00:33:11.458 align:middle line:84% AUDIENCE: Because of the [INAUDIBLE] retirement account, 00:33:11.458 --> 00:33:12.500 align:middle line:90% you can't take out money. 00:33:12.500 --> 00:33:13.292 align:middle line:90% PROFESSOR: Exactly. 00:33:13.292 --> 00:33:15.437 align:middle line:84% Reshuffling means that you're indifferent. 00:33:15.437 --> 00:33:18.020 align:middle line:84% But if you have precautionary savings, you're not indifferent. 00:33:18.020 --> 00:33:20.640 align:middle line:84% Remember, my guy said he took his $7,000 account and slapped 00:33:20.640 --> 00:33:21.820 align:middle line:90% an IRA label on it? 00:33:21.820 --> 00:33:23.380 align:middle line:90% Well, that is not costless. 00:33:23.380 --> 00:33:27.360 align:middle line:84% When he does that, he can't take the money out until he's 59.5. 00:33:27.360 --> 00:33:28.920 align:middle line:84% So that's not a costless activity. 00:33:28.920 --> 00:33:30.880 align:middle line:84% In this simple model, it is a costless activity 00:33:30.880 --> 00:33:32.620 align:middle line:84% because people only save for retirement. 00:33:32.620 --> 00:33:35.680 align:middle line:84% But the model where savings are for other reasons, 00:33:35.680 --> 00:33:39.200 align:middle line:84% then they may not want to simply reshuffle their money. 00:33:39.200 --> 00:33:42.520 align:middle line:84% And that is the reason why a raise might increase-- so that's 00:33:42.520 --> 00:33:44.940 align:middle line:84% the reason why the second panel might not be true, 00:33:44.940 --> 00:33:46.820 align:middle line:84% why they might not reshuffle all their money, 00:33:46.820 --> 00:33:48.280 align:middle line:90% they might only reshuffle some. 00:33:48.280 --> 00:33:50.720 align:middle line:90% So it could increase savings. 00:33:50.720 --> 00:33:51.360 align:middle line:90% Yeah? 00:33:51.360 --> 00:33:54.460 align:middle line:84% AUDIENCE: Are there any exceptions to [? 59? ?] 00:33:54.460 --> 00:33:55.180 align:middle line:90% PROFESSOR: Yeah. 00:33:55.180 --> 00:33:56.540 align:middle line:90% For IRA, there's not. 00:33:56.540 --> 00:33:58.293 align:middle line:84% For 401k, you can borrow against it. 00:33:58.293 --> 00:34:00.460 align:middle line:84% You can actually-- but it's at a high interest rate. 00:34:00.460 --> 00:34:02.340 align:middle line:84% Actually, and for both of them, you can take it out early. 00:34:02.340 --> 00:34:03.640 align:middle line:90% There's a 10% extra penalty. 00:34:03.640 --> 00:34:04.640 align:middle line:90% So there are exceptions. 00:34:04.640 --> 00:34:06.660 align:middle line:84% You can take it out early with a 10% penalty. 00:34:06.660 --> 00:34:09.659 align:middle line:84% Or for 401k, you can borrow against it. 00:34:09.659 --> 00:34:11.739 align:middle line:84% So if there's really dire circumstances, 00:34:11.739 --> 00:34:12.760 align:middle line:90% you get 10% penalty. 00:34:12.760 --> 00:34:14.302 align:middle line:84% But in some sense, that offsets a lot 00:34:14.302 --> 00:34:16.100 align:middle line:84% of the tax benefits due in the first place. 00:34:16.100 --> 00:34:19.060 align:middle line:84% So folks don't really want to do that OK? 00:34:19.060 --> 00:34:22.116 align:middle line:84% So likewise, think about the behavioral model. 00:34:22.116 --> 00:34:23.699 align:middle line:84% Remember, I said the problem is people 00:34:23.699 --> 00:34:25.860 align:middle line:84% don't have self-control with their money. 00:34:25.860 --> 00:34:28.659 align:middle line:84% What's the best form of self-control? 00:34:28.659 --> 00:34:31.775 align:middle line:84% Having money in a retirement account you can't touch. 00:34:31.775 --> 00:34:33.900 align:middle line:84% That's another reason why retirement accounts might 00:34:33.900 --> 00:34:35.775 align:middle line:84% be valuable and people might increase savings 00:34:35.775 --> 00:34:37.300 align:middle line:90% if you offer them. 00:34:37.300 --> 00:34:39.860 align:middle line:84% So the point is, in the standard model, 00:34:39.860 --> 00:34:42.162 align:middle line:84% retirement accounts almost certainly 00:34:42.162 --> 00:34:44.620 align:middle line:84% don't increase savings, given that most people are actually 00:34:44.620 --> 00:34:46.100 align:middle line:84% above these limits in their city, 00:34:46.100 --> 00:34:48.364 align:middle line:84% most rich people are, most people who save. 00:34:48.364 --> 00:34:49.239 align:middle line:90% Well, it's not clear. 00:34:49.239 --> 00:34:50.040 align:middle line:90% It's ambiguous. 00:34:50.040 --> 00:34:51.920 align:middle line:84% But these other factors which make retirement 00:34:51.920 --> 00:34:52.962 align:middle line:90% accounts more attractive. 00:34:52.962 --> 00:34:54.400 align:middle line:90% So what's the answer? 00:34:54.400 --> 00:34:57.320 align:middle line:84% Well, the answer was delivered to us 00:34:57.320 --> 00:35:02.160 align:middle line:84% in an outstanding study that was done by Raj Chetty at Harvard 00:35:02.160 --> 00:35:05.840 align:middle line:90% looking at a reform in-- 00:35:05.840 --> 00:35:07.680 align:middle line:84% which Scandinavian country was this? 00:35:07.680 --> 00:35:11.240 align:middle line:84% This was-- they have great data in Scandinavia. 00:35:11.240 --> 00:35:13.320 align:middle line:90% And that's why they do-- 00:35:13.320 --> 00:35:14.360 align:middle line:90% Denmark. 00:35:14.360 --> 00:35:19.720 align:middle line:84% So in Denmark, what happened was they 00:35:19.720 --> 00:35:22.260 align:middle line:84% had a change in the tax subsidy for savings. 00:35:22.260 --> 00:35:24.640 align:middle line:90% So look at figure 22-6. 00:35:24.640 --> 00:35:25.440 align:middle line:90% OK. 00:35:25.440 --> 00:35:28.840 align:middle line:84% So basically the tax subsidy to savings 00:35:28.840 --> 00:35:32.640 align:middle line:84% fell dramatically for one group and not another group. 00:35:32.640 --> 00:35:34.280 align:middle line:84% So basically, in other words, there 00:35:34.280 --> 00:35:36.040 align:middle line:84% was an IRA that was more generous 00:35:36.040 --> 00:35:39.133 align:middle line:84% for one group and not another group, and they equalized them. 00:35:39.133 --> 00:35:41.800 align:middle line:84% So what that meant was you have a difference in difference setup 00:35:41.800 --> 00:35:44.120 align:middle line:84% to understand, what does that do to savings? 00:35:44.120 --> 00:35:46.240 align:middle line:84% What he found was there was a dramatic effect 00:35:46.240 --> 00:35:48.000 align:middle line:84% in terms of money and retirement accounts, 00:35:48.000 --> 00:35:51.180 align:middle line:84% that when you lowered the tax break for money in retirement 00:35:51.180 --> 00:35:54.140 align:middle line:84% accounts, there was less money in retirement accounts. 00:35:54.140 --> 00:35:57.783 align:middle line:84% And it was completely offset by savings elsewhere. 00:35:57.783 --> 00:35:59.700 align:middle line:84% So all the less money retirement accounts just 00:35:59.700 --> 00:36:01.000 align:middle line:90% became more money elsewhere. 00:36:01.000 --> 00:36:06.240 align:middle line:84% Complete reshuffling, that there is no effect on net savings. 00:36:06.240 --> 00:36:06.740 align:middle line:90% OK? 00:36:06.740 --> 00:36:10.420 align:middle line:84% That overall, this big tax break wasn't 00:36:10.420 --> 00:36:12.300 align:middle line:90% doing anything for savings. 00:36:12.300 --> 00:36:15.938 align:middle line:84% And in general-- now, that's finding 1. 00:36:15.938 --> 00:36:17.480 align:middle line:84% Finding 2, I'll come back to summary. 00:36:17.480 --> 00:36:26.220 align:middle line:84% Finding 2 was Denmark also set up a new system at the same time 00:36:26.220 --> 00:36:29.980 align:middle line:84% which basically mandated that all Danish people have 00:36:29.980 --> 00:36:34.260 align:middle line:84% to contribute 1% of their earnings to a savings account. 00:36:34.260 --> 00:36:38.580 align:middle line:84% That change did increase savings. 00:36:38.580 --> 00:36:40.380 align:middle line:90% So what's going on here? 00:36:40.380 --> 00:36:43.700 align:middle line:84% What's going on here is two very different models of savings 00:36:43.700 --> 00:36:45.860 align:middle line:90% from two different populations. 00:36:45.860 --> 00:36:50.840 align:middle line:84% For non-savers, behavioral incentives are what matter. 00:36:50.840 --> 00:36:52.960 align:middle line:84% So tax breaks don't really affect them. 00:36:52.960 --> 00:36:55.135 align:middle line:84% They're not really paying attention to tax breaks. 00:36:55.135 --> 00:36:56.760 align:middle line:84% But if you say you have to save, or you 00:36:56.760 --> 00:36:59.920 align:middle line:84% make other behavioral interventions, they save. 00:36:59.920 --> 00:37:03.640 align:middle line:84% For high savers, they pay attention to tax rates. 00:37:03.640 --> 00:37:06.200 align:middle line:84% And they're just willing to reshuffle. 00:37:06.200 --> 00:37:10.560 align:middle line:84% So in some sense, the problem with tax subsidy retirement 00:37:10.560 --> 00:37:12.335 align:middle line:84% savings is, for the non-savers, they 00:37:12.335 --> 00:37:14.960 align:middle line:84% don't make much of a difference because non savers don't really 00:37:14.960 --> 00:37:16.440 align:middle line:90% pay attention to them. 00:37:16.440 --> 00:37:20.040 align:middle line:84% For savers, they just cause reshuffling. 00:37:20.040 --> 00:37:23.568 align:middle line:84% So at the end of the day, it's a very negative study 00:37:23.568 --> 00:37:25.360 align:middle line:84% and very negative piece of evidence for tax 00:37:25.360 --> 00:37:26.500 align:middle line:90% breaks for retirement savings. 00:37:26.500 --> 00:37:27.958 align:middle line:84% The tax rates of retirement savings 00:37:27.958 --> 00:37:30.520 align:middle line:84% largely seem to serve to relabel and not to really 00:37:30.520 --> 00:37:32.600 align:middle line:90% increase national savings. 00:37:32.600 --> 00:37:34.400 align:middle line:84% The real increase in national savings 00:37:34.400 --> 00:37:36.040 align:middle line:84% comes from things we do to actually get 00:37:36.040 --> 00:37:39.040 align:middle line:84% people who wouldn't participate to participate in the system. 00:37:39.040 --> 00:37:44.877 align:middle line:84% Stuff like mandated savings, stuff like, for example, 00:37:44.877 --> 00:37:47.460 align:middle line:84% one of the most famous studies ever in behavioral economics is 00:37:47.460 --> 00:37:51.380 align:middle line:84% a study that was done by Brigitte Omadrian, 00:37:51.380 --> 00:37:54.620 align:middle line:84% where she looked at what happened when firms changed 00:37:54.620 --> 00:37:56.820 align:middle line:84% the way people sign up for 401k's. 00:37:56.820 --> 00:37:58.507 align:middle line:84% It used to be when you got to the firm, 00:37:58.507 --> 00:38:00.840 align:middle line:84% they gave you a form like, do you want health insurance? 00:38:00.840 --> 00:38:01.340 align:middle line:90% Yes or no? 00:38:01.340 --> 00:38:02.180 align:middle line:90% Do you want 401k? 00:38:02.180 --> 00:38:03.172 align:middle line:90% Yes or no? 00:38:03.172 --> 00:38:05.380 align:middle line:84% And no young workers would choose 401k's because they 00:38:05.380 --> 00:38:06.860 align:middle line:90% wanted to go party. 00:38:06.860 --> 00:38:09.600 align:middle line:84% They then changed the form quite simply. 00:38:09.600 --> 00:38:13.280 align:middle line:84% They simply changed it to, if you don't want a 401k, 00:38:13.280 --> 00:38:13.920 align:middle line:90% check here. 00:38:13.920 --> 00:38:15.837 align:middle line:84% Rather than if you do want a 401k, check here, 00:38:15.837 --> 00:38:17.500 align:middle line:84% if you don't want a 401k, check here. 00:38:17.500 --> 00:38:21.140 align:middle line:84% Now, in any standard model, that should make no difference. 00:38:21.140 --> 00:38:26.280 align:middle line:84% It raised enrollment rates from 25% to 80% among young workers. 00:38:26.280 --> 00:38:27.580 align:middle line:90% Think about that for a second. 00:38:27.580 --> 00:38:29.220 align:middle line:90% That's profound. 00:38:29.220 --> 00:38:32.260 align:middle line:84% And it massively increased their savings. 00:38:32.260 --> 00:38:35.480 align:middle line:84% So that basically, the idea is for many people, 00:38:35.480 --> 00:38:37.580 align:middle line:90% savings is a passive activity. 00:38:37.580 --> 00:38:41.460 align:middle line:84% And if you passively can nudge them to save more, they will-- 00:38:41.460 --> 00:38:43.480 align:middle line:84% by enrolling them in retirement accounts, 00:38:43.480 --> 00:38:45.640 align:middle line:90% by mandating retirement savings. 00:38:45.640 --> 00:38:49.280 align:middle line:84% For other people who are high savers, 00:38:49.280 --> 00:38:53.600 align:middle line:84% they are largely going to save anyway, 00:38:53.600 --> 00:38:55.240 align:middle line:84% and that these tax breaks largely serve 00:38:55.240 --> 00:38:56.323 align:middle line:90% to reshuffle their assets. 00:38:56.323 --> 00:39:00.260 align:middle line:84% Now, let me just say I'm stating the conclusion very, extremely. 00:39:00.260 --> 00:39:02.760 align:middle line:84% There are other studies which suggest that these accounts do 00:39:02.760 --> 00:39:04.600 align:middle line:90% increase net savings. 00:39:04.600 --> 00:39:07.700 align:middle line:84% But I would say that the totality of the evidence 00:39:07.700 --> 00:39:10.200 align:middle line:84% suggests that there's not a whole lot of increase in savings 00:39:10.200 --> 00:39:11.498 align:middle line:90% coming from the tax break part. 00:39:11.498 --> 00:39:14.040 align:middle line:84% Most of it comes from the part of getting people to put money 00:39:14.040 --> 00:39:15.500 align:middle line:90% in forms they can't access. 00:39:15.500 --> 00:39:17.560 align:middle line:84% And so it increases their savings. 00:39:17.560 --> 00:39:18.600 align:middle line:90% OK? 00:39:18.600 --> 00:39:19.700 align:middle line:90% Questions about that? 00:39:19.700 --> 00:39:21.133 align:middle line:90% AUDIENCE: [INAUDIBLE]. 00:39:21.133 --> 00:39:21.800 align:middle line:90% PROFESSOR: Yeah? 00:39:21.800 --> 00:39:23.508 align:middle line:84% AUDIENCE: Do you think that it would ever 00:39:23.508 --> 00:39:25.760 align:middle line:84% be possible for America to mandate savings? 00:39:25.760 --> 00:39:29.180 align:middle line:84% PROFESSOR: We do-- well, actually, there are-- 00:39:29.180 --> 00:39:30.680 align:middle line:84% some states have started introducing 00:39:30.680 --> 00:39:33.520 align:middle line:84% what's called auto IRAs, which is basically 00:39:33.520 --> 00:39:37.860 align:middle line:84% it's a way for firms-- it's not a national mandate, 00:39:37.860 --> 00:39:40.995 align:middle line:84% but it's a state-level plan for firms that can sign up firms. 00:39:40.995 --> 00:39:42.370 align:middle line:84% So it's basically more efficient. 00:39:42.370 --> 00:39:44.328 align:middle line:84% But actually mandating savings-- and we do that 00:39:44.328 --> 00:39:45.750 align:middle line:84% with Social Security, effectively. 00:39:45.750 --> 00:39:47.750 align:middle line:84% But I think that's going to be very challenging. 00:39:47.750 --> 00:39:50.375 align:middle line:84% But in some sense, if you think about the money we spend on tax 00:39:50.375 --> 00:39:52.793 align:middle line:84% breaks every year, if we just took that money and instead 00:39:52.793 --> 00:39:55.210 align:middle line:84% said, we're going to distribute that money and just put it 00:39:55.210 --> 00:39:57.210 align:middle line:84% into people's accounts if they're-- 00:39:57.210 --> 00:40:01.210 align:middle line:84% because the bottom line is the fundamental fact about savings 00:40:01.210 --> 00:40:02.698 align:middle line:90% is most people don't save. 00:40:02.698 --> 00:40:04.490 align:middle line:84% Most savings is done by a very small number 00:40:04.490 --> 00:40:06.090 align:middle line:90% of very rich people. 00:40:06.090 --> 00:40:08.133 align:middle line:84% So when you subsidize savings, you're 00:40:08.133 --> 00:40:10.050 align:middle line:84% actually going after the people you actually-- 00:40:10.050 --> 00:40:12.150 align:middle line:84% who are the wrong set of people to go after that. 00:40:12.150 --> 00:40:13.590 align:middle line:84% They're people that save a lot anyway. 00:40:13.590 --> 00:40:15.770 align:middle line:84% And that's why the Chetty study found that when you gave this 00:40:15.770 --> 00:40:17.730 align:middle line:84% bigger tax break, it didn't-- this smaller tax break 00:40:17.730 --> 00:40:19.090 align:middle line:90% didn't really change savings. 00:40:19.090 --> 00:40:20.670 align:middle line:90% Because those folks save anyway. 00:40:20.670 --> 00:40:22.810 align:middle line:84% So you really have two populations, the non-savers 00:40:22.810 --> 00:40:23.985 align:middle line:90% and the savers. 00:40:23.985 --> 00:40:25.610 align:middle line:84% For the non-savers, what really matters 00:40:25.610 --> 00:40:28.170 align:middle line:84% is behavioral incentives in getting them to save. 00:40:28.170 --> 00:40:31.610 align:middle line:84% For the savers, they're going to save no matter what. 00:40:31.610 --> 00:40:32.410 align:middle line:90% Yeah? 00:40:32.410 --> 00:40:33.930 align:middle line:84% AUDIENCE: Do you think it makes sense to have a policy where 00:40:33.930 --> 00:40:34.770 align:middle line:90% you-- 00:40:34.770 --> 00:40:37.330 align:middle line:84% the government says, OK, if you-- 00:40:37.330 --> 00:40:40.030 align:middle line:84% we're going to top everyone up to some baseline amount 00:40:40.030 --> 00:40:41.343 align:middle line:90% of savings contribution. 00:40:41.343 --> 00:40:43.010 align:middle line:84% The people who are going to save anyway, 00:40:43.010 --> 00:40:44.830 align:middle line:84% they are planning on saving a lot. 00:40:44.830 --> 00:40:46.090 align:middle line:90% They won't get any of that. 00:40:46.090 --> 00:40:47.840 align:middle line:84% People who wouldn't save at all, they just 00:40:47.840 --> 00:40:50.795 align:middle line:84% get that basically straight from the government. 00:40:50.795 --> 00:40:52.170 align:middle line:84% PROFESSOR: I mean, in some sense, 00:40:52.170 --> 00:40:54.950 align:middle line:84% that's what privatized Social Security would be. 00:40:54.950 --> 00:40:59.750 align:middle line:84% Privatized Social Security would be instead of your taxes going 00:40:59.750 --> 00:41:02.292 align:middle line:84% to pay tomorrow's workers, your taxes are going to an account 00:41:02.292 --> 00:41:03.083 align:middle line:90% that you would get. 00:41:03.083 --> 00:41:04.330 align:middle line:90% And we'd mandate you do it. 00:41:04.330 --> 00:41:06.270 align:middle line:84% That would be a national mandate, privatized 00:41:06.270 --> 00:41:07.650 align:middle line:90% national mandatory savings. 00:41:07.650 --> 00:41:08.525 align:middle line:90% That'd be some floor. 00:41:08.525 --> 00:41:10.590 align:middle line:84% You could save on top of it, if you wanted. 00:41:10.590 --> 00:41:11.190 align:middle line:90% OK? 00:41:11.190 --> 00:41:13.917 align:middle line:84% So I guess what I'm saying is the evidence suggests 00:41:13.917 --> 00:41:15.750 align:middle line:84% that if we took whatever the amount of money 00:41:15.750 --> 00:41:17.208 align:middle line:84% we spend on tax breaks for savings, 00:41:17.208 --> 00:41:20.045 align:middle line:84% and instead gave that money to every American 00:41:20.045 --> 00:41:21.670 align:middle line:84% in the form of a couple hundred dollars 00:41:21.670 --> 00:41:23.045 align:middle line:84% in savings in their account, that 00:41:23.045 --> 00:41:24.950 align:middle line:84% would raise savings in America more 00:41:24.950 --> 00:41:26.430 align:middle line:90% than with the current system. 00:41:26.430 --> 00:41:28.210 align:middle line:90% That seems to be the evidence. 00:41:28.210 --> 00:41:28.710 align:middle line:90% OK? 00:41:28.710 --> 00:41:29.350 align:middle line:90% Yeah? 00:41:29.350 --> 00:41:31.100 align:middle line:84% AUDIENCE: If the tax break is not working, 00:41:31.100 --> 00:41:33.630 align:middle line:84% then why not move it in [INAUDIBLE]? 00:41:33.630 --> 00:41:36.190 align:middle line:90% PROFESSOR: Chapter 9. 00:41:36.190 --> 00:41:40.543 align:middle line:84% Look, I think that it's theoretically very attractive 00:41:40.543 --> 00:41:42.210 align:middle line:84% that if you give a tax break to savings, 00:41:42.210 --> 00:41:44.290 align:middle line:90% people will do more of it. 00:41:44.290 --> 00:41:46.570 align:middle line:84% And I think that unfortunately, the evidence 00:41:46.570 --> 00:41:49.290 align:middle line:90% has not carried the day. 00:41:49.290 --> 00:41:52.003 align:middle line:84% I would say, once again, I'm giving you my interpretation 00:41:52.003 --> 00:41:52.670 align:middle line:90% of the evidence. 00:41:52.670 --> 00:41:55.070 align:middle line:84% I'm sure other people teach this course in other places will-- 00:41:55.070 --> 00:41:57.110 align:middle line:84% which will discount the Chetty study because it's in Denmark, 00:41:57.110 --> 00:41:58.570 align:middle line:84% and find some study in America, which supports 00:41:58.570 --> 00:41:59.737 align:middle line:90% the way that I want to look. 00:41:59.737 --> 00:42:03.050 align:middle line:84% I think the totality of evidence supports my view on this. 00:42:03.050 --> 00:42:03.870 align:middle line:90% All right. 00:42:03.870 --> 00:42:04.370 align:middle line:90% OK. 00:42:04.370 --> 00:42:07.050 align:middle line:90% Now, that's chapter 22. 00:42:07.050 --> 00:42:08.930 align:middle line:90% Let's go into chapter 23. 00:42:08.930 --> 00:42:11.370 align:middle line:84% Chapter 23 is going to be different in the sense 00:42:11.370 --> 00:42:14.930 align:middle line:84% that it's still about behavioral responses to taxation. 00:42:14.930 --> 00:42:19.050 align:middle line:84% But chapter 21 and 22 are about behavioral responses 00:42:19.050 --> 00:42:23.230 align:middle line:84% to taxes on flows, how much you earn from labor income, 00:42:23.230 --> 00:42:25.850 align:middle line:90% how much you earn in interest. 00:42:25.850 --> 00:42:28.810 align:middle line:84% Chapter 23 is about taxes on stocks. 00:42:28.810 --> 00:42:33.370 align:middle line:84% Not stocks and bonds, but amounts, taxes on wealth. 00:42:33.370 --> 00:42:35.790 align:middle line:84% And that's what we're going to talk about in chapter 23, 00:42:35.790 --> 00:42:38.770 align:middle line:84% is things about not just how much you're earning, 00:42:38.770 --> 00:42:42.390 align:middle line:84% but taxes that affect your actual level of wealth, 00:42:42.390 --> 00:42:47.290 align:middle line:84% as well as taxes that affect the amount of risk you take. 00:42:47.290 --> 00:42:48.790 align:middle line:84% So, so far we're talking about taxes 00:42:48.790 --> 00:42:52.530 align:middle line:84% that affect mean flows like interest and labor income. 00:42:52.530 --> 00:42:54.030 align:middle line:84% We also talk about taxes that affect 00:42:54.030 --> 00:42:55.750 align:middle line:90% the amount of risk you take. 00:42:55.750 --> 00:42:56.890 align:middle line:90% So let's start with that. 00:42:56.890 --> 00:43:02.430 align:middle line:84% Let's ask, how does taxing risk impact risk taking? 00:43:02.430 --> 00:43:04.790 align:middle line:84% Well, you might say, well, that's pretty obvious. 00:43:04.790 --> 00:43:09.470 align:middle line:84% If you tax how much risk I take, I'm going to take less risk. 00:43:09.470 --> 00:43:11.550 align:middle line:90% But in fact, you'd be wrong. 00:43:11.550 --> 00:43:16.830 align:middle line:84% And to see why, let's go to table 23-1 for a very famous 00:43:16.830 --> 00:43:20.390 align:middle line:84% model back from the 19-- what is this, 1954? 00:43:20.390 --> 00:43:23.430 align:middle line:90% '44, the Domar-Musgrave model. 00:43:23.430 --> 00:43:25.270 align:middle line:84% They said, imagine a world where you have 00:43:25.270 --> 00:43:26.790 align:middle line:90% an investment that could pay-- 00:43:26.790 --> 00:43:30.310 align:middle line:84% there's a bet you could take where you invest $100. 00:43:30.310 --> 00:43:31.410 align:middle line:90% If you win, you earn $20. 00:43:31.410 --> 00:43:33.150 align:middle line:90% If you lose, you lose $20. 00:43:33.150 --> 00:43:37.475 align:middle line:84% And let's imagine there's no taxes, OK? 00:43:37.475 --> 00:43:39.850 align:middle line:84% So you just have a system where you put in your $100, you 00:43:39.850 --> 00:43:41.090 align:middle line:90% win $20, you lose $20. 00:43:41.090 --> 00:43:43.730 align:middle line:84% Now imagine you put in a tax system, 00:43:43.730 --> 00:43:51.225 align:middle line:84% OK, where basically we say if you win, we're going to tax you. 00:43:51.225 --> 00:43:52.850 align:middle line:84% And if you lose, we're going to let you 00:43:52.850 --> 00:43:55.410 align:middle line:90% deduct your losses from taxes. 00:43:55.410 --> 00:43:57.930 align:middle line:84% So it's a neutral tax to the extent 00:43:57.930 --> 00:44:00.185 align:middle line:90% that it's Haig-Simons, right? 00:44:00.185 --> 00:44:02.310 align:middle line:84% You win, your consumption opportunities are higher. 00:44:02.310 --> 00:44:03.450 align:middle line:90% We'll tax you more. 00:44:03.450 --> 00:44:05.242 align:middle line:84% You lose, your consumption taxes are lower. 00:44:05.242 --> 00:44:06.210 align:middle line:90% We'll tax you less. 00:44:06.210 --> 00:44:08.310 align:middle line:84% So if you win that gets added to your taxes. 00:44:08.310 --> 00:44:10.450 align:middle line:84% If you lose, it gets subtracted from your taxes. 00:44:10.450 --> 00:44:11.570 align:middle line:90% How would that work? 00:44:11.570 --> 00:44:16.250 align:middle line:84% Well, if you look at table 23-1, if there's a 50% tax rate, 00:44:16.250 --> 00:44:20.430 align:middle line:84% a 50% tax rate if you win, 50% deduction if you lose, 00:44:20.430 --> 00:44:21.750 align:middle line:90% then if you win, you keep $10. 00:44:21.750 --> 00:44:25.010 align:middle line:90% If you lose, you lose $10. 00:44:25.010 --> 00:44:27.250 align:middle line:90% Now here's the key point. 00:44:27.250 --> 00:44:30.010 align:middle line:84% With that system, I can completely 00:44:30.010 --> 00:44:32.110 align:middle line:90% undo the effect of taxation. 00:44:32.110 --> 00:44:33.750 align:middle line:90% How? 00:44:33.750 --> 00:44:35.652 align:middle line:84% Remember, individuals will always-- 00:44:35.652 --> 00:44:37.110 align:middle line:84% if you're at an equilibrium and you 00:44:37.110 --> 00:44:39.370 align:middle line:84% can undo government efforts to move you from equilibrium, 00:44:39.370 --> 00:44:40.037 align:middle line:90% you always will. 00:44:40.037 --> 00:44:40.965 align:middle line:90% You're happy there. 00:44:40.965 --> 00:44:43.090 align:middle line:84% I claim you can get back to exactly where you were. 00:44:43.090 --> 00:44:45.590 align:middle line:90% And how do you do that? 00:44:45.590 --> 00:44:48.270 align:middle line:84% How do you get back to exactly where you were in the first row? 00:44:48.270 --> 00:44:48.810 align:middle line:90% Yeah? 00:44:48.810 --> 00:44:49.670 align:middle line:90% AUDIENCE: [INAUDIBLE]. 00:44:49.670 --> 00:44:51.003 align:middle line:90% PROFESSOR: Just double your bet. 00:44:51.003 --> 00:44:53.770 align:middle line:84% If you double your bet, then it's win $40, 00:44:53.770 --> 00:44:55.930 align:middle line:84% lose $40, which after tax is win $20, lose $20. 00:44:55.930 --> 00:44:57.870 align:middle line:84% So you're back to where you were. 00:44:57.870 --> 00:45:02.250 align:middle line:84% So literally you can completely offset government taxation. 00:45:02.250 --> 00:45:02.750 align:middle line:90% Why? 00:45:02.750 --> 00:45:04.735 align:middle line:84% Because the government is a silent partner. 00:45:04.735 --> 00:45:06.610 align:middle line:84% The government is just saying, I'm a partner. 00:45:06.610 --> 00:45:08.750 align:middle line:90% I'm taking half of what you got. 00:45:08.750 --> 00:45:10.390 align:middle line:90% So what does this say taxes do? 00:45:10.390 --> 00:45:13.230 align:middle line:90% Taxes raise risk taking. 00:45:13.230 --> 00:45:17.190 align:middle line:84% Higher taxes cause more taking of risks. 00:45:17.190 --> 00:45:20.190 align:middle line:84% Because taxes essentially are the government grabbing 00:45:20.190 --> 00:45:21.023 align:middle line:90% a piece of your pie? 00:45:21.023 --> 00:45:22.857 align:middle line:84% So you just want a bigger pie, so you end up 00:45:22.857 --> 00:45:23.910 align:middle line:90% with the same-size piece. 00:45:23.910 --> 00:45:26.550 align:middle line:84% So it's the opposite of the standard intuition, 00:45:26.550 --> 00:45:30.450 align:middle line:84% that taxing risk actually causes more risk taking. 00:45:30.450 --> 00:45:31.370 align:middle line:90% OK? 00:45:31.370 --> 00:45:35.090 align:middle line:84% Now, that is, of course, not a description of the world. 00:45:35.090 --> 00:45:38.110 align:middle line:84% It's a description of a simple world, worlds that have existed, 00:45:38.110 --> 00:45:39.110 align:middle line:90% but not in reality. 00:45:39.110 --> 00:45:42.330 align:middle line:84% And in reality, there's two complications. 00:45:42.330 --> 00:45:46.342 align:middle line:84% The first is we don't let people fully offset their losses. 00:45:46.342 --> 00:45:48.050 align:middle line:84% And the reason is because we're basically 00:45:48.050 --> 00:45:50.100 align:middle line:84% worried about tax shenanigans, worried people 00:45:50.100 --> 00:45:51.850 align:middle line:84% are going to figure out some way to create 00:45:51.850 --> 00:45:53.475 align:middle line:84% all these massive paper losses and cost 00:45:53.475 --> 00:45:54.810 align:middle line:90% the government a ton of money. 00:45:54.810 --> 00:45:57.850 align:middle line:84% So we generally have what we call a loss offset. 00:45:57.850 --> 00:46:02.450 align:middle line:84% So when you have money, when you make income, 00:46:02.450 --> 00:46:04.030 align:middle line:84% you're taxed on it no matter what. 00:46:04.030 --> 00:46:06.072 align:middle line:84% When you lose income, there's a limit on how much 00:46:06.072 --> 00:46:08.290 align:middle line:90% you can deduct on your taxes. 00:46:08.290 --> 00:46:09.810 align:middle line:90% So let's imagine a world. 00:46:09.810 --> 00:46:13.310 align:middle line:84% If you win, you get taxed at 50%. 00:46:13.310 --> 00:46:16.370 align:middle line:84% But if you lose, you don't get any tax break at all. 00:46:16.370 --> 00:46:20.590 align:middle line:84% Well, in that world, if you double your bet to $200, 00:46:20.590 --> 00:46:24.050 align:middle line:84% it's win $20, lose $40, which is not as good as the first row. 00:46:24.050 --> 00:46:27.570 align:middle line:84% So you won't necessarily want to double your bet. 00:46:27.570 --> 00:46:30.190 align:middle line:84% So that's one reason why this model might not hold. 00:46:30.190 --> 00:46:32.150 align:middle line:84% A second reason is that in America, we 00:46:32.150 --> 00:46:34.013 align:middle line:90% have progressive taxation. 00:46:34.013 --> 00:46:35.930 align:middle line:84% The richer you are, the more you pay in taxes. 00:46:35.930 --> 00:46:36.763 align:middle line:90% What does that mean? 00:46:36.763 --> 00:46:40.030 align:middle line:84% That means if you win, you pay in a higher tax bracket. 00:46:40.030 --> 00:46:42.350 align:middle line:84% If you lose, you pay a lower tax bracket. 00:46:42.350 --> 00:46:44.370 align:middle line:90% That will also have an effect. 00:46:44.370 --> 00:46:46.690 align:middle line:84% So for example, let's imagine-- double my bet. 00:46:46.690 --> 00:46:50.630 align:middle line:84% But let's imagine a tax rate, if I win, is 75% The tax if I lose 00:46:50.630 --> 00:46:52.350 align:middle line:90% is 50%. 00:46:52.350 --> 00:46:54.810 align:middle line:84% Well, then now win is $15 and lose is minus $20. 00:46:54.810 --> 00:46:57.350 align:middle line:90% Once again, it's not the same. 00:46:57.350 --> 00:47:01.990 align:middle line:84% So complications make this simple model more difficult. 00:47:01.990 --> 00:47:04.708 align:middle line:84% But the bottom line is your basic intuition, 00:47:04.708 --> 00:47:06.750 align:middle line:84% which is if I tax risk, there will be less of it, 00:47:06.750 --> 00:47:09.270 align:middle line:90% is not obviously right. 00:47:09.270 --> 00:47:11.830 align:middle line:84% Because when the government comes in as a silent partner, 00:47:11.830 --> 00:47:13.470 align:middle line:84% there's this other effect, which is you 00:47:13.470 --> 00:47:14.950 align:middle line:84% want to increase your risk taking 00:47:14.950 --> 00:47:17.630 align:middle line:84% to offset the government taking its share. 00:47:17.630 --> 00:47:19.690 align:middle line:90% OK? 00:47:19.690 --> 00:47:21.230 align:middle line:90% That's the standard model. 00:47:21.230 --> 00:47:27.490 align:middle line:84% And essentially, that is kind of our starting point for thinking 00:47:27.490 --> 00:47:29.290 align:middle line:90% about taxation and risk taking. 00:47:29.290 --> 00:47:30.465 align:middle line:90% Well, what do we know? 00:47:30.465 --> 00:47:31.590 align:middle line:90% What's the actual evidence? 00:47:31.590 --> 00:47:33.850 align:middle line:90% Well, the evidence here sucks. 00:47:33.850 --> 00:47:36.190 align:middle line:84% And we really don't know the answer, actually, 00:47:36.190 --> 00:47:37.210 align:middle line:90% to this question. 00:47:37.210 --> 00:47:40.850 align:middle line:84% We do not have a good answer about in general 00:47:40.850 --> 00:47:45.090 align:middle line:84% how government taxation of risk impacts risk taking. 00:47:45.090 --> 00:47:47.810 align:middle line:90% We don't have a good answer. 00:47:47.810 --> 00:47:50.785 align:middle line:84% Now, we do have certain applications 00:47:50.785 --> 00:47:51.910 align:middle line:90% which give us some answers. 00:47:51.910 --> 00:47:53.930 align:middle line:84% And the most important application 00:47:53.930 --> 00:47:57.270 align:middle line:84% is to what's called capital gains taxation. 00:47:57.270 --> 00:48:00.718 align:middle line:90% 00:48:00.718 --> 00:48:02.510 align:middle line:84% This is something someone mentioned before. 00:48:02.510 --> 00:48:04.770 align:middle line:84% Capital gains taxation is the tax 00:48:04.770 --> 00:48:08.490 align:middle line:84% you pay on an increased value of your assets. 00:48:08.490 --> 00:48:10.850 align:middle line:84% So the way capital gains taxes work is 00:48:10.850 --> 00:48:14.450 align:middle line:90% you are taxed on realization. 00:48:14.450 --> 00:48:17.650 align:middle line:84% That is if you invest in something, 00:48:17.650 --> 00:48:20.410 align:middle line:84% you pay some price, that's called your basis. 00:48:20.410 --> 00:48:23.590 align:middle line:84% So let's say you buy-- let's say in this example, 00:48:23.590 --> 00:48:26.180 align:middle line:90% you buy a painting for $100. 00:48:26.180 --> 00:48:28.340 align:middle line:90% That's your basis. 00:48:28.340 --> 00:48:31.780 align:middle line:84% When you sell it, that's your sales price. 00:48:31.780 --> 00:48:34.740 align:middle line:84% You are taxed on the difference between the sales 00:48:34.740 --> 00:48:36.460 align:middle line:90% price and the basis. 00:48:36.460 --> 00:48:38.980 align:middle line:84% The fact it got more valuable along the way is irrelevant. 00:48:38.980 --> 00:48:41.620 align:middle line:84% A bank account is taxed on accrual. 00:48:41.620 --> 00:48:44.700 align:middle line:84% Every year when you earn interest, you're taxed on it. 00:48:44.700 --> 00:48:47.620 align:middle line:84% A capital gains is taxed on realization. 00:48:47.620 --> 00:48:49.620 align:middle line:84% You're only taxed when you sell it. 00:48:49.620 --> 00:48:53.460 align:middle line:84% So for example, if you-- let's say 00:48:53.460 --> 00:48:56.620 align:middle line:84% you had a painting that you bought for $100, 00:48:56.620 --> 00:48:59.500 align:middle line:84% increased in value by 10% for years per year. 00:48:59.500 --> 00:49:03.140 align:middle line:84% So after 7 years, the painting is worth $195. 00:49:03.140 --> 00:49:09.020 align:middle line:84% And let's say the capital gains tax rate is 20%. 00:49:09.020 --> 00:49:11.520 align:middle line:90% So you have a $95 capital gain. 00:49:11.520 --> 00:49:14.340 align:middle line:84% The painting has gone from $100 to $195. 00:49:14.340 --> 00:49:18.900 align:middle line:84% It's a 20% capital gains tax rate, so you pay $19 in taxes. 00:49:18.900 --> 00:49:25.300 align:middle line:84% Let's say instead you-- so you have not-- you paid $19. 00:49:25.300 --> 00:49:27.740 align:middle line:84% So at the end of the day, you're $95 minus $19. 00:49:27.740 --> 00:49:30.280 align:middle line:90% You have $76. 00:49:30.280 --> 00:49:32.800 align:middle line:84% If instead you put that same $100 00:49:32.800 --> 00:49:37.680 align:middle line:84% into a bank account and every-- at the same 10% rate 00:49:37.680 --> 00:49:40.880 align:middle line:84% of interest, but had to pay taxes every year, 00:49:40.880 --> 00:49:43.480 align:middle line:90% you'd only have $71. 00:49:43.480 --> 00:49:44.320 align:middle line:90% Why? 00:49:44.320 --> 00:49:47.560 align:middle line:84% Because by delaying paying taxes, you're better off. 00:49:47.560 --> 00:49:50.800 align:middle line:84% The capital gains allows you to delay the taxes till the end. 00:49:50.800 --> 00:49:52.860 align:middle line:84% The money in the bank, you pay taxes every time. 00:49:52.860 --> 00:49:54.280 align:middle line:84% And that tax money you pay gets taken out, 00:49:54.280 --> 00:49:55.947 align:middle line:84% and the government earns interest on it. 00:49:55.947 --> 00:49:57.000 align:middle line:90% You don't. 00:49:57.000 --> 00:49:57.840 align:middle line:90% OK? 00:49:57.840 --> 00:50:02.760 align:middle line:84% So taxation on realization is an implicit tax break. 00:50:02.760 --> 00:50:06.680 align:middle line:84% By taxing only when you sell it as opposed to along the way, 00:50:06.680 --> 00:50:09.360 align:middle line:90% you get an implicit tax break. 00:50:09.360 --> 00:50:09.860 align:middle line:90% OK? 00:50:09.860 --> 00:50:12.360 align:middle line:84% Because we delay when you pay the taxes. 00:50:12.360 --> 00:50:13.000 align:middle line:90% OK. 00:50:13.000 --> 00:50:14.240 align:middle line:90% Why do we do this? 00:50:14.240 --> 00:50:15.700 align:middle line:90% In principle, we don't have to. 00:50:15.700 --> 00:50:17.283 align:middle line:84% In principle, we could have a-- what's 00:50:17.283 --> 00:50:20.280 align:middle line:84% called a mark-to-market tax system, which is every period, 00:50:20.280 --> 00:50:21.820 align:middle line:90% I'm going to look at your asset. 00:50:21.820 --> 00:50:24.460 align:middle line:84% I'm going to currently value it and tax you 00:50:24.460 --> 00:50:26.340 align:middle line:84% on the delta between what you paid 00:50:26.340 --> 00:50:29.320 align:middle line:84% for it between the last period value and this period's value. 00:50:29.320 --> 00:50:30.980 align:middle line:90% So for stocks, it would be easy. 00:50:30.980 --> 00:50:32.640 align:middle line:90% I bought a stock for $100. 00:50:32.640 --> 00:50:33.320 align:middle line:90% One year later. 00:50:33.320 --> 00:50:35.278 align:middle line:84% I haven't sold it, but the stock is worth $110. 00:50:35.278 --> 00:50:36.300 align:middle line:90% I tax you on $10. 00:50:36.300 --> 00:50:37.500 align:middle line:90% It's easy. 00:50:37.500 --> 00:50:40.180 align:middle line:84% The problem is it's not so easy for paintings. 00:50:40.180 --> 00:50:42.500 align:middle line:84% You'd have to literally go in and every year, 00:50:42.500 --> 00:50:45.300 align:middle line:84% for every painting, reevaluate it-- 00:50:45.300 --> 00:50:46.340 align:middle line:90% be a nightmare. 00:50:46.340 --> 00:50:48.280 align:middle line:84% So the problem is, for non-liquid assets 00:50:48.280 --> 00:50:49.780 align:middle line:84% in particular, much of capital gains 00:50:49.780 --> 00:50:52.180 align:middle line:84% are on privately-held businesses. 00:50:52.180 --> 00:50:54.760 align:middle line:84% It would be very hard to ever value those businesses, 00:50:54.760 --> 00:50:56.780 align:middle line:90% be enormous undertaking. 00:50:56.780 --> 00:50:58.963 align:middle line:84% So that's why we don't actually do mark-to-market. 00:50:58.963 --> 00:51:00.380 align:middle line:84% There's some interesting proposals 00:51:00.380 --> 00:51:03.060 align:middle line:84% of ways to get around that are quite thought provoking. 00:51:03.060 --> 00:51:05.840 align:middle line:84% For example, you could-- at the end when you tax them, 00:51:05.840 --> 00:51:08.760 align:middle line:84% you could tax them higher to make up for the inside build-up. 00:51:08.760 --> 00:51:10.020 align:middle line:90% There's things you could do. 00:51:10.020 --> 00:51:12.520 align:middle line:84% But literal mark-to-market is very, very hard to pull off. 00:51:12.520 --> 00:51:14.140 align:middle line:90% Not impossible, but hard. 00:51:14.140 --> 00:51:17.020 align:middle line:84% So that's why, in some sense, we kind of just 00:51:17.020 --> 00:51:19.400 align:middle line:84% are stuck with taxing realization. 00:51:19.400 --> 00:51:21.760 align:middle line:84% So basically, we're stuck with the capital gains tax 00:51:21.760 --> 00:51:25.160 align:middle line:84% rate being effectively lower than the tax rate 00:51:25.160 --> 00:51:27.280 align:middle line:90% on, say, bank interest. 00:51:27.280 --> 00:51:28.520 align:middle line:90% OK? 00:51:28.520 --> 00:51:31.600 align:middle line:84% Despite that, we have additional subsidies 00:51:31.600 --> 00:51:33.760 align:middle line:90% to capital gains taxation. 00:51:33.760 --> 00:51:38.480 align:middle line:84% First of all, we have the step up in basis at death. 00:51:38.480 --> 00:51:39.800 align:middle line:90% What is that? 00:51:39.800 --> 00:51:43.640 align:middle line:84% That complicated thing is just the following. 00:51:43.640 --> 00:51:46.960 align:middle line:84% Let's say I have a painting that I bought for $100 00:51:46.960 --> 00:51:49.080 align:middle line:90% and is worth $1 million. 00:51:49.080 --> 00:51:52.560 align:middle line:84% If I sell it the day before I die, 00:51:52.560 --> 00:51:56.320 align:middle line:84% I pay capital gains tax on a million minus $100. 00:51:56.320 --> 00:52:02.040 align:middle line:84% If I leave it to my kid and sell it the next day for $1,000,001, 00:52:02.040 --> 00:52:06.320 align:middle line:84% they pay tax on $1 because the basis gets reset to what it was 00:52:06.320 --> 00:52:08.400 align:middle line:90% worth when I left it to them. 00:52:08.400 --> 00:52:11.880 align:middle line:84% So when I die and leave it to my kids, the books get wiped clean 00:52:11.880 --> 00:52:14.760 align:middle line:84% and they reset the basis it was worth when my kids got it. 00:52:14.760 --> 00:52:15.740 align:middle line:90% That's a huge subsidy. 00:52:15.740 --> 00:52:18.198 align:middle line:84% That means, effectively, I can avoid capital gains taxation 00:52:18.198 --> 00:52:19.620 align:middle line:90% by dying. 00:52:19.620 --> 00:52:20.380 align:middle line:90% OK? 00:52:20.380 --> 00:52:21.880 align:middle line:90% So that's an additional subsidy. 00:52:21.880 --> 00:52:23.240 align:middle line:84% More relevantly, it's a funny way to say it. 00:52:23.240 --> 00:52:25.360 align:middle line:84% But more relevant, the point is if you hold your capital gains, 00:52:25.360 --> 00:52:26.560 align:middle line:90% you're never taxed on them. 00:52:26.560 --> 00:52:28.120 align:middle line:84% Now, there's a state tax association. 00:52:28.120 --> 00:52:29.500 align:middle line:90% We'll come to that next time. 00:52:29.500 --> 00:52:32.620 align:middle line:84% But for the capital gains piece, you're never taxed on it. 00:52:32.620 --> 00:52:34.700 align:middle line:90% So that's another subsidy. 00:52:34.700 --> 00:52:35.260 align:middle line:90% Yeah? 00:52:35.260 --> 00:52:37.867 align:middle line:84% AUDIENCE: What happens if [INAUDIBLE]? 00:52:37.867 --> 00:52:38.700 align:middle line:90% PROFESSOR: This guy. 00:52:38.700 --> 00:52:40.180 align:middle line:90% What is up with this guy? 00:52:40.180 --> 00:52:41.120 align:middle line:90% He's getting divorced. 00:52:41.120 --> 00:52:42.320 align:middle line:90% He's faking his death. 00:52:42.320 --> 00:52:43.900 align:middle line:90% [LAUGHTER] 00:52:43.900 --> 00:52:46.260 align:middle line:90% I don't know. 00:52:46.260 --> 00:52:47.760 align:middle line:84% Presumably, if you get away with it, 00:52:47.760 --> 00:52:49.360 align:middle line:84% your kids that avoid capital gains taxation, 00:52:49.360 --> 00:52:51.193 align:middle line:84% they can send you checks in Turks and Caicos 00:52:51.193 --> 00:52:52.900 align:middle line:90% or wherever you're hanging out. 00:52:52.900 --> 00:52:55.320 align:middle line:90% So there's that argument. 00:52:55.320 --> 00:52:57.320 align:middle line:84% There's another tax preference to capital gains, 00:52:57.320 --> 00:53:02.020 align:middle line:84% which is a lot of capital gains are on housing. 00:53:02.020 --> 00:53:04.500 align:middle line:84% A lot of people's biggest asset's their house. 00:53:04.500 --> 00:53:07.940 align:middle line:84% So actually, we exclude the first $500,000 of capital gains 00:53:07.940 --> 00:53:09.350 align:middle line:90% on your house. 00:53:09.350 --> 00:53:11.100 align:middle line:84% So not only do we not tax the realization. 00:53:11.100 --> 00:53:13.558 align:middle line:84% We don't actually tax it at all for capital gains less than 00:53:13.558 --> 00:53:15.680 align:middle line:90% $500,000. 00:53:15.680 --> 00:53:19.280 align:middle line:84% Then there's the third tax subsidy, which is for almost all 00:53:19.280 --> 00:53:21.200 align:middle line:84% of US history, except for a brief shining 00:53:21.200 --> 00:53:23.160 align:middle line:90% moment for three years. 00:53:23.160 --> 00:53:25.960 align:middle line:84% We have tax capital gains at a lower rate 00:53:25.960 --> 00:53:27.800 align:middle line:90% than other forms of capital. 00:53:27.800 --> 00:53:31.500 align:middle line:84% So right now, if you save in the bank and you're rich, you pay-- 00:53:31.500 --> 00:53:34.600 align:middle line:84% I think it's 37.5% is the top tax rate. 00:53:34.600 --> 00:53:38.800 align:middle line:84% If it's a capital gain, saving capital gains, you pay 20%. 00:53:38.800 --> 00:53:41.800 align:middle line:84% So despite the fact that it's subsidized by realization, 00:53:41.800 --> 00:53:46.480 align:middle line:84% subsidized by step up basis in death, subsidized by housing, 00:53:46.480 --> 00:53:49.840 align:middle line:84% the tax rate is also cut largely in half and almost always 00:53:49.840 --> 00:53:51.840 align:middle line:90% has been from-- 00:53:51.840 --> 00:53:54.160 align:middle line:84% I guess it was seven years from-- 00:53:54.160 --> 00:53:57.000 align:middle line:84% '86 to '93 is the only time in my lifetime 00:53:57.000 --> 00:53:59.040 align:middle line:84% that capital gains have been taxed the same rate 00:53:59.040 --> 00:54:00.180 align:middle line:90% as regular income. 00:54:00.180 --> 00:54:02.555 align:middle line:84% If you're going to ask why, I'm going to cover that next. 00:54:02.555 --> 00:54:03.880 align:middle line:90% AUDIENCE: [INAUDIBLE]. 00:54:03.880 --> 00:54:06.422 align:middle line:84% PROFESSOR: The house piece was you're not taxed on your first 00:54:06.422 --> 00:54:08.420 align:middle line:84% $500,000 of capital gains on your house. 00:54:08.420 --> 00:54:09.415 align:middle line:90% AUDIENCE: [INAUDIBLE]. 00:54:09.415 --> 00:54:10.040 align:middle line:90% PROFESSOR: Yeah 00:54:10.040 --> 00:54:12.457 align:middle line:84% AUDIENCE: For some assets, why is it that if you [? put ?] 00:54:12.457 --> 00:54:13.832 align:middle line:84% [? it ?] for longer, [INAUDIBLE]? 00:54:13.832 --> 00:54:15.124 align:middle line:90% PROFESSOR: That's a good point. 00:54:15.124 --> 00:54:16.100 align:middle line:90% I'm taking a shorthand. 00:54:16.100 --> 00:54:18.380 align:middle line:84% The capital gains tax break is only 00:54:18.380 --> 00:54:21.860 align:middle line:84% applied to assets that are held more than six months. 00:54:21.860 --> 00:54:23.560 align:middle line:84% So if you sell in the first six months, 00:54:23.560 --> 00:54:25.900 align:middle line:84% you get all the other benefits, but you 00:54:25.900 --> 00:54:28.070 align:middle line:90% don't get the lower rate. 00:54:28.070 --> 00:54:30.320 align:middle line:84% Lower rate's on what's called long-term capital gains. 00:54:30.320 --> 00:54:31.280 align:middle line:84% It's either six months or a year. 00:54:31.280 --> 00:54:31.840 align:middle line:90% I forget. 00:54:31.840 --> 00:54:33.700 align:middle line:90% But that's what most people do. 00:54:33.700 --> 00:54:34.293 align:middle line:90% OK? 00:54:34.293 --> 00:54:35.960 align:middle line:84% So basically the point is, you're right. 00:54:35.960 --> 00:54:36.880 align:middle line:84% But actually, I'm going to come back. 00:54:36.880 --> 00:54:37.320 align:middle line:90% It's a good point. 00:54:37.320 --> 00:54:38.320 align:middle line:90% I should have emphasized this. 00:54:38.320 --> 00:54:40.140 align:middle line:84% So you only get the tax rate if you hold on to your assets 00:54:40.140 --> 00:54:40.820 align:middle line:90% for at least-- 00:54:40.820 --> 00:54:42.780 align:middle line:84% I forget if it's six months or a year. 00:54:42.780 --> 00:54:44.280 align:middle line:90% OK? 00:54:44.280 --> 00:54:45.660 align:middle line:90% So why? 00:54:45.660 --> 00:54:46.160 align:middle line:90% OK. 00:54:46.160 --> 00:54:48.120 align:middle line:84% I'm not going to give you a cheap answer of chapter 9 here. 00:54:48.120 --> 00:54:50.245 align:middle line:84% I'm going to actually give you a legitimate answer. 00:54:50.245 --> 00:54:53.220 align:middle line:84% Why do we have this system of tax breaks for capital gains? 00:54:53.220 --> 00:54:56.580 align:middle line:84% Well, there's really three arguments. 00:54:56.580 --> 00:55:03.220 align:middle line:84% The first argument of why we have this is inflation. 00:55:03.220 --> 00:55:06.660 align:middle line:84% Which is, look, I said that you sold that painting 00:55:06.660 --> 00:55:10.120 align:middle line:90% for $195 seven years later. 00:55:10.120 --> 00:55:12.760 align:middle line:84% But what if prices were going up 10% a year, as well? 00:55:12.760 --> 00:55:14.680 align:middle line:90% Then you're no richer. 00:55:14.680 --> 00:55:17.980 align:middle line:84% Yeah, you sold $185, but Skittles now costs $1.95 a bag. 00:55:17.980 --> 00:55:20.000 align:middle line:90% So you're no richer. 00:55:20.000 --> 00:55:22.600 align:middle line:84% And so this is-- we should address that. 00:55:22.600 --> 00:55:26.040 align:middle line:84% This is a terrible argument for two reasons. 00:55:26.040 --> 00:55:28.260 align:middle line:84% First of all, if you're worried about inflation, 00:55:28.260 --> 00:55:31.447 align:middle line:84% there's an easy way to fix that, which is index the prices. 00:55:31.447 --> 00:55:32.780 align:middle line:90% We've done it with tax brackets. 00:55:32.780 --> 00:55:35.680 align:middle line:84% No reason we couldn't do it with asset values. 00:55:35.680 --> 00:55:37.880 align:middle line:84% The second is this same problem applies 00:55:37.880 --> 00:55:40.160 align:middle line:84% to other forms of capital [? taxationists, ?] too. 00:55:40.160 --> 00:55:42.760 align:middle line:84% We talked about why it screws up the returns to savings 00:55:42.760 --> 00:55:44.320 align:middle line:90% in chapter 22. 00:55:44.320 --> 00:55:46.163 align:middle line:84% So why-- if it's a problem, why do we 00:55:46.163 --> 00:55:48.080 align:middle line:84% feel like we have to cut the capital gains tax 00:55:48.080 --> 00:55:50.205 align:middle line:84% rate, but not those other tax rates if we're really 00:55:50.205 --> 00:55:51.440 align:middle line:90% worried about inflation? 00:55:51.440 --> 00:55:53.240 align:middle line:90% This is a weak argument. 00:55:53.240 --> 00:55:54.480 align:middle line:90% Strikeout. 00:55:54.480 --> 00:55:56.440 align:middle line:90% Two, OK? 00:55:56.440 --> 00:56:02.480 align:middle line:84% Two, that there's improved efficiency 00:56:02.480 --> 00:56:05.920 align:middle line:90% of capital allocation. 00:56:05.920 --> 00:56:08.420 align:middle line:84% And this is a legitimate argument and an interesting one. 00:56:08.420 --> 00:56:12.780 align:middle line:90% 00:56:12.780 --> 00:56:17.020 align:middle line:84% Because we can only tax capital gains on realization, 00:56:17.020 --> 00:56:19.663 align:middle line:84% the longer you hold them, the better you are. 00:56:19.663 --> 00:56:21.580 align:middle line:84% And actually, because we only cut the tax rate 00:56:21.580 --> 00:56:23.260 align:middle line:84% if you held it for a year, the longer-- at least 00:56:23.260 --> 00:56:24.320 align:middle line:84% you want to hold it for that long. 00:56:24.320 --> 00:56:26.460 align:middle line:84% And even beyond, you want to keep holding it. 00:56:26.460 --> 00:56:27.500 align:middle line:90% What does that mean? 00:56:27.500 --> 00:56:30.980 align:middle line:84% That means people might pass up efficient investment 00:56:30.980 --> 00:56:33.420 align:middle line:84% opportunities because they are locked 00:56:33.420 --> 00:56:34.768 align:middle line:90% in on their capital gains. 00:56:34.768 --> 00:56:37.060 align:middle line:84% So let's say you're someone who's got a painting that's 00:56:37.060 --> 00:56:39.060 align:middle line:90% gone way up in value. 00:56:39.060 --> 00:56:39.780 align:middle line:90% OK? 00:56:39.780 --> 00:56:40.773 align:middle line:90% You're 75. 00:56:40.773 --> 00:56:42.940 align:middle line:84% You got a painting that's gone up millions in value, 00:56:42.940 --> 00:56:45.260 align:middle line:84% and you got this great investment opportunity. 00:56:45.260 --> 00:56:47.200 align:middle line:84% But if you sell your painting to invest, 00:56:47.200 --> 00:56:49.120 align:middle line:90% you got to pay 20% taxes. 00:56:49.120 --> 00:56:51.013 align:middle line:84% If you wait till you die, you pay nothing. 00:56:51.013 --> 00:56:53.180 align:middle line:84% Unless that investment opportunity is really, really 00:56:53.180 --> 00:56:55.860 align:middle line:90% good, I'm not going to take it. 00:56:55.860 --> 00:56:59.140 align:middle line:84% So this is going to lock me into old investments 00:56:59.140 --> 00:57:01.300 align:middle line:84% and make me unwilling to sell my assets. 00:57:01.300 --> 00:57:02.600 align:middle line:90% And it's inherent. 00:57:02.600 --> 00:57:06.350 align:middle line:84% It's inherent in the fact that we tax on realization. 00:57:06.350 --> 00:57:09.350 align:middle line:84% There's an inherent bias towards lock-in 00:57:09.350 --> 00:57:11.630 align:middle line:84% and that basically people will not efficiently 00:57:11.630 --> 00:57:13.950 align:middle line:90% invest their assets. 00:57:13.950 --> 00:57:14.450 align:middle line:90% OK? 00:57:14.450 --> 00:57:17.390 align:middle line:84% That's a legit argument, a good point. 00:57:17.390 --> 00:57:21.670 align:middle line:84% The third argument is also legitimate and a good point, 00:57:21.670 --> 00:57:25.910 align:middle line:84% which is that lower capital gains encourages 00:57:25.910 --> 00:57:26.970 align:middle line:90% entrepreneurship. 00:57:26.970 --> 00:57:31.550 align:middle line:90% 00:57:31.550 --> 00:57:33.550 align:middle line:84% That basically, if you think about what's 00:57:33.550 --> 00:57:36.010 align:middle line:84% the tax rate you care about when you're starting a company, 00:57:36.010 --> 00:57:39.423 align:middle line:84% a tech company, it's ultimately you want to get rich. 00:57:39.423 --> 00:57:41.090 align:middle line:84% It's not the money you're going to make. 00:57:41.090 --> 00:57:42.750 align:middle line:84% In fact, these companies make no money. 00:57:42.750 --> 00:57:45.630 align:middle line:84% Tesla is still negative profit or maybe marginally positive. 00:57:45.630 --> 00:57:48.470 align:middle line:84% It's the money you make when your stock goes through the roof 00:57:48.470 --> 00:57:50.330 align:middle line:84% and you sell it, and then you're super rich. 00:57:50.330 --> 00:57:52.790 align:middle line:84% Well, the relevant tax rate, then is capital gains. 00:57:52.790 --> 00:57:55.750 align:middle line:84% So the idea is we're going to encourage entrepreneurship 00:57:55.750 --> 00:57:58.630 align:middle line:84% by having a lower capital gains tax rate. 00:57:58.630 --> 00:58:00.070 align:middle line:90% OK? 00:58:00.070 --> 00:58:04.170 align:middle line:84% But this is actually a fairly weak argument for three reasons. 00:58:04.170 --> 00:58:06.590 align:middle line:84% First of all, as I just showed you 10 minutes ago, 00:58:06.590 --> 00:58:08.170 align:middle line:90% it's not clear it works. 00:58:08.170 --> 00:58:11.410 align:middle line:84% A lower tax rate may or may not encourage risk taking. 00:58:11.410 --> 00:58:12.530 align:middle line:90% It's ambiguous. 00:58:12.530 --> 00:58:14.730 align:middle line:90% So that's the first problem. 00:58:14.730 --> 00:58:19.650 align:middle line:84% The second problem, only a tiny fraction of capital gains 00:58:19.650 --> 00:58:21.530 align:middle line:90% actually go to entrepreneurs. 00:58:21.530 --> 00:58:24.810 align:middle line:84% Venture capital is 1% of all capital in America. 00:58:24.810 --> 00:58:25.450 align:middle line:90% OK? 00:58:25.450 --> 00:58:29.930 align:middle line:84% More generally, only about 10% of venture capital investments 00:58:29.930 --> 00:58:33.170 align:middle line:84% that are actually affected, venture capital investors 00:58:33.170 --> 00:58:34.850 align:middle line:90% actually pay taxes. 00:58:34.850 --> 00:58:38.450 align:middle line:84% Most are pensions and other tax-exempt organizations. 00:58:38.450 --> 00:58:41.410 align:middle line:84% So by cutting the taxes, VC is a tiny part of capital. 00:58:41.410 --> 00:58:43.830 align:middle line:84% And most people invest in VC don't pay those taxes anyway. 00:58:43.830 --> 00:58:45.330 align:middle line:84% So it's not clear you're encouraging 00:58:45.330 --> 00:58:47.530 align:middle line:90% investment for that reason. 00:58:47.530 --> 00:58:51.950 align:middle line:84% And then finally, there's the very important point, 00:58:51.950 --> 00:58:54.620 align:middle line:84% which is like the inframarginal point on steroids. 00:58:54.620 --> 00:58:56.370 align:middle line:84% Remember I said the inframarginal point is 00:58:56.370 --> 00:58:58.330 align:middle line:84% we spend a lot of money rewarding activity that already 00:58:58.330 --> 00:59:00.372 align:middle line:84% happened in order to encourage an activity that's 00:59:00.372 --> 00:59:01.250 align:middle line:90% going to happen. 00:59:01.250 --> 00:59:03.790 align:middle line:84% Well, this is even worse because we're not-- 00:59:03.790 --> 00:59:06.808 align:middle line:84% so that would say the idea of the infomercial, 00:59:06.808 --> 00:59:09.350 align:middle line:84% marginal argument was maybe I would have made that investment 00:59:09.350 --> 00:59:10.030 align:middle line:90% anyway. 00:59:10.030 --> 00:59:12.415 align:middle line:84% So let's say it's a capital gains of $40 versus $20. 00:59:12.415 --> 00:59:13.790 align:middle line:84% And you say by cutting it to $20, 00:59:13.790 --> 00:59:15.430 align:middle line:90% I'll encourage the investment. 00:59:15.430 --> 00:59:18.310 align:middle line:84% Well, first of all, we would have done the investment anyway, 00:59:18.310 --> 00:59:20.070 align:middle line:84% then you've just wasted that money. 00:59:20.070 --> 00:59:21.122 align:middle line:90% But what else? 00:59:21.122 --> 00:59:22.830 align:middle line:84% You've also just cut the tax rate in half 00:59:22.830 --> 00:59:24.950 align:middle line:90% on all past investments. 00:59:24.950 --> 00:59:28.470 align:middle line:84% Now, you're clearly not encouraging anything there. 00:59:28.470 --> 00:59:30.387 align:middle line:84% But you've given a huge tax break. 00:59:30.387 --> 00:59:31.970 align:middle line:84% So it's a double inframarginal effect. 00:59:31.970 --> 00:59:33.762 align:middle line:84% The inframarginal effect we learned before, 00:59:33.762 --> 00:59:35.470 align:middle line:84% plus an extra piece, which is a tax 00:59:35.470 --> 00:59:38.770 align:middle line:84% break to all the past investments OK? 00:59:38.770 --> 00:59:40.887 align:middle line:84% That doesn't encourage investment. 00:59:40.887 --> 00:59:41.970 align:middle line:90% Let me put it another way. 00:59:41.970 --> 00:59:43.650 align:middle line:84% Here's the way I like to think about it. 00:59:43.650 --> 00:59:46.090 align:middle line:84% And my mentor Larry Summers proposed this in 1987. 00:59:46.090 --> 00:59:47.470 align:middle line:90% I quite like this. 00:59:47.470 --> 00:59:50.950 align:middle line:84% Imagine I announced I was going to capital gains tax 00:59:50.950 --> 00:59:57.230 align:middle line:84% cut, starting on all investment made starting tomorrow. 00:59:57.230 --> 00:59:58.730 align:middle line:84% On all investment starting tomorrow, 00:59:58.730 --> 01:00:02.090 align:middle line:84% get a cap-- that would have exactly the same effect 01:00:02.090 --> 01:00:05.010 align:middle line:84% of encouraging entrepreneurship, but would not 01:00:05.010 --> 01:00:07.010 align:middle line:84% give away a ton of money to people who 01:00:07.010 --> 01:00:08.770 align:middle line:90% already invested in the past. 01:00:08.770 --> 01:00:10.625 align:middle line:84% That would never fly in Washington. 01:00:10.625 --> 01:00:12.250 align:middle line:84% And the reason it flies is because this 01:00:12.250 --> 01:00:13.770 align:middle line:84% isn't the real reason that people like lower capital 01:00:13.770 --> 01:00:14.395 align:middle line:90% gains tax cuts. 01:00:14.395 --> 01:00:16.062 align:middle line:84% It's because when you cut capital gains, 01:00:16.062 --> 01:00:18.450 align:middle line:84% you give a break to old capital as well as new capital. 01:00:18.450 --> 01:00:20.170 align:middle line:84% And that's an important-- that's why 01:00:20.170 --> 01:00:22.230 align:middle line:84% I say it's the inframarginal effect on steroids. 01:00:22.230 --> 01:00:23.530 align:middle line:84% It's not just rewarding investment 01:00:23.530 --> 01:00:24.550 align:middle line:90% that would have happened anyway. 01:00:24.550 --> 01:00:26.175 align:middle line:84% You're rewarding past investment which, 01:00:26.175 --> 01:00:28.610 align:middle line:90% by definition, happened anyway. 01:00:28.610 --> 01:00:30.548 align:middle line:90% And that is why it's-- 01:00:30.548 --> 01:00:32.090 align:middle line:84% so once again, it's not that it's not 01:00:32.090 --> 01:00:33.670 align:middle line:90% encouraging entrepreneurship. 01:00:33.670 --> 01:00:35.850 align:middle line:84% I'm not saying that this effect is zero. 01:00:35.850 --> 01:00:37.490 align:middle line:84% I'm saying the inframarginal effect 01:00:37.490 --> 01:00:40.350 align:middle line:84% is massive compared to the potential marginal effect. 01:00:40.350 --> 01:00:41.050 align:middle line:90% Yeah? 01:00:41.050 --> 01:00:42.842 align:middle line:84% AUDIENCE: Is it necessarily true that you'd 01:00:42.842 --> 01:00:44.990 align:middle line:84% see the same level of encouraged entrepreneurship? 01:00:44.990 --> 01:00:49.007 align:middle line:84% Because don't you avoid some of the lock-in issues by cutting-- 01:00:49.007 --> 01:00:50.590 align:middle line:84% PROFESSOR: Excellent, excellent point. 01:00:50.590 --> 01:00:52.480 align:middle line:90% You wouldn't get this. 01:00:52.480 --> 01:00:54.230 align:middle line:84% You would get encouraged entrepreneurship. 01:00:54.230 --> 01:00:55.147 align:middle line:90% You wouldn't get this. 01:00:55.147 --> 01:00:57.890 align:middle line:84% Now, the question is-- so this is a separate point. 01:00:57.890 --> 01:01:00.453 align:middle line:84% If you didn't unlock the past capital gains, 01:01:00.453 --> 01:01:01.370 align:middle line:90% you wouldn't get this. 01:01:01.370 --> 01:01:01.930 align:middle line:90% That's a great point. 01:01:01.930 --> 01:01:02.690 align:middle line:90% You would get this. 01:01:02.690 --> 01:01:03.630 align:middle line:84% That's why I'm saying this is the most 01:01:03.630 --> 01:01:05.270 align:middle line:90% legitimate of the arguments. 01:01:05.270 --> 01:01:07.190 align:middle line:84% OK, this is the one I respect the most. 01:01:07.190 --> 01:01:09.430 align:middle line:84% Because this one, I think it's a weak argument 01:01:09.430 --> 01:01:11.110 align:middle line:90% and the evidence is unclear. 01:01:11.110 --> 01:01:13.570 align:middle line:84% This one, I think you just fix any many other ways. 01:01:13.570 --> 01:01:14.810 align:middle line:90% This one's a legit argument. 01:01:14.810 --> 01:01:17.185 align:middle line:84% And the only way to get out of this is with a lower rate. 01:01:17.185 --> 01:01:17.685 align:middle line:90% Yeah? 01:01:17.685 --> 01:01:19.852 align:middle line:84% AUDIENCE: For number 2, if you could mark-to-market, 01:01:19.852 --> 01:01:21.630 align:middle line:84% [? that ?] would be even more efficient? 01:01:21.630 --> 01:01:23.610 align:middle line:84% PROFESSOR: Mark-to-market, then this would go away. 01:01:23.610 --> 01:01:25.950 align:middle line:84% And we clearly shouldn't give a capital gains tax break. 01:01:25.950 --> 01:01:27.490 align:middle line:84% Yeah, if you could mark-to-market. 01:01:27.490 --> 01:01:29.365 align:middle line:84% Now on the other hand, if you mark-to-market, 01:01:29.365 --> 01:01:31.710 align:middle line:84% you'd lose the benefit of taxing realization. 01:01:31.710 --> 01:01:33.870 align:middle line:84% So then capital gains taxes-- let's say we just, 01:01:33.870 --> 01:01:35.930 align:middle line:90% tomorrow, mark-to-market OK? 01:01:35.930 --> 01:01:38.083 align:middle line:84% Well, capital gains taxes would go up. 01:01:38.083 --> 01:01:39.750 align:middle line:84% Now, you then say, well, we should maybe 01:01:39.750 --> 01:01:41.690 align:middle line:84% raise them even more because you'd lose this argument. 01:01:41.690 --> 01:01:43.090 align:middle line:84% But that seems like a double whammy. 01:01:43.090 --> 01:01:44.840 align:middle line:84% You'd already be raising capital gains tax 01:01:44.840 --> 01:01:47.510 align:middle line:90% if you could mark-to-market. 01:01:47.510 --> 01:01:48.410 align:middle line:90% OK? 01:01:48.410 --> 01:01:49.790 align:middle line:90% Other questions? 01:01:49.790 --> 01:01:50.830 align:middle line:90% OK. 01:01:50.830 --> 01:01:54.110 align:middle line:84% AUDIENCE: [INAUDIBLE] argument that lower tax rates means more 01:01:54.110 --> 01:01:55.590 align:middle line:84% money in the economy, which means-- 01:01:55.590 --> 01:01:57.970 align:middle line:84% PROFESSOR: Well, we say that-- what we always 01:01:57.970 --> 01:02:00.410 align:middle line:84% say to that is we're assuming a full employment economy 01:02:00.410 --> 01:02:01.850 align:middle line:90% in all of these discussions. 01:02:01.850 --> 01:02:03.210 align:middle line:90% We're not doing macro. 01:02:03.210 --> 01:02:07.010 align:middle line:84% Now, if you want to take that argument, that's great. 01:02:07.010 --> 01:02:08.350 align:middle line:90% But let's talk. 01:02:08.350 --> 01:02:13.970 align:middle line:84% That's a great segue to why not prefer capital gains taxation. 01:02:13.970 --> 01:02:14.770 align:middle line:90% OK? 01:02:14.770 --> 01:02:16.770 align:middle line:90% Well, here's why not. 01:02:16.770 --> 01:02:21.770 align:middle line:84% In 2017, capital gains accounted for 2/3 of the incomes 01:02:21.770 --> 01:02:27.330 align:middle line:84% of the top 0.01% of households, people's income of above $50 01:02:27.330 --> 01:02:28.290 align:middle line:90% million. 01:02:28.290 --> 01:02:30.770 align:middle line:84% 2/3 of their income was capital gains. 01:02:30.770 --> 01:02:33.070 align:middle line:84% For the bottom 80% of households, 01:02:33.070 --> 01:02:35.510 align:middle line:84% capital gains are 5% of their income. 01:02:35.510 --> 01:02:36.010 align:middle line:90% OK? 01:02:36.010 --> 01:02:37.810 align:middle line:90% Here's another way to put it. 01:02:37.810 --> 01:02:40.610 align:middle line:90% The top 0.1%-- 01:02:40.610 --> 01:02:45.850 align:middle line:84% 0.1% of taxpayers pay the same amount of capital gains taxes 01:02:45.850 --> 01:02:50.850 align:middle line:84% as the bottom 99% of capital gains taxpayers. 01:02:50.850 --> 01:02:53.522 align:middle line:84% It's an incredibly progressive tax. 01:02:53.522 --> 01:02:55.230 align:middle line:84% So the reason why we wouldn't necessarily 01:02:55.230 --> 01:02:57.390 align:middle line:84% want to favor capital gains-- if we go back to our optimal income 01:02:57.390 --> 01:02:59.470 align:middle line:84% tax discussion, you're trading off efficiency 01:02:59.470 --> 01:03:00.610 align:middle line:90% against redistribution. 01:03:00.610 --> 01:03:02.587 align:middle line:84% You get a lot of distribution from this tax. 01:03:02.587 --> 01:03:04.170 align:middle line:84% Moreover, that's how it wouldn't help. 01:03:04.170 --> 01:03:06.837 align:middle line:84% It doesn't help these arguments that Trump made for his tax cuts 01:03:06.837 --> 01:03:08.910 align:middle line:90% in 2017, boosting the economy-- 01:03:08.910 --> 01:03:09.610 align:middle line:90% doesn't work. 01:03:09.610 --> 01:03:10.850 align:middle line:90% It boosts the stock market. 01:03:10.850 --> 01:03:13.030 align:middle line:84% But it's going to people who just save money anyway. 01:03:13.030 --> 01:03:14.550 align:middle line:84% All the money is going to people who aren't consuming it 01:03:14.550 --> 01:03:15.133 align:middle line:90% on the margin. 01:03:15.133 --> 01:03:16.460 align:middle line:90% They're just saving it. 01:03:16.460 --> 01:03:18.210 align:middle line:84% Remember, if we want to boost the economy, 01:03:18.210 --> 01:03:19.410 align:middle line:84% we get money in the hands of poor people. 01:03:19.410 --> 01:03:20.070 align:middle line:90% They spend it. 01:03:20.070 --> 01:03:21.190 align:middle line:84% Getting money in the hands of the rich people 01:03:21.190 --> 01:03:22.050 align:middle line:90% doesn't boost the economy. 01:03:22.050 --> 01:03:23.550 align:middle line:84% It just boosts their bank accounts. 01:03:23.550 --> 01:03:24.590 align:middle line:84% You boost the economy getting money 01:03:24.590 --> 01:03:25.950 align:middle line:90% in the hands of poor people. 01:03:25.950 --> 01:03:31.910 align:middle line:84% So the main argument for raising capital gains taxes 01:03:31.910 --> 01:03:34.350 align:middle line:90% is that it's very progressive. 01:03:34.350 --> 01:03:37.150 align:middle line:84% The second argument, it goes back 01:03:37.150 --> 01:03:39.550 align:middle line:84% to chapter 18, which it moves us back 01:03:39.550 --> 01:03:42.550 align:middle line:84% to the Haig-Simons principle of a broad [? brace ?] 01:03:42.550 --> 01:03:45.510 align:middle line:90% with a low rate. 01:03:45.510 --> 01:03:46.530 align:middle line:90% There's two points here. 01:03:46.530 --> 01:03:49.617 align:middle line:84% One is the higher rate is the rate on capital gains, the more 01:03:49.617 --> 01:03:50.450 align:middle line:90% revenues we'll have. 01:03:50.450 --> 01:03:51.890 align:middle line:90% The lower the rate can be. 01:03:51.890 --> 01:03:52.890 align:middle line:90% That's a small argument. 01:03:52.890 --> 01:03:55.050 align:middle line:84% Capital gains revenues lost aren't that large. 01:03:55.050 --> 01:03:56.490 align:middle line:84% The bigger point is the following. 01:03:56.490 --> 01:03:59.290 align:middle line:84% It's the idea of tax wedges, which 01:03:59.290 --> 01:04:03.250 align:middle line:84% is by taxing capital gains at a [INAUDIBLE] income, 01:04:03.250 --> 01:04:05.310 align:middle line:84% you create jobs for an army of lawyers. 01:04:05.310 --> 01:04:07.770 align:middle line:84% Remember, lawyers are just deadweight loss-- 01:04:07.770 --> 01:04:09.325 align:middle line:84% create jobs for an army of lawyers 01:04:09.325 --> 01:04:11.450 align:middle line:84% to figure out how to recategorize income as capital 01:04:11.450 --> 01:04:17.095 align:middle line:84% gains, therefore creating deadweight loss to just cost 01:04:17.095 --> 01:04:18.970 align:middle line:84% the government tax revenues by shifting money 01:04:18.970 --> 01:04:20.730 align:middle line:90% to this other form. 01:04:20.730 --> 01:04:23.250 align:middle line:84% If all income was taxed the same, none of those lawyers 01:04:23.250 --> 01:04:24.150 align:middle line:90% would have jobs. 01:04:24.150 --> 01:04:25.970 align:middle line:84% So you wouldn't be wasting that money. 01:04:25.970 --> 01:04:27.387 align:middle line:84% They'd go to something productive, 01:04:27.387 --> 01:04:28.890 align:middle line:90% like be doctors or something. 01:04:28.890 --> 01:04:32.910 align:middle line:84% And at the same time, you'd raise more money. 01:04:32.910 --> 01:04:35.130 align:middle line:84% So as the Haig-Simons argument, as well. 01:04:35.130 --> 01:04:39.630 align:middle line:90% So under both efficiency-- 01:04:39.630 --> 01:04:42.310 align:middle line:84% and moreover, there's another version of that argument. 01:04:42.310 --> 01:04:45.130 align:middle line:84% The point is that basically, if you're thinking of investing, 01:04:45.130 --> 01:04:47.850 align:middle line:84% we want you to invest in the asset that yields the highest 01:04:47.850 --> 01:04:51.430 align:middle line:84% return, not the one which yields the highest tax break. 01:04:51.430 --> 01:04:56.170 align:middle line:84% By taxing all asset income equally, we maximize the effect. 01:04:56.170 --> 01:04:57.670 align:middle line:84% We basically maximize the incentive 01:04:57.670 --> 01:04:59.087 align:middle line:84% to effect in the highest returning 01:04:59.087 --> 01:05:02.070 align:middle line:84% asset, not the one which yields the highest tax break. 01:05:02.070 --> 01:05:02.790 align:middle line:90% OK? 01:05:02.790 --> 01:05:05.650 align:middle line:84% And so that is-- those are strong arguments. 01:05:05.650 --> 01:05:09.203 align:middle line:84% Indeed, I-- now, to be fair, I like 01:05:09.203 --> 01:05:10.870 align:middle line:84% to own where I'm outside the mainstream. 01:05:10.870 --> 01:05:12.590 align:middle line:84% I'm outside the mainstream on this. 01:05:12.590 --> 01:05:17.323 align:middle line:90% Most economists think that low-- 01:05:17.323 --> 01:05:19.490 align:middle line:84% having lower capital gains tax rates is a good idea. 01:05:19.490 --> 01:05:21.270 align:middle line:90% Indeed, most countries do. 01:05:21.270 --> 01:05:24.160 align:middle line:84% Actually, even these liberal lefty countries in Europe 01:05:24.160 --> 01:05:26.410 align:middle line:84% have much higher tax rates on labor income than we do. 01:05:26.410 --> 01:05:28.950 align:middle line:84% They actually have very low tax rates on capital income. 01:05:28.950 --> 01:05:31.070 align:middle line:84% Almost every major country has a tax preference 01:05:31.070 --> 01:05:32.590 align:middle line:90% for capital gains. 01:05:32.590 --> 01:05:33.990 align:middle line:90% So clearly, this is in the water 01:05:33.990 --> 01:05:37.470 align:middle line:84% Clearly, this is a feeling that we 01:05:37.470 --> 01:05:40.350 align:middle line:84% can encourage risk taking by raising capital-- by lowering 01:05:40.350 --> 01:05:41.730 align:middle line:90% capital gains tax rates. 01:05:41.730 --> 01:05:43.210 align:middle line:84% There's no evidence to that effect. 01:05:43.210 --> 01:05:44.810 align:middle line:84% Now, I'm not saying there's evidence to the contrary. 01:05:44.810 --> 01:05:46.790 align:middle line:84% It just hasn't really been well studied. 01:05:46.790 --> 01:05:50.280 align:middle line:84% What we can do is we can ask, what 01:05:50.280 --> 01:05:54.200 align:middle line:84% is the elasticity of capital gains 01:05:54.200 --> 01:05:55.700 align:middle line:90% with respect to the tax rate? 01:05:55.700 --> 01:05:57.575 align:middle line:84% That is, we can ask, are we on the wrong side 01:05:57.575 --> 01:05:59.080 align:middle line:90% of the Laffer curve? 01:05:59.080 --> 01:06:02.720 align:middle line:84% If raising capital gains taxes by 1% 01:06:02.720 --> 01:06:05.980 align:middle line:84% means we lose tax revenues-- so the argument-- 01:06:05.980 --> 01:06:08.240 align:middle line:84% the main argument people make-- people often 01:06:08.240 --> 01:06:09.420 align:middle line:90% rely on the locket argument. 01:06:09.420 --> 01:06:11.837 align:middle line:84% They'll say, well, look, if we raise tax on capital gains, 01:06:11.837 --> 01:06:13.960 align:middle line:84% people will never sell their assets, 01:06:13.960 --> 01:06:15.300 align:middle line:90% and we'll actually lose money. 01:06:15.300 --> 01:06:17.400 align:middle line:84% There could be Laffer effect here, right? 01:06:17.400 --> 01:06:20.520 align:middle line:84% If I raised tax by 1% and people decrease their sales 01:06:20.520 --> 01:06:22.760 align:middle line:84% by more than 1%, then actually we 01:06:22.760 --> 01:06:26.040 align:middle line:84% could lose money by raising capital gains tax rates. 01:06:26.040 --> 01:06:28.240 align:middle line:84% So there's actually a wonderful study of that, 01:06:28.240 --> 01:06:31.520 align:middle line:84% and that's illustrated in figure 23-2. 01:06:31.520 --> 01:06:32.720 align:middle line:90% OK? 01:06:32.720 --> 01:06:35.560 align:middle line:84% Which is from a study where they looked 01:06:35.560 --> 01:06:39.560 align:middle line:84% at variation across states in capital gains tax rates. 01:06:39.560 --> 01:06:41.720 align:middle line:84% And this is a graph of the regression coefficients 01:06:41.720 --> 01:06:43.640 align:middle line:90% of what we call an event study. 01:06:43.640 --> 01:06:45.220 align:middle line:90% So how do we read this table? 01:06:45.220 --> 01:06:48.420 align:middle line:84% So first of all, the green line is the regression estimates. 01:06:48.420 --> 01:06:50.540 align:middle line:84% The bars are the standard error bars. 01:06:50.540 --> 01:06:52.980 align:middle line:84% Remember, statistical evidence is only as valuable 01:06:52.980 --> 01:06:54.580 align:middle line:90% as is reliable. 01:06:54.580 --> 01:06:55.200 align:middle line:90% OK? 01:06:55.200 --> 01:06:57.060 align:middle line:84% Lots of people come up with an estimate and say this, 01:06:57.060 --> 01:06:57.760 align:middle line:90% this did this. 01:06:57.760 --> 01:07:00.680 align:middle line:84% But unless they're statistically reliably, it's useless. 01:07:00.680 --> 01:07:02.260 align:middle line:84% So what the error bars are-- what 01:07:02.260 --> 01:07:03.760 align:middle line:84% those error bars are telling you is, 01:07:03.760 --> 01:07:05.140 align:middle line:90% how reliable is the estimate? 01:07:05.140 --> 01:07:08.660 align:middle line:84% What you see is if you look to the left of period 0, 01:07:08.660 --> 01:07:10.900 align:middle line:90% you get an estimate of 0. 01:07:10.900 --> 01:07:13.980 align:middle line:84% That is, what that's saying, is that future capital gains 01:07:13.980 --> 01:07:17.160 align:middle line:84% tax cuts, which people don't know about, 01:07:17.160 --> 01:07:18.440 align:middle line:90% don't affect behavior today. 01:07:18.440 --> 01:07:19.040 align:middle line:90% That's good. 01:07:19.040 --> 01:07:20.180 align:middle line:90% You should want that. 01:07:20.180 --> 01:07:22.340 align:middle line:84% That's what we call a specification check. 01:07:22.340 --> 01:07:24.420 align:middle line:84% If that was not 0, you'd worry that people-- 01:07:24.420 --> 01:07:28.300 align:middle line:84% that these capital gains cuts were, for example, responding 01:07:28.300 --> 01:07:30.640 align:middle line:84% to other things that were in the economy. 01:07:30.640 --> 01:07:32.285 align:middle line:84% This says they're effectively random. 01:07:32.285 --> 01:07:33.660 align:middle line:84% Then you see, the minute they cut 01:07:33.660 --> 01:07:37.140 align:middle line:84% capital gains tax rates, capital gains realizations do go up. 01:07:37.140 --> 01:07:39.740 align:middle line:84% What that says is some combination 01:07:39.740 --> 01:07:43.200 align:middle line:84% of new entrepreneurial activity and the lock in effect exists. 01:07:43.200 --> 01:07:44.620 align:middle line:90% We can't tell which it is. 01:07:44.620 --> 01:07:46.960 align:middle line:84% We know more capital gains are realized and capital 01:07:46.960 --> 01:07:48.440 align:middle line:90% gains tax rate goes up. 01:07:48.440 --> 01:07:50.800 align:middle line:84% We don't know, is that because people 01:07:50.800 --> 01:07:53.160 align:middle line:84% sold assets they were just holding on to 01:07:53.160 --> 01:07:56.120 align:middle line:84% or they actually made new investments and took new risks? 01:07:56.120 --> 01:07:58.400 align:middle line:84% That's the piece we haven't really separated. 01:07:58.400 --> 01:08:03.080 align:middle line:84% But the important thing is the elasticity here is well below 1. 01:08:03.080 --> 01:08:06.720 align:middle line:84% The elasticity is around minus 0.4, 01:08:06.720 --> 01:08:09.560 align:middle line:84% which says that we could raise a lot more revenues by taxing 01:08:09.560 --> 01:08:13.040 align:middle line:84% capital gains or well on the right side of the Laffer curve. 01:08:13.040 --> 01:08:16.160 align:middle line:84% In other words, this says that we could basically 01:08:16.160 --> 01:08:20.399 align:middle line:84% raise capital gains tax rate from its current level of 20% 01:08:20.399 --> 01:08:24.680 align:middle line:84% to something like 50% and still raise money. 01:08:24.680 --> 01:08:27.140 align:middle line:84% Now, the goal with taxation is not to just raise money. 01:08:27.140 --> 01:08:28.600 align:middle line:90% You don't have an optimal tax. 01:08:28.600 --> 01:08:30.460 align:middle line:84% But remember, what term is an optimal tax? 01:08:30.460 --> 01:08:34.160 align:middle line:84% It's the benefits of redistribution against the costs 01:08:34.160 --> 01:08:36.040 align:middle line:90% of lost revenues. 01:08:36.040 --> 01:08:37.592 align:middle line:84% Well here the cost loss revenue says 01:08:37.592 --> 01:08:39.300 align:middle line:84% that we can have a much higher tax rates. 01:08:39.300 --> 01:08:42.319 align:middle line:90% And the benefit is huge. 01:08:42.319 --> 01:08:44.979 align:middle line:84% Their argument would say there's not a lot of argument 01:08:44.979 --> 01:08:47.632 align:middle line:84% for taxing capital gains less than other income. 01:08:47.632 --> 01:08:49.340 align:middle line:84% You favor super rich people, which is not 01:08:49.340 --> 01:08:51.020 align:middle line:90% the goal of the tax system. 01:08:51.020 --> 01:08:54.939 align:middle line:84% And you actually lose money, that you could make money 01:08:54.939 --> 01:08:55.439 align:middle line:90% if you-- 01:08:55.439 --> 01:08:57.939 align:middle line:84% In other words, if you tax capital gains more highly, 01:08:57.939 --> 01:09:01.060 align:middle line:84% you collect more tax revenues from a wealthier segment 01:09:01.060 --> 01:09:02.479 align:middle line:90% of the population. 01:09:02.479 --> 01:09:02.979 align:middle line:90% OK? 01:09:02.979 --> 01:09:07.082 align:middle line:84% Now once again, what's the bottom line efficiency? 01:09:07.082 --> 01:09:08.540 align:middle line:84% That depends on a question we still 01:09:08.540 --> 01:09:09.620 align:middle line:84% haven't answer, which is, how much is 01:09:09.620 --> 01:09:11.620 align:middle line:84% discouraging entrepreneurial activity as opposed 01:09:11.620 --> 01:09:13.010 align:middle line:90% to just undoing the lock in? 01:09:13.010 --> 01:09:15.260 align:middle line:84% But the evidence-- there's at least no strong evidence 01:09:15.260 --> 01:09:18.180 align:middle line:84% that it is encouraging a lot of entrepreneurial activity. 01:09:18.180 --> 01:09:19.680 align:middle line:90% OK? 01:09:19.680 --> 01:09:24.279 align:middle line:84% So that's the first thing we want to cover in this chapter. 01:09:24.279 --> 01:09:26.668 align:middle line:84% Why don't I stop a little early rather 01:09:26.668 --> 01:09:27.960 align:middle line:90% than going on to the next part? 01:09:27.960 --> 01:09:29.279 align:middle line:84% Because I'm going to get into the next part. 01:09:29.279 --> 01:09:31.140 align:middle line:84% I'm going to get into the estate tax, which 01:09:31.140 --> 01:09:32.700 align:middle line:90% is a complicated topic. 01:09:32.700 --> 01:09:35.399 align:middle line:84% And I want to do that all at once. 01:09:35.399 --> 01:09:38.250 align:middle line:84% So I'm just going to stop a little early. 01:09:38.250 --> 01:09:42.000 align:middle line:90%