WEBVTT 00:00:00.000 --> 00:00:00.500 align:middle line:90% 00:00:00.500 --> 00:00:01.967 align:middle line:90% [SQUEAKING] 00:00:01.967 --> 00:00:03.923 align:middle line:90% [RUSTLING] 00:00:03.923 --> 00:00:05.879 align:middle line:90% [CLICKING] 00:00:05.879 --> 00:00:09.738 align:middle line:90% 00:00:09.738 --> 00:00:11.280 align:middle line:84% PROFESSOR: So today, we're continuing 00:00:11.280 --> 00:00:13.067 align:middle line:90% our discussion of chapter 23. 00:00:13.067 --> 00:00:15.400 align:middle line:84% Remember, we're talking about how taxes affect behavior. 00:00:15.400 --> 00:00:17.340 align:middle line:84% We talked about savings and labor supply. 00:00:17.340 --> 00:00:19.680 align:middle line:84% And now we're talking about risk-taking. 00:00:19.680 --> 00:00:22.200 align:middle line:84% And now we'll turn to taxes on wealth. 00:00:22.200 --> 00:00:24.200 align:middle line:84% This is relevant for a particular reason, which 00:00:24.200 --> 00:00:26.600 align:middle line:84% is in the next few decades, the US 00:00:26.600 --> 00:00:28.680 align:middle line:84% will undergo the greatest transfer of wealth 00:00:28.680 --> 00:00:29.740 align:middle line:90% in our nation's history. 00:00:29.740 --> 00:00:33.900 align:middle line:84% Currently, the Baby Boomers, your parents, are sitting on-- 00:00:33.900 --> 00:00:35.400 align:middle line:84% and your parents and their parents-- 00:00:35.400 --> 00:00:38.800 align:middle line:84% are sitting on about $84 trillion in assets 00:00:38.800 --> 00:00:42.100 align:middle line:84% that they are going to leave to their descendants. 00:00:42.100 --> 00:00:45.640 align:middle line:84% That amounts to about 81% of all the wealth in America 00:00:45.640 --> 00:00:48.480 align:middle line:84% will be transferred over the coming decades 00:00:48.480 --> 00:00:51.960 align:middle line:84% to future generations, hopefully yourselves. 00:00:51.960 --> 00:00:55.200 align:middle line:84% And this raises the important issue of, 00:00:55.200 --> 00:00:57.140 align:middle line:90% should that be a taxable event? 00:00:57.140 --> 00:00:58.540 align:middle line:90% And how should it be taxed? 00:00:58.540 --> 00:01:03.800 align:middle line:84% This massive transfer of assets, how should that be taxed? 00:01:03.800 --> 00:01:07.260 align:middle line:84% Now in the US, we have a system what's called transfer taxes. 00:01:07.260 --> 00:01:09.760 align:middle line:90% And they come in two forms. 00:01:09.760 --> 00:01:12.308 align:middle line:90% The first form is the gift tax. 00:01:12.308 --> 00:01:13.100 align:middle line:90% Well, let me start. 00:01:13.100 --> 00:01:14.460 align:middle line:90% The first one is the estate tax. 00:01:14.460 --> 00:01:19.560 align:middle line:84% The way the estate tax works is when you die, 00:01:19.560 --> 00:01:22.880 align:middle line:84% the money you leave behind that gets transferred to descendants 00:01:22.880 --> 00:01:28.120 align:middle line:84% gets taxed, but only above $12 million for a couple. 00:01:28.120 --> 00:01:34.020 align:middle line:84% So basically, for the first $12 million you leave, 00:01:34.020 --> 00:01:35.440 align:middle line:90% it does not get taxed. 00:01:35.440 --> 00:01:37.740 align:middle line:84% Once you're leaving above $12 million, 00:01:37.740 --> 00:01:40.720 align:middle line:84% there's then a marginal tax rate in the above $12 million, 00:01:40.720 --> 00:01:44.240 align:middle line:84% with rates that rise from 18% to 40%. 00:01:44.240 --> 00:01:50.900 align:middle line:84% So this tax, this is what happens when you die. 00:01:50.900 --> 00:01:53.108 align:middle line:84% Now along the way, you could say, well, 00:01:53.108 --> 00:01:54.900 align:middle line:84% then you could just say, look, that's easy. 00:01:54.900 --> 00:01:56.480 align:middle line:84% I could just transfer all the money to my kid the day 00:01:56.480 --> 00:01:57.467 align:middle line:90% before I die. 00:01:57.467 --> 00:01:58.550 align:middle line:90% Then I don't pay that tax. 00:01:58.550 --> 00:02:00.370 align:middle line:84% Well, the government wised up to that. 00:02:00.370 --> 00:02:03.990 align:middle line:84% And we also-- we have what's called a gift tax, 00:02:03.990 --> 00:02:07.430 align:middle line:84% which is gift tax exemption, which basically, in any year, 00:02:07.430 --> 00:02:09.729 align:middle line:84% you can give-- it says $15,000 in the textbook. 00:02:09.729 --> 00:02:11.210 align:middle line:90% It's now up to $18,000. 00:02:11.210 --> 00:02:14.730 align:middle line:84% You can give $18,000 a year to any person. 00:02:14.730 --> 00:02:17.050 align:middle line:90% And that is tax-free to them. 00:02:17.050 --> 00:02:19.570 align:middle line:84% And it can be deducted from your estate. 00:02:19.570 --> 00:02:22.650 align:middle line:84% So let's say I'm going to die with-- 00:02:22.650 --> 00:02:24.610 align:middle line:90% the exemption is $11.6 million. 00:02:24.610 --> 00:02:30.170 align:middle line:84% Say I'm going to die with $11.6 million plus $18,000. 00:02:30.170 --> 00:02:33.370 align:middle line:84% The year before I die, I can give that $18,000 to my kid. 00:02:33.370 --> 00:02:34.970 align:middle line:84% And then I will have no estate tax 00:02:34.970 --> 00:02:36.510 align:middle line:84% when I die because that money will be out. 00:02:36.510 --> 00:02:38.343 align:middle line:84% Here's our guy who likes to have-- go ahead. 00:02:38.343 --> 00:02:39.680 align:middle line:90% AUDIENCE: Is it $18k per person? 00:02:39.680 --> 00:02:41.430 align:middle line:84% PROFESSOR: It's actually better than that. 00:02:41.430 --> 00:02:45.970 align:middle line:84% It's 18k per person per person you give to. 00:02:45.970 --> 00:02:50.210 align:middle line:84% So if you're a married couple with three kids and six 00:02:50.210 --> 00:02:56.330 align:middle line:84% grandkids, each of you can give away nine 18ks. 00:02:56.330 --> 00:03:00.608 align:middle line:84% So you can, as a couple, give away 18 18ks, 00:03:00.608 --> 00:03:02.983 align:middle line:84% because you can give it to each of your children and each 00:03:02.983 --> 00:03:04.130 align:middle line:90% of your grandchildren. 00:03:04.130 --> 00:03:07.530 align:middle line:84% So basically-- and you can do that without-- but anything 00:03:07.530 --> 00:03:09.130 align:middle line:84% you give above that, they're going 00:03:09.130 --> 00:03:11.570 align:middle line:90% to subtract from your 11.6. 00:03:11.570 --> 00:03:13.990 align:middle line:84% So if you give away 100,000 they'll say great. 00:03:13.990 --> 00:03:15.830 align:middle line:90% The first 18k is tax exempt. 00:03:15.830 --> 00:03:18.750 align:middle line:84% But the remaining 82, we're going to now say when you die, 00:03:18.750 --> 00:03:19.790 align:middle line:90% you don't get 11.6. 00:03:19.790 --> 00:03:22.850 align:middle line:90% You 11.518 as your exemption. 00:03:22.850 --> 00:03:24.630 align:middle line:84% So basically it's an integrated set. 00:03:24.630 --> 00:03:26.588 align:middle line:84% Together, these make what we call an integrated 00:03:26.588 --> 00:03:28.050 align:middle line:90% set of transfer taxes. 00:03:28.050 --> 00:03:30.930 align:middle line:84% We can transfer while you're alive or when you're dead. 00:03:30.930 --> 00:03:35.130 align:middle line:84% Ultimately, the bottom line is at least 11.6 million 00:03:35.130 --> 00:03:36.910 align:middle line:84% of those transfers are tax exempt. 00:03:36.910 --> 00:03:39.950 align:middle line:84% More than that is tax exempt if you do it while you're alive, 00:03:39.950 --> 00:03:41.450 align:middle line:90% up to these limits. 00:03:41.450 --> 00:03:45.802 align:middle line:84% Striking fact, there's incredibly little use of gifts 00:03:45.802 --> 00:03:48.010 align:middle line:84% even among people who eventually face the estate tax. 00:03:48.010 --> 00:03:50.410 align:middle line:84% People massively underuse the ability 00:03:50.410 --> 00:03:54.290 align:middle line:84% to give gifts to your kids along the way relative to the estate 00:03:54.290 --> 00:03:54.798 align:middle line:90% tax. 00:03:54.798 --> 00:03:56.090 align:middle line:90% Interesting theories as to why. 00:03:56.090 --> 00:03:58.750 align:middle line:84% The best theory is that people just don't trust their kids. 00:03:58.750 --> 00:04:00.830 align:middle line:84% Either they don't trust them, so they don't give them the money, 00:04:00.830 --> 00:04:01.890 align:middle line:84% or they don't trust them because they're 00:04:01.890 --> 00:04:03.370 align:middle line:84% afraid they'll give it away and then the kids won't take 00:04:03.370 --> 00:04:04.650 align:middle line:90% care of them when they're old. 00:04:04.650 --> 00:04:07.890 align:middle line:84% But it is a fascinating fact that, in fact, 00:04:07.890 --> 00:04:11.265 align:middle line:84% there's a lot of money being left on the table in terms 00:04:11.265 --> 00:04:13.890 align:middle line:84% of excess estate taxes paid by people who could be giving money 00:04:13.890 --> 00:04:15.690 align:middle line:90% along the way and aren't. 00:04:15.690 --> 00:04:21.370 align:middle line:84% Now, the US is not the only country that has estate taxes. 00:04:21.370 --> 00:04:27.470 align:middle line:84% If you look at Table 23.2, this shows how wealth and transfers-- 00:04:27.470 --> 00:04:27.970 align:middle line:90% yeah? 00:04:27.970 --> 00:04:30.610 align:middle line:90% AUDIENCE: [INAUDIBLE] 00:04:30.610 --> 00:04:32.310 align:middle line:84% PROFESSOR: I'm going to get to those. 00:04:32.310 --> 00:04:34.890 align:middle line:90% 00:04:34.890 --> 00:04:37.530 align:middle line:84% Around the world, there's also transfer taxes. 00:04:37.530 --> 00:04:43.210 align:middle line:84% You can see that on average, in the OECD, 0.3% of revenue 00:04:43.210 --> 00:04:45.210 align:middle line:90% is raised from transfer taxes. 00:04:45.210 --> 00:04:47.470 align:middle line:84% In the United States, it's 0.5% of revenue. 00:04:47.470 --> 00:04:50.010 align:middle line:84% So about one in every $20 the government raises 00:04:50.010 --> 00:04:51.610 align:middle line:90% is from transfer taxes. 00:04:51.610 --> 00:04:57.000 align:middle line:84% Some other countries also have wealth taxes. 00:04:57.000 --> 00:04:57.920 align:middle line:90% This is different. 00:04:57.920 --> 00:04:59.920 align:middle line:84% This is not a tax on the transfer of wealth. 00:04:59.920 --> 00:05:02.833 align:middle line:84% It is literally a tax every year on your level of wealth. 00:05:02.833 --> 00:05:04.000 align:middle line:90% And we'll come back to that. 00:05:04.000 --> 00:05:05.940 align:middle line:84% That's something that's been proposed in the US. 00:05:05.940 --> 00:05:08.315 align:middle line:84% That would be very different than we've discussed so far. 00:05:08.315 --> 00:05:10.760 align:middle line:84% Everything we've discussed so far is taxes on flows, 00:05:10.760 --> 00:05:13.000 align:middle line:84% your flow of labor income, your flow of savings, 00:05:13.000 --> 00:05:14.460 align:middle line:90% your flow of transfers. 00:05:14.460 --> 00:05:16.460 align:middle line:84% This is literally a tax on a stock. 00:05:16.460 --> 00:05:19.220 align:middle line:84% As you can see, not many countries do that. 00:05:19.220 --> 00:05:21.060 align:middle line:90% Switzerland does it the most. 00:05:21.060 --> 00:05:23.040 align:middle line:84% Actually, one in every $20 they raise-- 00:05:23.040 --> 00:05:24.800 align:middle line:84% I should have said one in every $200. 00:05:24.800 --> 00:05:26.720 align:middle line:84% When I said half a percent, one in every $200. 00:05:26.720 --> 00:05:31.253 align:middle line:84% One in every $20 Switzerland raises is from the wealth tax. 00:05:31.253 --> 00:05:32.920 align:middle line:84% So let me correct my previous statement. 00:05:32.920 --> 00:05:36.280 align:middle line:84% One in every $200 the US raises is from the wealth tax. 00:05:36.280 --> 00:05:40.020 align:middle line:84% One in every $20 Switzerland raises is from the estate tax. 00:05:40.020 --> 00:05:43.300 align:middle line:84% One in every $20 Switzerland raises from their wealth tax. 00:05:43.300 --> 00:05:46.800 align:middle line:84% Put it all together, and the US is somewhat below average. 00:05:46.800 --> 00:05:50.980 align:middle line:84% The average OECD country raised about almost 0.8% 00:05:50.980 --> 00:05:53.480 align:middle line:84% of their revenues from wealth and transfer taxes. 00:05:53.480 --> 00:05:55.880 align:middle line:90% The US, it's 0.5. 00:05:55.880 --> 00:05:57.860 align:middle line:90% So this is not unique to the US. 00:05:57.860 --> 00:06:00.692 align:middle line:90% So why do countries have these? 00:06:00.692 --> 00:06:02.400 align:middle line:84% Let's focus now on the transfer tax part. 00:06:02.400 --> 00:06:04.500 align:middle line:84% We'll come back to the wealth tax part later. 00:06:04.500 --> 00:06:06.480 align:middle line:84% Let's focus on the transfer tax part. 00:06:06.480 --> 00:06:09.340 align:middle line:84% Why do countries have these transfer taxes? 00:06:09.340 --> 00:06:12.960 align:middle line:84% Well, there's basically one most important argument, 00:06:12.960 --> 00:06:15.580 align:middle line:84% which this is the single most progressive tax that 00:06:15.580 --> 00:06:17.980 align:middle line:84% exists known to mankind, I would argue. 00:06:17.980 --> 00:06:27.780 align:middle line:84% So in the US in 2020, 0.1% of decedents paid the estate tax-- 00:06:27.780 --> 00:06:29.900 align:middle line:90% 0.1%. 00:06:29.900 --> 00:06:37.820 align:middle line:84% So that means we raise 0.5% of our entire federal revenues 00:06:37.820 --> 00:06:42.220 align:middle line:90% of 0.1% of people who die. 00:06:42.220 --> 00:06:44.860 align:middle line:90% That's pretty amazing. 00:06:44.860 --> 00:06:48.760 align:middle line:84% The average estate tax rate was about 17%. 00:06:48.760 --> 00:06:52.980 align:middle line:84% So on average, 0.1% of people are paying about 17% 00:06:52.980 --> 00:06:56.660 align:middle line:84% of their estates to the government. 00:06:56.660 --> 00:06:59.860 align:middle line:84% So for example, if just a simple example 00:06:59.860 --> 00:07:01.500 align:middle line:90% of the importance of this-- 00:07:01.500 --> 00:07:06.700 align:middle line:84% if, in 2009, we exempted 3.5 million from estate tax-- today 00:07:06.700 --> 00:07:08.380 align:middle line:90% it's 11.6 million. 00:07:08.380 --> 00:07:13.020 align:middle line:84% If we returned to 3.5 million, we would raise 27 billion 00:07:13.020 --> 00:07:15.100 align:middle line:90% more every single year. 00:07:15.100 --> 00:07:17.960 align:middle line:84% And in doing so, we would only apply-- 00:07:17.960 --> 00:07:21.380 align:middle line:84% it would only go from applying to-- 00:07:21.380 --> 00:07:23.200 align:middle line:90% it would only apply to-- 00:07:23.200 --> 00:07:27.300 align:middle line:90% 00:07:27.300 --> 00:07:29.540 align:middle line:84% so going further, if we exempted it, 00:07:29.540 --> 00:07:31.460 align:middle line:84% if we lowered it to 1 million, we 00:07:31.460 --> 00:07:34.620 align:middle line:84% could raise almost 800 billion over the next decade. 00:07:34.620 --> 00:07:37.580 align:middle line:84% So there's a lot of money at stake here in this exemption. 00:07:37.580 --> 00:07:41.060 align:middle line:84% So that's the main argument that we tax wealth, 00:07:41.060 --> 00:07:42.720 align:middle line:90% that we might tax transfers. 00:07:42.720 --> 00:07:44.600 align:middle line:84% Another argument is a political argument, 00:07:44.600 --> 00:07:48.433 align:middle line:84% which is that basically political systems fail when 00:07:48.433 --> 00:07:50.100 align:middle line:84% there's more of a concentration of power 00:07:50.100 --> 00:07:53.060 align:middle line:84% in the hands of particularly interested parties, 00:07:53.060 --> 00:07:55.260 align:middle line:84% and that the transfer tax is a way 00:07:55.260 --> 00:07:57.700 align:middle line:84% to reduce the concentration of wealth in the US, 00:07:57.700 --> 00:07:59.800 align:middle line:84% that rich families don't always stay rich, 00:07:59.800 --> 00:08:01.960 align:middle line:84% but that you need to become rich through hard work. 00:08:01.960 --> 00:08:05.673 align:middle line:84% And then in particular, we don't want an aristocracy of the rich 00:08:05.673 --> 00:08:08.340 align:middle line:84% that continually stay rich just because they made a lot of money 00:08:08.340 --> 00:08:09.558 align:middle line:90% in the past. 00:08:09.558 --> 00:08:11.100 align:middle line:84% So that's the argument for the estate 00:08:11.100 --> 00:08:14.340 align:middle line:84% tax, largely progressivity/political 00:08:14.340 --> 00:08:15.692 align:middle line:90% argument. 00:08:15.692 --> 00:08:18.400 align:middle line:84% There are a number of arguments, however, against the estate tax. 00:08:18.400 --> 00:08:21.583 align:middle line:84% And it's very controversial, one of our most controversial taxes. 00:08:21.583 --> 00:08:23.000 align:middle line:84% What are the arguments against it? 00:08:23.000 --> 00:08:25.860 align:middle line:84% The first tax is that it's just darn cruel, 00:08:25.860 --> 00:08:28.380 align:middle line:84% that someone just died, you go to the family 00:08:28.380 --> 00:08:31.580 align:middle line:84% and say, hey, sorry your dad died, but write us a check. 00:08:31.580 --> 00:08:33.740 align:middle line:90% That seems kind of unfair. 00:08:33.740 --> 00:08:35.840 align:middle line:90% Now, that argument is-- 00:08:35.840 --> 00:08:38.860 align:middle line:90% 00:08:38.860 --> 00:08:42.740 align:middle line:84% that is really not, I think, a particularly compelling argument 00:08:42.740 --> 00:08:45.287 align:middle line:84% in the sense that it's the right time to do it, 00:08:45.287 --> 00:08:46.870 align:middle line:84% in the sense that when you die, that's 00:08:46.870 --> 00:08:49.470 align:middle line:84% when we get your assets together and figure out what you owe. 00:08:49.470 --> 00:08:52.965 align:middle line:84% So we're going to tax people on their wealth or anything 00:08:52.965 --> 00:08:54.090 align:middle line:90% approximating their wealth. 00:08:54.090 --> 00:08:55.990 align:middle line:90% That's the time to do it. 00:08:55.990 --> 00:08:58.850 align:middle line:84% So it's also true that like taxes in general, 00:08:58.850 --> 00:09:01.950 align:middle line:84% it's hard to say why taxing a rich guy when he died 00:09:01.950 --> 00:09:05.770 align:middle line:84% is more cruel than taxing a low-income worker 00:09:05.770 --> 00:09:08.450 align:middle line:84% when they go to buy hamburgers with the sales tax. 00:09:08.450 --> 00:09:10.690 align:middle line:84% It's not clear how that's more cruel. 00:09:10.690 --> 00:09:13.110 align:middle line:84% So that's kind of a silly argument. 00:09:13.110 --> 00:09:15.390 align:middle line:84% There is a more rigorous argument, 00:09:15.390 --> 00:09:19.150 align:middle line:84% which is that the estate tax is essentially double taxation. 00:09:19.150 --> 00:09:21.950 align:middle line:84% The idea is you paid taxes your whole life, 00:09:21.950 --> 00:09:24.430 align:middle line:84% you die, and then you're going to pay tax again 00:09:24.430 --> 00:09:25.750 align:middle line:90% on what you saved. 00:09:25.750 --> 00:09:27.630 align:middle line:90% And that seems a bit unfair. 00:09:27.630 --> 00:09:29.830 align:middle line:84% In particular, more than unfair, it 00:09:29.830 --> 00:09:32.700 align:middle line:84% might actually deter people from saving, 00:09:32.700 --> 00:09:34.950 align:middle line:84% because if you're going to save and then just pay back 00:09:34.950 --> 00:09:37.550 align:middle line:90% to the government, why save? 00:09:37.550 --> 00:09:40.150 align:middle line:84% And as we talked about, we're concerned about low levels 00:09:40.150 --> 00:09:41.630 align:middle line:90% of savings in America. 00:09:41.630 --> 00:09:44.430 align:middle line:90% So that's a particular concern. 00:09:44.430 --> 00:09:47.250 align:middle line:84% Now there are three problems with this argument. 00:09:47.250 --> 00:09:48.770 align:middle line:90% This argument has-- yeah? 00:09:48.770 --> 00:09:53.130 align:middle line:84% AUDIENCE: [INAUDIBLE] The people who are at that margin 00:09:53.130 --> 00:09:54.630 align:middle line:84% are not the people who are concerned 00:09:54.630 --> 00:09:55.690 align:middle line:90% about not saving enough. 00:09:55.690 --> 00:09:56.690 align:middle line:90% PROFESSOR: Well, no, no. 00:09:56.690 --> 00:09:57.570 align:middle line:90% Well hold on. 00:09:57.570 --> 00:09:59.890 align:middle line:84% If we care, there's two different reasons 00:09:59.890 --> 00:10:01.390 align:middle line:90% we care about saving. 00:10:01.390 --> 00:10:03.542 align:middle line:84% There's making sure people can smooth 00:10:03.542 --> 00:10:06.250 align:middle line:84% their consumption through shocks and have something to retire on. 00:10:06.250 --> 00:10:08.670 align:middle line:84% And then there's the aggregate capital stock. 00:10:08.670 --> 00:10:10.550 align:middle line:84% For the aggregate capital stock, that's exactly are the people 00:10:10.550 --> 00:10:12.710 align:middle line:84% we care about because they do most of the savings. 00:10:12.710 --> 00:10:14.168 align:middle line:84% The rich who do most of the savings 00:10:14.168 --> 00:10:15.910 align:middle line:84% exactly are the people we care about. 00:10:15.910 --> 00:10:18.550 align:middle line:84% So now there's three counterarguments. 00:10:18.550 --> 00:10:21.350 align:middle line:84% The first is-- I always go back to this old saw, which 00:10:21.350 --> 00:10:24.170 align:middle line:84% is, given income and substitution effects, 00:10:24.170 --> 00:10:25.750 align:middle line:84% we don't know which way this goes. 00:10:25.750 --> 00:10:27.750 align:middle line:84% We don't know if taxing estates leads to smaller 00:10:27.750 --> 00:10:28.827 align:middle line:90% states or bigger estates. 00:10:28.827 --> 00:10:31.410 align:middle line:84% If your goal is to leave a fixed amount of money to your kids, 00:10:31.410 --> 00:10:33.870 align:middle line:84% then estate taxes will lead to bigger estates. 00:10:33.870 --> 00:10:35.750 align:middle line:84% So it's not clear which way it goes. 00:10:35.750 --> 00:10:37.070 align:middle line:90% That's argument one. 00:10:37.070 --> 00:10:40.530 align:middle line:84% Argument two is that much like the death tax is cruel, 00:10:40.530 --> 00:10:42.970 align:middle line:84% double taxation is cruel, it's also a silly argument. 00:10:42.970 --> 00:10:44.870 align:middle line:84% We all face double taxation every day 00:10:44.870 --> 00:10:47.490 align:middle line:84% when we buy anything that pays the sales tax. 00:10:47.490 --> 00:10:48.770 align:middle line:90% We paid taxes on our wages. 00:10:48.770 --> 00:10:50.270 align:middle line:84% Now we're paying taxes on our sales. 00:10:50.270 --> 00:10:52.550 align:middle line:84% Why should we get rid of the double taxation of incredibly 00:10:52.550 --> 00:10:54.758 align:middle line:84% rich people, but leave it in place for the rest of us 00:10:54.758 --> 00:10:56.670 align:middle line:90% through sales taxation? 00:10:56.670 --> 00:11:00.430 align:middle line:84% So that seems kind of a weak argument. 00:11:00.430 --> 00:11:03.670 align:middle line:84% And then finally, there's an important conceptual point this 00:11:03.670 --> 00:11:06.830 align:middle line:84% misses, which is if you remember when we talked about the tax 00:11:06.830 --> 00:11:09.070 align:middle line:84% favoritism towards capital gains, 00:11:09.070 --> 00:11:12.130 align:middle line:84% I mentioned you could exempt $500,000 of your house. 00:11:12.130 --> 00:11:13.450 align:middle line:90% I mentioned the rate's lower. 00:11:13.450 --> 00:11:15.075 align:middle line:84% I also then quickly mentioned something 00:11:15.075 --> 00:11:17.350 align:middle line:84% called the step up in basis at death, 00:11:17.350 --> 00:11:20.790 align:middle line:84% which is that when you die, the basis at which you 00:11:20.790 --> 00:11:23.210 align:middle line:84% sell assets gets raised to value when you die. 00:11:23.210 --> 00:11:24.788 align:middle line:84% So once again, remember the example. 00:11:24.788 --> 00:11:26.330 align:middle line:84% If I have a painting I bought for $10 00:11:26.330 --> 00:11:29.130 align:middle line:84% and it's now worth a million, if I sell it the day before I die, 00:11:29.130 --> 00:11:31.122 align:middle line:84% I pay capital gains on the million minus 10. 00:11:31.122 --> 00:11:33.330 align:middle line:84% If I leave it to my kid and he sells it the next day, 00:11:33.330 --> 00:11:35.630 align:middle line:84% they pay no capital gains because the basis 00:11:35.630 --> 00:11:37.070 align:middle line:90% is raised to a million. 00:11:37.070 --> 00:11:38.050 align:middle line:90% What does that mean? 00:11:38.050 --> 00:11:39.480 align:middle line:84% That means capital gains are never 00:11:39.480 --> 00:11:42.380 align:middle line:90% taxed absent the estate tax. 00:11:42.380 --> 00:11:44.760 align:middle line:84% So the argument of double taxation is actually wrong. 00:11:44.760 --> 00:11:47.320 align:middle line:84% For capital gains, it's single taxation. 00:11:47.320 --> 00:11:49.495 align:middle line:84% Absent the estate tax with this step up, 00:11:49.495 --> 00:11:51.120 align:middle line:84% capital gains would never face taxation 00:11:51.120 --> 00:11:53.280 align:middle line:84% if you passed it on to your kids. 00:11:53.280 --> 00:11:55.080 align:middle line:84% So in some sense, it's not just-- 00:11:55.080 --> 00:11:56.820 align:middle line:84% it's double taxation in some sense, 00:11:56.820 --> 00:11:59.320 align:middle line:84% but it's also, for capital gains, single taxation. 00:11:59.320 --> 00:12:01.240 align:middle line:84% So that's another weakness of this argument. 00:12:01.240 --> 00:12:05.080 align:middle line:84% Nonetheless, it's a legit argument, theoretically. 00:12:05.080 --> 00:12:09.640 align:middle line:84% Another argument is that this is just an enormously complicated 00:12:09.640 --> 00:12:11.185 align:middle line:90% tax to administer. 00:12:11.185 --> 00:12:12.560 align:middle line:84% It's just hard to figure out what 00:12:12.560 --> 00:12:14.800 align:middle line:84% people's assets are to add it all together, to put it 00:12:14.800 --> 00:12:16.880 align:middle line:90% all together. 00:12:16.880 --> 00:12:20.960 align:middle line:84% And also, you're basically saying to people, hey, 00:12:20.960 --> 00:12:22.300 align:middle line:90% grandpa died. 00:12:22.300 --> 00:12:24.140 align:middle line:84% He's got this farm worth $20 million. 00:12:24.140 --> 00:12:25.693 align:middle line:84% You kids have to pay us $2 million. 00:12:25.693 --> 00:12:27.360 align:middle line:84% And the kids are like, we can't pay that 00:12:27.360 --> 00:12:28.600 align:middle line:90% without selling the farm. 00:12:28.600 --> 00:12:30.367 align:middle line:84% You're going to force me to sell the farm. 00:12:30.367 --> 00:12:32.200 align:middle line:84% This is a common argument against these kind 00:12:32.200 --> 00:12:35.880 align:middle line:84% of wealth taxes, is people just can't afford it at that time. 00:12:35.880 --> 00:12:39.240 align:middle line:84% Now it turns out-- and that is the number one 00:12:39.240 --> 00:12:40.500 align:middle line:90% argument against estate taxes. 00:12:40.500 --> 00:12:41.965 align:middle line:90% It's all about the farmers, man. 00:12:41.965 --> 00:12:43.840 align:middle line:84% If you look at people who oppose state taxes, 00:12:43.840 --> 00:12:46.320 align:middle line:84% or what they call the death tax, it's 00:12:46.320 --> 00:12:48.120 align:middle line:90% all about these poor farmers. 00:12:48.120 --> 00:12:53.680 align:middle line:84% Well, it turns out that in 2013, when the exemption was half 00:12:53.680 --> 00:12:57.280 align:middle line:84% of what it is today, 80 farms and small businesses 00:12:57.280 --> 00:12:58.340 align:middle line:90% paid the estate tax. 00:12:58.340 --> 00:13:00.000 align:middle line:90% 80. 00:13:00.000 --> 00:13:02.240 align:middle line:84% This is, once again, another red herring 00:13:02.240 --> 00:13:06.013 align:middle line:84% that's used to oppose what's very progressive taxation. 00:13:06.013 --> 00:13:07.680 align:middle line:84% The truth is we also have a system where 00:13:07.680 --> 00:13:10.777 align:middle line:84% when the estate tax is owed, you can pay it back over 17 years. 00:13:10.777 --> 00:13:12.360 align:middle line:84% So you can essentially take a loan out 00:13:12.360 --> 00:13:14.240 align:middle line:84% against your farm to pay it back. 00:13:14.240 --> 00:13:16.893 align:middle line:84% So it's, once again, not a super compelling argument. 00:13:16.893 --> 00:13:19.560 align:middle line:84% But the final argument, I think, is probably the most compelling 00:13:19.560 --> 00:13:23.600 align:middle line:84% and the most interesting, which is that basically, the estate 00:13:23.600 --> 00:13:25.800 align:middle line:84% tax is a tax on the unprepared or, to be 00:13:25.800 --> 00:13:28.560 align:middle line:84% less charitable, a tax on the stupid, 00:13:28.560 --> 00:13:32.680 align:middle line:84% which is that basically, with good tax planning, 00:13:32.680 --> 00:13:35.920 align:middle line:84% you can avoid a lot of the estate tax. 00:13:35.920 --> 00:13:38.540 align:middle line:84% So for example, if you give away those gifts every year, 00:13:38.540 --> 00:13:39.935 align:middle line:90% you can avoid the estate tax. 00:13:39.935 --> 00:13:42.060 align:middle line:84% Second of all, you can set up what's called trusts. 00:13:42.060 --> 00:13:43.220 align:middle line:84% This was Steven's earlier question. 00:13:43.220 --> 00:13:45.680 align:middle line:84% You can set up a trust where basically, what that means 00:13:45.680 --> 00:13:47.822 align:middle line:90% is you can put away money. 00:13:47.822 --> 00:13:49.780 align:middle line:84% Let's say you want to leave money to your kids, 00:13:49.780 --> 00:13:52.760 align:middle line:84% but you don't want to give your six-year-old kid $18,000. 00:13:52.760 --> 00:13:54.133 align:middle line:90% You put it in a trust. 00:13:54.133 --> 00:13:55.800 align:middle line:84% And then every year, you can leave money 00:13:55.800 --> 00:13:57.965 align:middle line:84% to all your decedents-- in fact, anyone you know. 00:13:57.965 --> 00:13:59.340 align:middle line:84% It doesn't have to be a decedent. 00:13:59.340 --> 00:14:01.600 align:middle line:84% You can leave money to anyone into this trust, 00:14:01.600 --> 00:14:03.440 align:middle line:84% and they can't get it till they're older. 00:14:03.440 --> 00:14:05.273 align:middle line:84% So you can deal with your desire for control 00:14:05.273 --> 00:14:08.560 align:middle line:84% and your desire to avoid taxes in that way. 00:14:08.560 --> 00:14:10.100 align:middle line:84% Moreover, it's even worse than that. 00:14:10.100 --> 00:14:12.760 align:middle line:84% If you leave stock in a trust, the entire appreciation 00:14:12.760 --> 00:14:14.880 align:middle line:90% is tax free. 00:14:14.880 --> 00:14:21.340 align:middle line:84% So if I put a stock in a trust and it goes through the roof, 00:14:21.340 --> 00:14:24.880 align:middle line:84% then basically, the kids get that all tax-free. 00:14:24.880 --> 00:14:27.280 align:middle line:84% So basically, there's a lot of argument 00:14:27.280 --> 00:14:30.200 align:middle line:84% that, essentially, these loopholes 00:14:30.200 --> 00:14:32.440 align:middle line:90% mean that it's really unfair. 00:14:32.440 --> 00:14:35.570 align:middle line:84% It's unfair to have a tax where the more sophisticated people 00:14:35.570 --> 00:14:38.570 align:middle line:84% can basically largely avoid it, and the less sophisticated 00:14:38.570 --> 00:14:39.070 align:middle line:90% can't. 00:14:39.070 --> 00:14:42.090 align:middle line:90% 00:14:42.090 --> 00:14:43.890 align:middle line:84% I think that's a legitimate point. 00:14:43.890 --> 00:14:45.570 align:middle line:84% I mean, there's a really interesting 00:14:45.570 --> 00:14:47.530 align:middle line:84% philosophical question about, do we 00:14:47.530 --> 00:14:50.650 align:middle line:84% want policies in America that, think about the extreme, that 00:14:50.650 --> 00:14:52.010 align:middle line:90% aren't enforceable? 00:14:52.010 --> 00:14:55.970 align:middle line:84% Probably not, because it deters faith in government 00:14:55.970 --> 00:14:57.270 align:middle line:90% and doesn't do any good. 00:14:57.270 --> 00:14:59.250 align:middle line:84% So if you literally thought about a law which 00:14:59.250 --> 00:15:01.450 align:middle line:84% was annoying and totally avoidable, 00:15:01.450 --> 00:15:04.250 align:middle line:90% that's probably a very bad law. 00:15:04.250 --> 00:15:06.450 align:middle line:84% So basically, the question is, does the estate tax 00:15:06.450 --> 00:15:07.310 align:middle line:90% cross that line? 00:15:07.310 --> 00:15:08.650 align:middle line:90% I would argue not. 00:15:08.650 --> 00:15:10.790 align:middle line:84% I would argue yeah, there's some avoidance. 00:15:10.790 --> 00:15:13.210 align:middle line:84% But at the end of the day, it does raise about $20 billion 00:15:13.210 --> 00:15:14.010 align:middle line:90% a year. 00:15:14.010 --> 00:15:16.890 align:middle line:84% That's a lot of money you raised off the top 0.1% of richest 00:15:16.890 --> 00:15:19.935 align:middle line:84% families every year-- richest families who die every year. 00:15:19.935 --> 00:15:22.310 align:middle line:84% So I would argue that while that's a legitimate argument, 00:15:22.310 --> 00:15:24.960 align:middle line:84% it's hard to say it's large enough to offset $20 billion 00:15:24.960 --> 00:15:25.710 align:middle line:90% a year in revenue. 00:15:25.710 --> 00:15:27.710 align:middle line:90% But it is a legitimate argument. 00:15:27.710 --> 00:15:28.690 align:middle line:90% Yeah? 00:15:28.690 --> 00:15:30.570 align:middle line:84% AUDIENCE: [INAUDIBLE] growth in trust 00:15:30.570 --> 00:15:32.770 align:middle line:84% happens in a similar [INAUDIBLE] basis, then? 00:15:32.770 --> 00:15:34.442 align:middle line:90% Or how is it that can happen? 00:15:34.442 --> 00:15:36.150 align:middle line:84% PROFESSOR: It's just the way trusts work. 00:15:36.150 --> 00:15:37.650 align:middle line:84% Anything I put in a trust, then it's 00:15:37.650 --> 00:15:40.430 align:middle line:84% just if I'm putting stock in a trust and then it grows. 00:15:40.430 --> 00:15:43.890 align:middle line:84% It's the same with-- by the way, you were too young. 00:15:43.890 --> 00:15:46.190 align:middle line:84% But when Mitt Romney ran for president in 2012, 00:15:46.190 --> 00:15:48.290 align:middle line:84% it turned out he had like $5 million in his IRA 00:15:48.290 --> 00:15:50.387 align:middle line:90% or $50 million in his IRA. 00:15:50.387 --> 00:15:52.470 align:middle line:84% Well you might say, with a limit of $6,000 a year, 00:15:52.470 --> 00:15:53.720 align:middle line:90% how could he have $50 million? 00:15:53.720 --> 00:15:55.717 align:middle line:84% Because he put stock in and that all grew. 00:15:55.717 --> 00:15:58.050 align:middle line:84% Now the IRA, of course, what he takes out will be taxed. 00:15:58.050 --> 00:16:01.070 align:middle line:84% With the trust, it won't be taxed. 00:16:01.070 --> 00:16:01.570 align:middle line:90% So-- 00:16:01.570 --> 00:16:04.195 align:middle line:84% AUDIENCE: Do people ever invest not through a trust [INAUDIBLE] 00:16:04.195 --> 00:16:05.490 align:middle line:90% they're a beneficiary? 00:16:05.490 --> 00:16:07.030 align:middle line:84% PROFESSOR: Well, you can't make yourself the only beneficiary. 00:16:07.030 --> 00:16:08.110 align:middle line:84% Someone else has to be the beneficiary. 00:16:08.110 --> 00:16:09.818 align:middle line:84% And there has to be an objective trustee. 00:16:09.818 --> 00:16:13.970 align:middle line:84% There's various hurdles you have to go through. 00:16:13.970 --> 00:16:16.690 align:middle line:84% So that's the estate tax debate, which 00:16:16.690 --> 00:16:18.690 align:middle line:90% I think is largely pretty-- 00:16:18.690 --> 00:16:19.630 align:middle line:90% I'm being pretty calm. 00:16:19.630 --> 00:16:21.172 align:middle line:84% Usually, I get more irate about this. 00:16:21.172 --> 00:16:24.170 align:middle line:84% It's pretty straightforward that we should have higher estate 00:16:24.170 --> 00:16:24.990 align:middle line:90% taxes. 00:16:24.990 --> 00:16:26.590 align:middle line:84% That's a very progressive way to raise revenue. 00:16:26.590 --> 00:16:29.048 align:middle line:84% It's hard to argue there's a lot of negative effects of it. 00:16:29.048 --> 00:16:32.490 align:middle line:84% Unfortunately, what's interesting is the taxes that 00:16:32.490 --> 00:16:35.910 align:middle line:84% seem to make the people most upset are taxes on stocks, 00:16:35.910 --> 00:16:36.750 align:middle line:90% not flows. 00:16:36.750 --> 00:16:39.030 align:middle line:84% So we'll talk later about the property tax on homes. 00:16:39.030 --> 00:16:41.488 align:middle line:84% That's another tax that gets people really, really upset, 00:16:41.488 --> 00:16:43.030 align:middle line:84% because the theory is, wait a second. 00:16:43.030 --> 00:16:44.072 align:middle line:90% I've just got this asset. 00:16:44.072 --> 00:16:44.863 align:middle line:90% It's sitting there. 00:16:44.863 --> 00:16:46.090 align:middle line:90% And you want to tax me on it? 00:16:46.090 --> 00:16:46.870 align:middle line:90% That seems unfair. 00:16:46.870 --> 00:16:49.377 align:middle line:84% When I earn income, I see I'm making something. 00:16:49.377 --> 00:16:50.710 align:middle line:90% You just want to tax me on that. 00:16:50.710 --> 00:16:51.670 align:middle line:90% That seems unfair. 00:16:51.670 --> 00:16:54.130 align:middle line:84% And that leads us to the debate over wealth taxation. 00:16:54.130 --> 00:16:57.590 align:middle line:84% So, as you know, in the 2020 presidential election, 00:16:57.590 --> 00:16:59.590 align:middle line:84% a big topic of conversation was wealth taxation. 00:16:59.590 --> 00:17:02.710 align:middle line:84% Elizabeth Warren made a lot of news by proposing a wealth tax. 00:17:02.710 --> 00:17:06.609 align:middle line:84% She proposed a wealth tax of 2% on people 00:17:06.609 --> 00:17:10.250 align:middle line:90% with assets over $50 million. 00:17:10.250 --> 00:17:14.790 align:middle line:84% So that's only the richest 0.06% of families. 00:17:14.790 --> 00:17:18.089 align:middle line:84% Her proposal was every year, the richest 0.06% of families 00:17:18.089 --> 00:17:20.470 align:middle line:84% would pay a tax of 2% on the money. 00:17:20.470 --> 00:17:22.810 align:middle line:90% They have above 50 million. 00:17:22.810 --> 00:17:26.730 align:middle line:84% That tax would raise $3 trillion over a decade, 00:17:26.730 --> 00:17:28.967 align:middle line:84% just to speak to the wealth inequality in America. 00:17:28.967 --> 00:17:29.800 align:middle line:90% So think about that. 00:17:29.800 --> 00:17:32.700 align:middle line:84% You're just taking the richest 0.06% of people, 00:17:32.700 --> 00:17:36.680 align:middle line:84% making them pay 2% of the amount they have about 50 million, 00:17:36.680 --> 00:17:40.820 align:middle line:84% and that would raise almost $3 trillion over a decade. 00:17:40.820 --> 00:17:43.820 align:middle line:84% The problem with that is that basically-- there 00:17:43.820 --> 00:17:44.600 align:middle line:90% were two problems. 00:17:44.600 --> 00:17:47.860 align:middle line:84% One is that basically, it would be unenforceable. 00:17:47.860 --> 00:17:49.700 align:middle line:84% Wealth is incredibly hard to measure. 00:17:49.700 --> 00:17:51.080 align:middle line:84% Forms of wealth are incredible to measure. 00:17:51.080 --> 00:17:52.497 align:middle line:84% Everyone would shift their wealth. 00:17:52.497 --> 00:17:55.602 align:middle line:84% Basically, there's easy parts to measure wealth, which is stocks. 00:17:55.602 --> 00:17:57.560 align:middle line:84% There's the hardest parts of wealth to measure, 00:17:57.560 --> 00:18:00.060 align:middle line:84% like paintings and privately held businesses. 00:18:00.060 --> 00:18:03.040 align:middle line:84% And basically, it would be incredibly hard to enforce this. 00:18:03.040 --> 00:18:05.620 align:middle line:84% And once again, it would cross that boundary of the juice 00:18:05.620 --> 00:18:07.900 align:middle line:84% not being worth the squeeze, that the effort we'd 00:18:07.900 --> 00:18:10.380 align:middle line:84% have to do to enforce this and the uproar it would cause 00:18:10.380 --> 00:18:13.420 align:middle line:84% would not be worth the revenues we'd raise. 00:18:13.420 --> 00:18:17.147 align:middle line:84% And so basically, the question is, does it raise revenue? 00:18:17.147 --> 00:18:18.980 align:middle line:84% And actually, there's now a large literature 00:18:18.980 --> 00:18:21.800 align:middle line:84% that I've contributed to on wealth taxes in other countries. 00:18:21.800 --> 00:18:24.820 align:middle line:84% I studied Switzerland, which has the world's largest wealth tax. 00:18:24.820 --> 00:18:29.180 align:middle line:84% And the evidence is that basically, wealth taxes 00:18:29.180 --> 00:18:32.317 align:middle line:84% do raise money, in the sense that people can't avoid them. 00:18:32.317 --> 00:18:34.400 align:middle line:84% But people are still pretty good at avoiding them. 00:18:34.400 --> 00:18:35.640 align:middle line:84% And so if you think about the Laffer curve, 00:18:35.640 --> 00:18:37.980 align:middle line:84% we're still on the right side of the Laffer curve. 00:18:37.980 --> 00:18:40.140 align:middle line:84% They do raise money, but we're still 00:18:40.140 --> 00:18:42.580 align:middle line:84% pretty-- we're almost at the top, in the sense 00:18:42.580 --> 00:18:44.740 align:middle line:84% that people are pretty good at avoiding them. 00:18:44.740 --> 00:18:48.635 align:middle line:84% So basically, wealth taxes won't raise nearly the $3 trillion 00:18:48.635 --> 00:18:49.760 align:middle line:90% Elizabeth Warren estimated. 00:18:49.760 --> 00:18:51.500 align:middle line:84% It wouldn't have raised nearly that much. 00:18:51.500 --> 00:18:53.487 align:middle line:90% But even at half that-- 00:18:53.487 --> 00:18:55.820 align:middle line:84% let's say she was wrong and it only raised half as much. 00:18:55.820 --> 00:18:57.740 align:middle line:84% $1.5 trillion over decades is a lot of money 00:18:57.740 --> 00:19:02.740 align:middle line:84% to raise off the 0.06% richest families in America. 00:19:02.740 --> 00:19:05.025 align:middle line:84% So there's a lot of interesting arguments. 00:19:05.025 --> 00:19:06.400 align:middle line:84% Thinking about this also legally, 00:19:06.400 --> 00:19:08.358 align:middle line:84% apparently, it's not clear it's constitutional. 00:19:08.358 --> 00:19:11.220 align:middle line:84% That's a whole separate issue I'm not prepared to weigh in on. 00:19:11.220 --> 00:19:13.900 align:middle line:84% But basically, the wealth tax is certainly 00:19:13.900 --> 00:19:15.880 align:middle line:90% something that will not go away. 00:19:15.880 --> 00:19:22.220 align:middle line:90% 00:19:22.220 --> 00:19:26.580 align:middle line:84% According to the latest estimates, 20% of households-- 00:19:26.580 --> 00:19:29.880 align:middle line:84% I'm sorry, 20% of all wealth in America-- 00:19:29.880 --> 00:19:33.200 align:middle line:84% America is a 360-million-person country. 00:19:33.200 --> 00:19:36.700 align:middle line:84% 20% of all the wealth is held by 250,000 people. 00:19:36.700 --> 00:19:40.020 align:middle line:84% Hold 20% of the wealth-- and yet their effective tax rates 00:19:40.020 --> 00:19:42.900 align:middle line:84% are lower than the average tax rate in America. 00:19:42.900 --> 00:19:47.420 align:middle line:84% So the 250,000 people who hold 20% of all the wealth 00:19:47.420 --> 00:19:50.205 align:middle line:84% in America, because of things like capital gains exemptions, 00:19:50.205 --> 00:19:52.580 align:middle line:84% step up in basis at death, and other ways to avoid estate 00:19:52.580 --> 00:19:55.840 align:middle line:84% taxation, they actually pay less in tax than, say, 00:19:55.840 --> 00:19:59.077 align:middle line:84% I do as a professor or a middle class worker would pay. 00:19:59.077 --> 00:20:01.160 align:middle line:84% So basically, this debate is not going to go away. 00:20:01.160 --> 00:20:01.968 align:middle line:90% Yeah? 00:20:01.968 --> 00:20:04.385 align:middle line:84% AUDIENCE: That's a portion of their income or their wealth 00:20:04.385 --> 00:20:04.600 align:middle line:90% or-- 00:20:04.600 --> 00:20:05.480 align:middle line:90% PROFESSOR: Great question. 00:20:05.480 --> 00:20:07.063 align:middle line:84% When this is measured, they measure it 00:20:07.063 --> 00:20:08.355 align:middle line:90% as their effective wealth flow. 00:20:08.355 --> 00:20:10.771 align:middle line:84% Their income is very low because they just are building up 00:20:10.771 --> 00:20:11.980 align:middle line:90% this huge stock of wealth. 00:20:11.980 --> 00:20:14.300 align:middle line:84% So what they say is, where these calculations are done 00:20:14.300 --> 00:20:15.860 align:middle line:84% is they say, look, take your wealth. 00:20:15.860 --> 00:20:17.280 align:middle line:84% Effectively, what's your flow on that? 00:20:17.280 --> 00:20:19.520 align:middle line:84% We can't measure it because it's all privately-held businesses. 00:20:19.520 --> 00:20:21.080 align:middle line:84% We can measure what's the effective flow. 00:20:21.080 --> 00:20:22.740 align:middle line:84% And then we can say, how much are you paying in tax compared 00:20:22.740 --> 00:20:23.920 align:middle line:90% to that effective flow? 00:20:23.920 --> 00:20:25.300 align:middle line:90% And the answer is very low. 00:20:25.300 --> 00:20:26.580 align:middle line:84% AUDIENCE: Flow as in the appreciation? 00:20:26.580 --> 00:20:28.413 align:middle line:84% PROFESSOR: The appreciation of those assets. 00:20:28.413 --> 00:20:30.740 align:middle line:84% So in other words, imagine that your capital gains 00:20:30.740 --> 00:20:31.820 align:middle line:90% were taxed on accrual. 00:20:31.820 --> 00:20:34.580 align:middle line:84% So the accrual of your wealth, even if it's not realized, 00:20:34.580 --> 00:20:35.700 align:middle line:84% we're going to measure how much you're paying a tax 00:20:35.700 --> 00:20:36.560 align:middle line:90% rate to the accrual. 00:20:36.560 --> 00:20:37.777 align:middle line:90% And it's tiny. 00:20:37.777 --> 00:20:39.360 align:middle line:84% It's tiny when measured in that basis. 00:20:39.360 --> 00:20:40.200 align:middle line:90% Yeah? 00:20:40.200 --> 00:20:41.820 align:middle line:84% AUDIENCE: Politically, if we wanted 00:20:41.820 --> 00:20:44.840 align:middle line:84% to change that, if we wanted to get their effective tax rate up, 00:20:44.840 --> 00:20:45.840 align:middle line:90% would that be difficult? 00:20:45.840 --> 00:20:48.060 align:middle line:84% Because do you foresee that group of people 00:20:48.060 --> 00:20:50.220 align:middle line:84% has a lot of political power or ties 00:20:50.220 --> 00:20:52.100 align:middle line:90% to people with political power? 00:20:52.100 --> 00:20:53.700 align:middle line:84% PROFESSOR: This is, in some sense, 00:20:53.700 --> 00:20:56.467 align:middle line:84% the vicious cycle of wealth concentration, 00:20:56.467 --> 00:20:58.300 align:middle line:84% which is that wealth gets very concentrated, 00:20:58.300 --> 00:20:59.820 align:middle line:84% that leads to political power, which 00:20:59.820 --> 00:21:01.900 align:middle line:84% makes it harder to take on issues, 00:21:01.900 --> 00:21:04.400 align:middle line:84% which makes it harder to take on those progressivity issues. 00:21:04.400 --> 00:21:07.540 align:middle line:90% And that is a concern. 00:21:07.540 --> 00:21:11.380 align:middle line:90% It's a large concern, I think. 00:21:11.380 --> 00:21:14.160 align:middle line:84% We have, in the past, raised taxes on the wealthy, 00:21:14.160 --> 00:21:16.520 align:middle line:84% most notably to fund the Affordable Care Act. 00:21:16.520 --> 00:21:20.340 align:middle line:84% We put in a large new tax on the highest-income Americans. 00:21:20.340 --> 00:21:22.590 align:middle line:90% That wasn't that long ago. 00:21:22.590 --> 00:21:27.370 align:middle line:84% But nonetheless, I believe it's a challenge that faces us. 00:21:27.370 --> 00:21:30.520 align:middle line:84% And the question is, how we're going to deal with a society, 00:21:30.520 --> 00:21:32.270 align:middle line:84% with one where increasing shares of wealth 00:21:32.270 --> 00:21:33.770 align:middle line:84% are concentrated in fewer people who 00:21:33.770 --> 00:21:36.750 align:middle line:84% are paying lower and lower tax rates on that? 00:21:36.750 --> 00:21:39.693 align:middle line:84% So the last thing I want to talk in chapter 23 00:21:39.693 --> 00:21:41.110 align:middle line:84% is the other form of wealth tax we 00:21:41.110 --> 00:21:43.830 align:middle line:84% have is property taxation, largely on houses. 00:21:43.830 --> 00:21:47.550 align:middle line:84% So we also tax-- we don't just-- we don't tax-- 00:21:47.550 --> 00:21:50.310 align:middle line:84% currently, there's no tax, really, on a stock 00:21:50.310 --> 00:21:53.950 align:middle line:84% because we don't have a wealth tax other than property taxes. 00:21:53.950 --> 00:21:56.850 align:middle line:84% Property taxes largely go to states and localities, 00:21:56.850 --> 00:21:57.990 align:middle line:90% mostly localities. 00:21:57.990 --> 00:22:01.390 align:middle line:84% They're the majority of the tax revenue earned by localities. 00:22:01.390 --> 00:22:04.380 align:middle line:84% And the vast majority is on housing. 00:22:04.380 --> 00:22:06.130 align:middle line:84% Now how do property taxes and houses work? 00:22:06.130 --> 00:22:06.990 align:middle line:90% Let's be clear. 00:22:06.990 --> 00:22:10.270 align:middle line:84% It's a tax on the assessed value of the house. 00:22:10.270 --> 00:22:12.630 align:middle line:84% What that means is there's some tax assessor who 00:22:12.630 --> 00:22:14.990 align:middle line:84% comes by and says, based on all the characteristics 00:22:14.990 --> 00:22:17.410 align:middle line:84% of your house, this is what your house is worth. 00:22:17.410 --> 00:22:19.830 align:middle line:84% And we will tax you based on that assessment. 00:22:19.830 --> 00:22:24.990 align:middle line:84% However, that is as much art as science in many cases. 00:22:24.990 --> 00:22:27.270 align:middle line:84% And it can lead to a lot of variation. 00:22:27.270 --> 00:22:30.610 align:middle line:84% So for example, if you take the assessment ratio-- 00:22:30.610 --> 00:22:32.870 align:middle line:84% if you take the assessed value of houses 00:22:32.870 --> 00:22:37.590 align:middle line:84% in Columbia, South Carolina, to their market value, it's 4%. 00:22:37.590 --> 00:22:40.070 align:middle line:84% So assessors assessed the value at 4% of the market value 00:22:40.070 --> 00:22:41.710 align:middle line:84% because they haven't done it forever, 00:22:41.710 --> 00:22:43.750 align:middle line:84% and they tend to maybe go too low. 00:22:43.750 --> 00:22:49.490 align:middle line:84% Whereas if you look at Providence, Rhode Island, 00:22:49.490 --> 00:22:50.550 align:middle line:90% it's 100%. 00:22:50.550 --> 00:22:54.590 align:middle line:84% Nationwide, it's about a 50%, 57% ratio of assessment 00:22:54.590 --> 00:22:56.030 align:middle line:90% to property value. 00:22:56.030 --> 00:23:02.150 align:middle line:84% So basically, that's one challenge. 00:23:02.150 --> 00:23:07.590 align:middle line:84% And in particularly, there's a racial imbalance component, 00:23:07.590 --> 00:23:09.090 align:middle line:84% which is quite interesting actually. 00:23:09.090 --> 00:23:11.630 align:middle line:84% Research found that the assessment rate 00:23:11.630 --> 00:23:13.590 align:middle line:84% is higher in minority neighborhoods 00:23:13.590 --> 00:23:16.030 align:middle line:84% because heavily minority neighborhoods tend 00:23:16.030 --> 00:23:17.730 align:middle line:90% to have lower property values. 00:23:17.730 --> 00:23:19.535 align:middle line:84% And the assessors don't account for that. 00:23:19.535 --> 00:23:20.910 align:middle line:84% So actually, the assessment ratio 00:23:20.910 --> 00:23:24.070 align:middle line:84% is a higher facing minorities, which is quite interesting. 00:23:24.070 --> 00:23:26.310 align:middle line:90% So this is a big issue. 00:23:26.310 --> 00:23:28.302 align:middle line:84% There's a lot in the book on this. 00:23:28.302 --> 00:23:30.010 align:middle line:84% It's getting towards the end of semester, 00:23:30.010 --> 00:23:32.310 align:middle line:84% so I'm just going to focus on two issues. 00:23:32.310 --> 00:23:37.730 align:middle line:84% The first issue is property tax incentives to businesses. 00:23:37.730 --> 00:23:39.890 align:middle line:84% Not only individuals pay property taxes, 00:23:39.890 --> 00:23:42.030 align:middle line:84% but businesses pay property taxes. 00:23:42.030 --> 00:23:46.310 align:middle line:84% And the big debate in state and local public finance 00:23:46.310 --> 00:23:52.350 align:middle line:84% is using property tax breaks to try to attract businesses, OK? 00:23:52.350 --> 00:23:55.370 align:middle line:90% This is a common tactic. 00:23:55.370 --> 00:24:00.070 align:middle line:84% Indeed, more than about $50 billion every year 00:24:00.070 --> 00:24:03.990 align:middle line:84% is given away in tax breaks to companies by localities 00:24:03.990 --> 00:24:06.030 align:middle line:84% to try to get them to move there. 00:24:06.030 --> 00:24:09.910 align:middle line:84% So for example, Foxconn is a maker of flat screen 00:24:09.910 --> 00:24:11.990 align:middle line:90% TVs and other things. 00:24:11.990 --> 00:24:15.230 align:middle line:84% They were considering a new plant in January 2017 in the US. 00:24:15.230 --> 00:24:19.720 align:middle line:84% There were bids put in and, eventually, Foxconn 00:24:19.720 --> 00:24:22.440 align:middle line:84% agreed to set up a $10 billion plant in Wisconsin 00:24:22.440 --> 00:24:28.200 align:middle line:84% in return for about $5 billion in tax breaks. 00:24:28.200 --> 00:24:31.920 align:middle line:84% The evidence was that the state itself 00:24:31.920 --> 00:24:35.320 align:middle line:84% estimated that even if Foxconn are the most ambitious estimates 00:24:35.320 --> 00:24:38.120 align:middle line:84% of their proposal, it would take until 2043 for the state 00:24:38.120 --> 00:24:39.617 align:middle line:84% to recoup the investment it made. 00:24:39.617 --> 00:24:41.700 align:middle line:84% And I think Foxconn, in end, has backed out of it. 00:24:41.700 --> 00:24:43.120 align:middle line:90% I haven't updated this. 00:24:43.120 --> 00:24:46.740 align:middle line:84% But this is not uncommon the state uses tax breaks. 00:24:46.740 --> 00:24:51.192 align:middle line:84% Now, this raises two interesting questions. 00:24:51.192 --> 00:24:53.400 align:middle line:84% and sometimes it's less important to a specific thing 00:24:53.400 --> 00:24:55.640 align:middle line:84% than it helps you think about tax breaks. 00:24:55.640 --> 00:24:58.220 align:middle line:84% The first question is, is this a good idea for Wisconsin? 00:24:58.220 --> 00:25:01.200 align:middle line:90% 00:25:01.200 --> 00:25:05.022 align:middle line:84% What two factors will determine whether it's 00:25:05.022 --> 00:25:07.480 align:middle line:84% a good idea for Wisconsin to give a tax break to a business 00:25:07.480 --> 00:25:09.400 align:middle line:90% to move there? 00:25:09.400 --> 00:25:12.040 align:middle line:84% What are the two things that determine that? 00:25:12.040 --> 00:25:13.448 align:middle line:90% I'll give credit for either one. 00:25:13.448 --> 00:25:15.240 align:middle line:84% What are two things to determine whether it 00:25:15.240 --> 00:25:17.698 align:middle line:84% makes sense for Wisconsin to have a tax break for a company 00:25:17.698 --> 00:25:18.880 align:middle line:90% to move there? 00:25:18.880 --> 00:25:19.800 align:middle line:90% Yeah? 00:25:19.800 --> 00:25:22.000 align:middle line:84% AUDIENCE: Revenue and tax revenue. 00:25:22.000 --> 00:25:24.168 align:middle line:84% PROFESSOR: Well, it'll be, basically, let's call it 00:25:24.168 --> 00:25:25.460 align:middle line:90% the social value for the state. 00:25:25.460 --> 00:25:28.168 align:middle line:84% You could define it just as tax revenue. 00:25:28.168 --> 00:25:30.460 align:middle line:84% If you think you care about your residents having jobs, 00:25:30.460 --> 00:25:32.100 align:middle line:84% it could be more than just tax revenue. 00:25:32.100 --> 00:25:35.320 align:middle line:84% But one factor is the social value delivered by that plant 00:25:35.320 --> 00:25:36.487 align:middle line:90% being in Wisconsin. 00:25:36.487 --> 00:25:37.820 align:middle line:90% That's one part of the equation. 00:25:37.820 --> 00:25:38.740 align:middle line:90% What's the other part? 00:25:38.740 --> 00:25:39.720 align:middle line:90% AUDIENCE: [INAUDIBLE] 00:25:39.720 --> 00:25:41.960 align:middle line:84% PROFESSOR: No, that'll be part of your social value 00:25:41.960 --> 00:25:42.620 align:middle line:90% calculation. 00:25:42.620 --> 00:25:43.260 align:middle line:90% What's the other thing? 00:25:43.260 --> 00:25:43.680 align:middle line:90% Yeah? 00:25:43.680 --> 00:25:45.638 align:middle line:84% AUDIENCE: The opportunity cost of that revenue? 00:25:45.638 --> 00:25:47.200 align:middle line:84% PROFESSOR: Well the opportunity cost 00:25:47.200 --> 00:25:48.660 align:middle line:90% would be in the social cost. 00:25:48.660 --> 00:25:50.695 align:middle line:84% So social cost would be net of opportunity cost. 00:25:50.695 --> 00:25:53.320 align:middle line:84% But the opportunity cost relates to the answer I'm looking for, 00:25:53.320 --> 00:25:56.200 align:middle line:84% which is what determines the effectiveness of tax breaks? 00:25:56.200 --> 00:26:00.200 align:middle line:90% AUDIENCE: [INAUDIBLE] 00:26:00.200 --> 00:26:01.580 align:middle line:90% PROFESSOR: You guys know this. 00:26:01.580 --> 00:26:02.080 align:middle line:90% Yeah? 00:26:02.080 --> 00:26:03.280 align:middle line:90% AUDIENCE: The [INAUDIBLE] 00:26:03.280 --> 00:26:05.120 align:middle line:84% PROFESSOR: The elasticity of movement. 00:26:05.120 --> 00:26:07.900 align:middle line:84% To what extent are firms actually going to move. 00:26:07.900 --> 00:26:09.515 align:middle line:90% So let's have a big tax break. 00:26:09.515 --> 00:26:12.140 align:middle line:84% Remember, anytime I give a tax break, two things are happening. 00:26:12.140 --> 00:26:13.765 align:middle line:84% I'm giving away money to companies that 00:26:13.765 --> 00:26:15.040 align:middle line:90% would have been there anyway. 00:26:15.040 --> 00:26:17.333 align:middle line:84% For Wisconsin's perspective, that's a total waste. 00:26:17.333 --> 00:26:19.500 align:middle line:84% That's just costing the opportunity cost that money, 00:26:19.500 --> 00:26:21.600 align:middle line:84% and I'm inducing firms to move there. 00:26:21.600 --> 00:26:24.600 align:middle line:84% So Wisconsin's perspective, it's the product 00:26:24.600 --> 00:26:27.518 align:middle line:84% of how elastic our movement decision times how valuable 00:26:27.518 --> 00:26:29.560 align:middle line:84% is it for them to move into Wisconsin, accounting 00:26:29.560 --> 00:26:32.360 align:middle line:84% for government costs, accounting for environmental, et cetera. 00:26:32.360 --> 00:26:36.100 align:middle line:84% It's the product of those two, very important to keep in mind. 00:26:36.100 --> 00:26:42.120 align:middle line:84% The best estimates are, roughly speaking, it's about worth it, 00:26:42.120 --> 00:26:44.740 align:middle line:84% that basically there are large social benefits. 00:26:44.740 --> 00:26:47.080 align:middle line:84% In particular, there's large positive externalities 00:26:47.080 --> 00:26:48.840 align:middle line:84% from manufacturing plants to move 00:26:48.840 --> 00:26:51.440 align:middle line:84% to a place, when manufacturing plants move to a place 00:26:51.440 --> 00:26:54.080 align:middle line:84% and increase the productivity of everyone around them. 00:26:54.080 --> 00:26:56.000 align:middle line:84% So there are large spillover benefits 00:26:56.000 --> 00:26:57.480 align:middle line:84% to getting a plant to move there. 00:26:57.480 --> 00:27:01.430 align:middle line:84% However, the elasticity is much less than 1. 00:27:01.430 --> 00:27:03.180 align:middle line:84% And so when you multiply the two together, 00:27:03.180 --> 00:27:05.780 align:middle line:84% you get that, roughly speaking, from Wisconsin perspective, 00:27:05.780 --> 00:27:07.760 align:middle line:90% it's roughly a break even. 00:27:07.760 --> 00:27:09.480 align:middle line:84% Depends how you do the social benefits. 00:27:09.480 --> 00:27:10.940 align:middle line:84% Maybe it's a little good, a little bad, 00:27:10.940 --> 00:27:12.898 align:middle line:84% but basically essentially two things counteract 00:27:12.898 --> 00:27:14.110 align:middle line:90% each other, OK? 00:27:14.110 --> 00:27:15.110 align:middle line:90% People understand that? 00:27:15.110 --> 00:27:15.610 align:middle line:90% Yeah? 00:27:15.610 --> 00:27:17.930 align:middle line:84% AUDIENCE: The elasticity of the business? 00:27:17.930 --> 00:27:19.290 align:middle line:84% PROFESSOR: The elasticity of the business decision 00:27:19.290 --> 00:27:21.373 align:middle line:84% to move to Wisconsin as opposed to somewhere else. 00:27:21.373 --> 00:27:21.970 align:middle line:90% AUDIENCE: OK. 00:27:21.970 --> 00:27:23.470 align:middle line:84% PROFESSOR: Because I'm paying to get them to move-- 00:27:23.470 --> 00:27:25.890 align:middle line:84% I'm going to say to Foxconn, I'll give you $5 billion 00:27:25.890 --> 00:27:26.830 align:middle line:90% in tax breaks. 00:27:26.830 --> 00:27:29.890 align:middle line:84% To what extent does that cause Foxconn to move to Wisconsin? 00:27:29.890 --> 00:27:30.910 align:middle line:90% That's the key thing. 00:27:30.910 --> 00:27:33.010 align:middle line:90% AUDIENCE: How's that measured? 00:27:33.010 --> 00:27:35.230 align:middle line:84% PROFESSOR: How's that elasticity measured? 00:27:35.230 --> 00:27:39.770 align:middle line:84% So you basically look at when states give tax breaks, 00:27:39.770 --> 00:27:41.593 align:middle line:90% you look at where firms locate. 00:27:41.593 --> 00:27:44.010 align:middle line:84% So essentially, you do what's called a spatial equilibrium 00:27:44.010 --> 00:27:45.468 align:middle line:84% model, where, essentially, you look 00:27:45.468 --> 00:27:47.883 align:middle line:84% at when a firm puts up to bid, which tax breaks 00:27:47.883 --> 00:27:48.550 align:middle line:90% each place give. 00:27:48.550 --> 00:27:50.330 align:middle line:84% And where does it end up as a function of those relative tax 00:27:50.330 --> 00:27:51.130 align:middle line:90% breaks. 00:27:51.130 --> 00:27:52.570 align:middle line:90% Does that make sense? 00:27:52.570 --> 00:27:54.890 align:middle line:90% Now here's the next question. 00:27:54.890 --> 00:27:56.610 align:middle line:84% We've just done Wisconsin analysis. 00:27:56.610 --> 00:27:59.770 align:middle line:84% From the US perspective, how do we think about this 00:27:59.770 --> 00:28:01.290 align:middle line:90% a good deal or not? 00:28:01.290 --> 00:28:02.170 align:middle line:90% Yeah? 00:28:02.170 --> 00:28:03.850 align:middle line:84% AUDIENCE: It's a bad deal because the firm's probably 00:28:03.850 --> 00:28:04.767 align:middle line:90% going to be in the US. 00:28:04.767 --> 00:28:06.970 align:middle line:84% PROFESSOR: It's definitionally a bad deal. 00:28:06.970 --> 00:28:11.810 align:middle line:84% Because if Wisconsin and New Mexico are fighting, 00:28:11.810 --> 00:28:14.770 align:middle line:84% yes, it's true, they may be fighting against Taiwan, 00:28:14.770 --> 00:28:20.090 align:middle line:84% but the extra Wisconsin pays over New Mexico is pure waste. 00:28:20.090 --> 00:28:22.450 align:middle line:84% Because we don't care if it's in New Mexico or Wisconsin 00:28:22.450 --> 00:28:23.610 align:middle line:90% as a nation. 00:28:23.610 --> 00:28:27.610 align:middle line:84% So it's unambiguously a bad idea from a national perspective 00:28:27.610 --> 00:28:29.650 align:middle line:90% to have these states competing. 00:28:29.650 --> 00:28:32.450 align:middle line:84% It may be or may not be a good idea for the states, probably 00:28:32.450 --> 00:28:33.310 align:middle line:90% roughly neutral. 00:28:33.310 --> 00:28:35.890 align:middle line:84% But it's obviously bad for the country because the benefits-- 00:28:35.890 --> 00:28:38.490 align:middle line:84% the countries have, regardless of where the plant locates. 00:28:38.490 --> 00:28:40.330 align:middle line:84% Once again, I care less about the example 00:28:40.330 --> 00:28:42.010 align:middle line:84% and more about how you think about tax breaks. 00:28:42.010 --> 00:28:43.330 align:middle line:84% You're going to read-- especially 00:28:43.330 --> 00:28:44.788 align:middle line:84% in this new administration-- you're 00:28:44.788 --> 00:28:47.650 align:middle line:84% going to read about tax breaks every day in the newspaper. 00:28:47.650 --> 00:28:49.983 align:middle line:84% And you always want to think about them this way. 00:28:49.983 --> 00:28:51.650 align:middle line:84% Think about the marginal and [INAUDIBLE] 00:28:51.650 --> 00:28:54.678 align:middle line:90% effects of those tax breaks. 00:28:54.678 --> 00:28:56.470 align:middle line:84% Now that's the first thing I want to cover. 00:28:56.470 --> 00:28:57.928 align:middle line:84% The second thing I want to cover is 00:28:57.928 --> 00:29:02.250 align:middle line:84% kind of interesting, which is that, remember, what's 00:29:02.250 --> 00:29:04.230 align:middle line:90% the ultimate inelastic factor? 00:29:04.230 --> 00:29:05.410 align:middle line:90% It's land. 00:29:05.410 --> 00:29:09.930 align:middle line:84% We economists love taxing land because there's 00:29:09.930 --> 00:29:11.387 align:middle line:90% no deadweight loss. 00:29:11.387 --> 00:29:12.970 align:middle line:84% And the truth is, landowners generally 00:29:12.970 --> 00:29:14.702 align:middle line:84% tend to be richer than non-landowners, 00:29:14.702 --> 00:29:15.910 align:middle line:90% so it seems like a great tax. 00:29:15.910 --> 00:29:18.250 align:middle line:84% It's fairly progressive and no deadweight loss. 00:29:18.250 --> 00:29:20.150 align:middle line:84% The problem is, we don't tax land. 00:29:20.150 --> 00:29:21.770 align:middle line:90% We tax homes on that land. 00:29:21.770 --> 00:29:23.850 align:middle line:90% And homes are elastic. 00:29:23.850 --> 00:29:25.970 align:middle line:84% So the problem is property taxes are 00:29:25.970 --> 00:29:28.442 align:middle line:84% distortionary because they don't tax the value of the land. 00:29:28.442 --> 00:29:30.150 align:middle line:84% They tax the value of the whole property, 00:29:30.150 --> 00:29:31.650 align:middle line:90% which includes the house. 00:29:31.650 --> 00:29:34.210 align:middle line:84% So a famous idea dating the philosopher Henry George is, 00:29:34.210 --> 00:29:36.610 align:middle line:90% why not just have a land tax? 00:29:36.610 --> 00:29:39.490 align:middle line:84% Why not just tax the land itself? 00:29:39.490 --> 00:29:43.330 align:middle line:84% Indeed, there's some success stories of this approach. 00:29:43.330 --> 00:29:47.890 align:middle line:84% Pittsburgh, in the 1940s and 1950s, 00:29:47.890 --> 00:29:53.370 align:middle line:84% had a bunch of properties that were sitting on-- 00:29:53.370 --> 00:29:57.330 align:middle line:84% they had a bunch of properties that 00:29:57.330 --> 00:29:59.890 align:middle line:84% were assessed as fairly high value, 00:29:59.890 --> 00:30:04.210 align:middle line:84% but were on land that was basically not that valuable. 00:30:04.210 --> 00:30:06.580 align:middle line:84% Pittsburgh said, we're just going to assess the land. 00:30:06.580 --> 00:30:07.900 align:middle line:84% People were like, wow, it's really cheap 00:30:07.900 --> 00:30:08.720 align:middle line:90% to move to Pittsburgh. 00:30:08.720 --> 00:30:09.678 align:middle line:90% Property taxes are low. 00:30:09.678 --> 00:30:12.680 align:middle line:84% They moved there and didn't have this distortionary effect. 00:30:12.680 --> 00:30:14.805 align:middle line:84% So this is an idea that's very appealing to people, 00:30:14.805 --> 00:30:17.580 align:middle line:84% sort of Georgian taxation of just tax the land. 00:30:17.580 --> 00:30:20.633 align:middle line:84% The problem is, this is a great example of egg-headed economists 00:30:20.633 --> 00:30:22.300 align:middle line:84% and things that work well in theory, not 00:30:22.300 --> 00:30:25.060 align:middle line:84% in practice, which, it's incredibly hard to value land. 00:30:25.060 --> 00:30:26.360 align:middle line:90% Because we don't sell land. 00:30:26.360 --> 00:30:28.380 align:middle line:90% We sell the land plus the house. 00:30:28.380 --> 00:30:30.360 align:middle line:84% So the problem is, you can imagine, 00:30:30.360 --> 00:30:33.040 align:middle line:84% it's hard enough to assess what a house is worth. 00:30:33.040 --> 00:30:36.100 align:middle line:84% To assess the value of just the land part of the house 00:30:36.100 --> 00:30:37.440 align:middle line:90% is incredibly hard. 00:30:37.440 --> 00:30:40.260 align:middle line:84% Just to give you an idea, I had a special mortgage at MIT 00:30:40.260 --> 00:30:41.360 align:middle line:90% that had to get paid off. 00:30:41.360 --> 00:30:43.902 align:middle line:84% I had people come assess my-- it's a fairly rare old property 00:30:43.902 --> 00:30:44.900 align:middle line:90% in Lexington. 00:30:44.900 --> 00:30:47.000 align:middle line:90% I had two assessors. 00:30:47.000 --> 00:30:50.940 align:middle line:84% There was a 50% variance in what they said my house was worth. 00:30:50.940 --> 00:30:52.380 align:middle line:90% There's a lot of art here. 00:30:52.380 --> 00:30:54.140 align:middle line:84% Then you add on top of that, well, you 00:30:54.140 --> 00:30:55.320 align:middle line:84% got to me how much of that's the land. 00:30:55.320 --> 00:30:56.440 align:middle line:90% It gets incredibly hard. 00:30:56.440 --> 00:30:58.387 align:middle line:84% So these land taxes never end up getting used. 00:30:58.387 --> 00:31:00.220 align:middle line:84% It's just an interesting theoretical concept 00:31:00.220 --> 00:31:03.420 align:middle line:84% that that's what you'd ideally like to do. 00:31:03.420 --> 00:31:06.140 align:middle line:84% So that's all I really want to say about property taxes. 00:31:06.140 --> 00:31:07.680 align:middle line:84% Once again, like everything else in this course, 00:31:07.680 --> 00:31:09.555 align:middle line:84% there's millions of other fascinating aspects 00:31:09.555 --> 00:31:11.220 align:middle line:84% that we don't have time to cover. 00:31:11.220 --> 00:31:13.632 align:middle line:84% But I do want to have time, since many of you 00:31:13.632 --> 00:31:15.340 align:middle line:84% have been going out in the business world 00:31:15.340 --> 00:31:17.220 align:middle line:84% when this is all over, I do want to have time 00:31:17.220 --> 00:31:19.820 align:middle line:84% to go carefully through chapter 24 and the taxation 00:31:19.820 --> 00:31:21.700 align:middle line:90% of corporate income. 00:31:21.700 --> 00:31:25.180 align:middle line:84% This is, quite frankly, perhaps the most important chapter 00:31:25.180 --> 00:31:27.980 align:middle line:84% we teach for the foreseeable future, this 00:31:27.980 --> 00:31:31.800 align:middle line:84% and the next chapter, because of the giant debate over taxation 00:31:31.800 --> 00:31:33.300 align:middle line:90% that's about to happen. 00:31:33.300 --> 00:31:37.420 align:middle line:84% Because in 2017, we saw the largest corporate tax reduction, 00:31:37.420 --> 00:31:39.980 align:middle line:84% probably, in our nation's history in terms of dollars. 00:31:39.980 --> 00:31:43.620 align:middle line:90% 00:31:43.620 --> 00:31:44.700 align:middle line:90% Was it TCJA? 00:31:44.700 --> 00:31:47.620 align:middle line:84% The Tax Cuts and Jobs Act-- you got to love the names of these 00:31:47.620 --> 00:31:50.580 align:middle line:90% laws-- of 2017-- 00:31:50.580 --> 00:31:54.100 align:middle line:84% it was the largest overhaul in corporate taxation in 30 years. 00:31:54.100 --> 00:31:55.603 align:middle line:84% And part of the reason was legit, 00:31:55.603 --> 00:31:57.020 align:middle line:84% which is the US corporate tax rate 00:31:57.020 --> 00:31:59.220 align:middle line:84% was well out of line with other countries with which we compete 00:31:59.220 --> 00:32:00.180 align:middle line:90% for countries. 00:32:00.180 --> 00:32:03.540 align:middle line:84% So the average developed country which would compete 00:32:03.540 --> 00:32:05.760 align:middle line:90% had a corporate tax rate of 24%. 00:32:05.760 --> 00:32:07.940 align:middle line:84% We had a corporate tax rate of 35%. 00:32:07.940 --> 00:32:10.240 align:middle line:84% And the view that was first international competition, 00:32:10.240 --> 00:32:13.260 align:middle line:84% et cetera, and so there was a large corporate tax 00:32:13.260 --> 00:32:18.320 align:middle line:84% cut down from 35% to 21% of the corporate tax rate. 00:32:18.320 --> 00:32:23.280 align:middle line:84% So what I want to talk about is, why do we have corporate taxes? 00:32:23.280 --> 00:32:24.000 align:middle line:90% How do they work? 00:32:24.000 --> 00:32:27.020 align:middle line:84% And how do we think about evaluating a corporate tax cut? 00:32:27.020 --> 00:32:27.580 align:middle line:90% Yeah? 00:32:27.580 --> 00:32:28.820 align:middle line:84% AUDIENCE: How did the US end up in a position 00:32:28.820 --> 00:32:30.420 align:middle line:84% where it had such a higher corporate tax 00:32:30.420 --> 00:32:32.140 align:middle line:84% rate than other countries to begin with? 00:32:32.140 --> 00:32:33.140 align:middle line:90% PROFESSOR: I don't know. 00:32:33.140 --> 00:32:34.320 align:middle line:90% That's a good question. 00:32:34.320 --> 00:32:36.820 align:middle line:84% I mean, one fascinating thing about-- people 00:32:36.820 --> 00:32:38.560 align:middle line:84% always talk about high tax Europe. 00:32:38.560 --> 00:32:41.180 align:middle line:84% But in fact, Europe, in general, has higher labor taxes 00:32:41.180 --> 00:32:43.800 align:middle line:84% and lower capital taxes that the US, which is interesting. 00:32:43.800 --> 00:32:44.920 align:middle line:84% You think of it as a progressive country 00:32:44.920 --> 00:32:46.795 align:middle line:84% but, in fact, actually, capital tax in Europe 00:32:46.795 --> 00:32:49.940 align:middle line:84% are often quite lower than the US. 00:32:49.940 --> 00:32:54.500 align:middle line:84% So let's talk about, what are corporations? 00:32:54.500 --> 00:32:55.560 align:middle line:90% What are corporations? 00:32:55.560 --> 00:33:00.480 align:middle line:84% Corporations are essentially-- they're modes of production, 00:33:00.480 --> 00:33:02.580 align:middle line:84% but you can produce things in corporations 00:33:02.580 --> 00:33:03.760 align:middle line:90% or non-corporate entities. 00:33:03.760 --> 00:33:04.760 align:middle line:90% There's two key sectors. 00:33:04.760 --> 00:33:06.220 align:middle line:84% There's the non-corporate sector. 00:33:06.220 --> 00:33:08.240 align:middle line:84% That would be things like individuals, 00:33:08.240 --> 00:33:10.780 align:middle line:84% so individuals providing services or partnerships 00:33:10.780 --> 00:33:11.960 align:middle line:90% providing services. 00:33:11.960 --> 00:33:13.540 align:middle line:90% Then there's a corporate sector. 00:33:13.540 --> 00:33:17.300 align:middle line:84% And the big difference in the corporate sector 00:33:17.300 --> 00:33:20.380 align:middle line:84% and a non-corporate sector is limited liability. 00:33:20.380 --> 00:33:23.380 align:middle line:84% Limited liability means once I incorporate, 00:33:23.380 --> 00:33:26.160 align:middle line:84% I'm only liable for the value of that corporation. 00:33:26.160 --> 00:33:29.157 align:middle line:84% So if I'm running my company as a non-incorporated company, 00:33:29.157 --> 00:33:30.740 align:middle line:84% and I something bad, they could sue me 00:33:30.740 --> 00:33:32.380 align:middle line:90% for all my personal wealth. 00:33:32.380 --> 00:33:35.620 align:middle line:84% Once I've incorporated, I'm only liable for the value 00:33:35.620 --> 00:33:39.500 align:middle line:84% of that company itself, so that's a big plus, 00:33:39.500 --> 00:33:41.980 align:middle line:90% as you can imagine. 00:33:41.980 --> 00:33:44.820 align:middle line:84% The fundamental feature of corporations 00:33:44.820 --> 00:33:49.340 align:middle line:84% is a separation between ownership and control. 00:33:49.340 --> 00:33:51.460 align:middle line:84% The fundamental feature-- do you have a question? 00:33:51.460 --> 00:33:53.085 align:middle line:84% The fundamental feature is a separation 00:33:53.085 --> 00:33:54.660 align:middle line:90% between ownership and control. 00:33:54.660 --> 00:33:57.360 align:middle line:84% That the people who own the firm, 00:33:57.360 --> 00:33:58.980 align:middle line:84% who own the stock in the firm, may not 00:33:58.980 --> 00:34:03.450 align:middle line:84% be the people who actually run the firm. 00:34:03.450 --> 00:34:07.030 align:middle line:84% Now this leads to a common problem 00:34:07.030 --> 00:34:08.750 align:middle line:90% that we call the agency problem. 00:34:08.750 --> 00:34:10.708 align:middle line:84% You may have learned about it in other classes. 00:34:10.708 --> 00:34:13.929 align:middle line:84% We talked about a little bit in 1401-- 00:34:13.929 --> 00:34:18.190 align:middle line:84% which is a misalignment of incentives between the owners 00:34:18.190 --> 00:34:20.070 align:middle line:90% and managers of a company. 00:34:20.070 --> 00:34:22.070 align:middle line:84% So the example I use in 1401 that I like 00:34:22.070 --> 00:34:26.010 align:middle line:84% is let's say I'm a CEO of some company. 00:34:26.010 --> 00:34:27.750 align:middle line:90% I'm managing it. 00:34:27.750 --> 00:34:30.188 align:middle line:90% And I manage this company. 00:34:30.188 --> 00:34:32.230 align:middle line:84% And the company is pretty big, but not really big 00:34:32.230 --> 00:34:35.070 align:middle line:84% enough to justify my own corporate jet. 00:34:35.070 --> 00:34:36.732 align:middle line:84% But all my friends have corporate jets, 00:34:36.732 --> 00:34:37.690 align:middle line:90% and I'm really jealous. 00:34:37.690 --> 00:34:39.350 align:middle line:84% I feel I'm like the left-out kid because they 00:34:39.350 --> 00:34:40.469 align:middle line:90% have their corporate jets. 00:34:40.469 --> 00:34:43.010 align:middle line:84% So I want a corporate jet, but I can't really justify it. 00:34:43.010 --> 00:34:45.670 align:middle line:90% So what do I do? 00:34:45.670 --> 00:34:46.838 align:middle line:90% It's not profit maximizing. 00:34:46.838 --> 00:34:49.130 align:middle line:84% So if I was the owner, I wouldn't have a corporate jet. 00:34:49.130 --> 00:34:49.730 align:middle line:90% But I'm not the owner. 00:34:49.730 --> 00:34:50.330 align:middle line:90% I'm the manager. 00:34:50.330 --> 00:34:50.872 align:middle line:90% So what I do? 00:34:50.872 --> 00:34:53.250 align:middle line:84% I make a fancy PowerPoint slide, and I cook the numbers 00:34:53.250 --> 00:34:55.127 align:middle line:84% so it looks like the company will save money 00:34:55.127 --> 00:34:56.210 align:middle line:90% if I have a corporate jet. 00:34:56.210 --> 00:34:57.370 align:middle line:90% I present it to the owners. 00:34:57.370 --> 00:34:58.570 align:middle line:84% They're like, well, that sounds good to me. 00:34:58.570 --> 00:34:59.945 align:middle line:84% And they gave me a corporate jet. 00:34:59.945 --> 00:35:02.190 align:middle line:84% And the company makes less money. 00:35:02.190 --> 00:35:05.310 align:middle line:84% That is a classic example of a misalignment between managers 00:35:05.310 --> 00:35:07.810 align:middle line:84% who want to lead good lives and want the company to do well. 00:35:07.810 --> 00:35:08.870 align:middle line:84% But basically, fundamentally, they're 00:35:08.870 --> 00:35:10.510 align:middle line:84% about themselves and the owners who 00:35:10.510 --> 00:35:12.790 align:middle line:84% are just about the profitability of the company. 00:35:12.790 --> 00:35:18.110 align:middle line:84% And that can lead to things like outrageous CEO compensation 00:35:18.110 --> 00:35:23.350 align:middle line:90% and other issues. 00:35:23.350 --> 00:35:25.173 align:middle line:90% So that's what a corporation is. 00:35:25.173 --> 00:35:26.090 align:middle line:90% How are they financed? 00:35:26.090 --> 00:35:32.310 align:middle line:84% Well, let's look at figure 24.1-- 00:35:32.310 --> 00:35:34.810 align:middle line:84% talks about how firms finance investments. 00:35:34.810 --> 00:35:37.590 align:middle line:84% How do firms finance their investments? 00:35:37.590 --> 00:35:41.050 align:middle line:84% Well, let's say a firm wants to finance an investment. 00:35:41.050 --> 00:35:41.968 align:middle line:90% It needs money. 00:35:41.968 --> 00:35:43.010 align:middle line:90% It wants to invest money. 00:35:43.010 --> 00:35:43.490 align:middle line:90% It needs money. 00:35:43.490 --> 00:35:44.157 align:middle line:90% What does it do? 00:35:44.157 --> 00:35:46.655 align:middle line:84% Well, it can use its retained earnings. 00:35:46.655 --> 00:35:48.530 align:middle line:84% It can say, I've got a bunch of money around. 00:35:48.530 --> 00:35:50.510 align:middle line:90% That's the bottom first arrow. 00:35:50.510 --> 00:35:52.270 align:middle line:84% We're going to ignore that for now. 00:35:52.270 --> 00:35:54.950 align:middle line:84% Let's say it doesn't have enough retained earnings around. 00:35:54.950 --> 00:35:56.273 align:middle line:90% It needs to raise money. 00:35:56.273 --> 00:35:57.690 align:middle line:84% So it can raise money in two ways. 00:35:57.690 --> 00:36:00.510 align:middle line:90% It can issue bonds or stocks. 00:36:00.510 --> 00:36:02.530 align:middle line:90% So what's the difference? 00:36:02.530 --> 00:36:05.590 align:middle line:84% Bonds or what's called debt finance are literally 00:36:05.590 --> 00:36:07.835 align:middle line:84% loans where you agree to a fixed term of payment. 00:36:07.835 --> 00:36:09.710 align:middle line:84% You say, I'll pay you back this interest rate 00:36:09.710 --> 00:36:12.670 align:middle line:90% for this period of time, OK? 00:36:12.670 --> 00:36:15.270 align:middle line:90% And if I don't, I'm in default. 00:36:15.270 --> 00:36:18.818 align:middle line:84% Stocks are essentially a share of the company, where 00:36:18.818 --> 00:36:21.110 align:middle line:84% the only promise you're giving is that these people own 00:36:21.110 --> 00:36:21.810 align:middle line:90% shares of the company. 00:36:21.810 --> 00:36:23.090 align:middle line:84% You don't owe them any other money. 00:36:23.090 --> 00:36:24.530 align:middle line:84% You don't ever have to pay them anything. 00:36:24.530 --> 00:36:26.390 align:middle line:84% It's just they own a share of the company. 00:36:26.390 --> 00:36:30.265 align:middle line:84% Now when you own stock, then why would people buy stock? 00:36:30.265 --> 00:36:31.890 align:middle line:84% Well, they can be rewarded in two ways. 00:36:31.890 --> 00:36:33.870 align:middle line:84% One is they can get dividends, which 00:36:33.870 --> 00:36:35.470 align:middle line:84% are periodic payments that companies 00:36:35.470 --> 00:36:36.862 align:middle line:90% make to their shareholders. 00:36:36.862 --> 00:36:39.070 align:middle line:84% And the other is they can accrue capital gains, which 00:36:39.070 --> 00:36:40.750 align:middle line:90% is stock goes up in value. 00:36:40.750 --> 00:36:42.830 align:middle line:90% I can sell it and make money. 00:36:42.830 --> 00:36:44.490 align:middle line:84% So we're going to come back to this, 00:36:44.490 --> 00:36:48.830 align:middle line:84% but that's the basic structure of firm financing. 00:36:48.830 --> 00:36:51.170 align:middle line:84% I lay this out now-- we'll come back to it next time, 00:36:51.170 --> 00:36:56.000 align:middle line:84% but I'll lay this out now to highlight the question of, 00:36:56.000 --> 00:36:59.442 align:middle line:84% why do we have a corporate tax at all? 00:36:59.442 --> 00:37:00.900 align:middle line:84% Why do have a corporate tax at all? 00:37:00.900 --> 00:37:05.480 align:middle line:84% Well, there's really two reasons. 00:37:05.480 --> 00:37:10.240 align:middle line:84% The first reason is that, in fact, the optimal tax 00:37:10.240 --> 00:37:12.960 align:middle line:90% is a pure profits tax. 00:37:12.960 --> 00:37:15.480 align:middle line:84% A pure profits tax is a terrific tax. 00:37:15.480 --> 00:37:18.520 align:middle line:84% Why is a pure profits tax a terrific tax? 00:37:18.520 --> 00:37:27.760 align:middle line:84% For a simple reason, max pi gives the same answer as max 1 00:37:27.760 --> 00:37:31.640 align:middle line:90% minus tau times pi. 00:37:31.640 --> 00:37:34.200 align:middle line:84% Pure profit taxes are not distortionary. 00:37:34.200 --> 00:37:36.220 align:middle line:84% Whatever I'm going to do to maximize my profits, 00:37:36.220 --> 00:37:38.660 align:middle line:84% I'm going to maximize 1 minus tau times my profits. 00:37:38.660 --> 00:37:39.700 align:middle line:90% There's no distortion. 00:37:39.700 --> 00:37:42.380 align:middle line:84% So a pure profit tax is a great tax. 00:37:42.380 --> 00:37:45.302 align:middle line:84% You're taxing profits, which are generally held by the wealthy, 00:37:45.302 --> 00:37:46.760 align:middle line:84% and you're not distorting behavior. 00:37:46.760 --> 00:37:49.260 align:middle line:84% Because whatever they did to make as much money as possible, 00:37:49.260 --> 00:37:51.200 align:middle line:84% they're still going to do it afterwards. 00:37:51.200 --> 00:37:53.945 align:middle line:84% So that's one argument for corporate taxes. 00:37:53.945 --> 00:37:55.320 align:middle line:84% The problem with this argument is 00:37:55.320 --> 00:37:57.040 align:middle line:90% we don't measure pure profits. 00:37:57.040 --> 00:37:59.520 align:middle line:84% We measure reported profits, which go 00:37:59.520 --> 00:38:00.820 align:middle line:90% through a series of exercises. 00:38:00.820 --> 00:38:02.945 align:middle line:84% We'll discuss some-- but are incredibly complicated 00:38:02.945 --> 00:38:05.800 align:middle line:84% and detailed concept, which do involve choices 00:38:05.800 --> 00:38:07.240 align:middle line:90% that you can change. 00:38:07.240 --> 00:38:11.100 align:middle line:84% You will distort your behavior when there's taxation. 00:38:11.100 --> 00:38:13.320 align:middle line:84% And we'll talk about how that happens. 00:38:13.320 --> 00:38:16.240 align:middle line:84% So unfortunately, we don't have a pure profit tax. 00:38:16.240 --> 00:38:17.900 align:middle line:90% We don't tax economic profits. 00:38:17.900 --> 00:38:19.600 align:middle line:90% We tax accounting profits. 00:38:19.600 --> 00:38:22.480 align:middle line:84% And accounting profits are very different than economic profits. 00:38:22.480 --> 00:38:24.820 align:middle line:84% And so as a result, taxes can be distortionary, 00:38:24.820 --> 00:38:29.760 align:middle line:84% so this pure argument doesn't quite hold. 00:38:29.760 --> 00:38:31.840 align:middle line:84% The second reason is more interesting 00:38:31.840 --> 00:38:35.737 align:middle line:84% is that, basically, is the inside build-up argument 00:38:35.737 --> 00:38:38.320 align:middle line:84% we talked about then we talked about savings incentives, which 00:38:38.320 --> 00:38:40.780 align:middle line:84% is companies can always retain their earnings. 00:38:40.780 --> 00:38:42.680 align:middle line:84% I can make money and hold on to it. 00:38:42.680 --> 00:38:44.920 align:middle line:84% And absent a corporate tax, if I never pay it out, 00:38:44.920 --> 00:38:46.363 align:middle line:90% I never get taxed on it. 00:38:46.363 --> 00:38:48.280 align:middle line:84% So let's say I have a company that makes money 00:38:48.280 --> 00:38:50.240 align:middle line:84% and for 100 years, just sits on it. 00:38:50.240 --> 00:38:52.200 align:middle line:84% That means 100 years, they're not paying taxes 00:38:52.200 --> 00:38:53.158 align:middle line:90% on what they've earned. 00:38:53.158 --> 00:38:55.200 align:middle line:84% By the time they do, the [INAUDIBLE] value 00:38:55.200 --> 00:38:56.400 align:middle line:90% is essentially 0. 00:38:56.400 --> 00:38:59.240 align:middle line:84% You essentially have allowed them to escape taxation. 00:38:59.240 --> 00:39:00.720 align:middle line:84% So the idea of a corporate tax is 00:39:00.720 --> 00:39:04.640 align:middle line:84% the idea of why we'd like an accrual tax on capital gains. 00:39:04.640 --> 00:39:08.000 align:middle line:84% That basically we want to capture along 00:39:08.000 --> 00:39:09.497 align:middle line:90% the way what they're making. 00:39:09.497 --> 00:39:11.080 align:middle line:84% Unlike with capital gains, we actually 00:39:11.080 --> 00:39:13.835 align:middle line:84% have a measure of what they're making, which is their profits. 00:39:13.835 --> 00:39:16.460 align:middle line:84% So while it'd be hard to have an accrual tax for capital gains, 00:39:16.460 --> 00:39:18.057 align:middle line:84% it's not hard to have a corporate tax. 00:39:18.057 --> 00:39:19.140 align:middle line:90% We just tax their profits. 00:39:19.140 --> 00:39:21.182 align:middle line:84% And that way, they don't just infinitely build up 00:39:21.182 --> 00:39:23.040 align:middle line:90% a stock of assets. 00:39:23.040 --> 00:39:24.880 align:middle line:84% So how does the corporate tax work? 00:39:24.880 --> 00:39:26.440 align:middle line:90% Well, it's very simple. 00:39:26.440 --> 00:39:32.400 align:middle line:84% The corporate tax is the corporate tax revenue 00:39:32.400 --> 00:39:38.800 align:middle line:84% is equal to the tax rate, tau, times revenues minus 00:39:38.800 --> 00:39:44.940 align:middle line:90% expenses minus any tax credits. 00:39:44.940 --> 00:39:48.760 align:middle line:90% 00:39:48.760 --> 00:39:53.170 align:middle line:84% So let's talk about the three elements of this formula. 00:39:53.170 --> 00:39:54.370 align:middle line:90% Let's talk about revenues. 00:39:54.370 --> 00:39:54.870 align:middle line:90% That's easy. 00:39:54.870 --> 00:39:57.570 align:middle line:90% It's what the firm makes. 00:39:57.570 --> 00:39:59.910 align:middle line:84% There's some controversy in measuring it, but not a lot. 00:39:59.910 --> 00:40:01.410 align:middle line:84% A lot of the controversy in taxation 00:40:01.410 --> 00:40:02.993 align:middle line:90% comes-- there's not a lot there. 00:40:02.993 --> 00:40:04.410 align:middle line:84% The big controversy in taxation is 00:40:04.410 --> 00:40:09.130 align:middle line:84% expenses, which is what the firm pay to make those revenues? 00:40:09.130 --> 00:40:12.450 align:middle line:84% Now this consists critically of three components. 00:40:12.450 --> 00:40:16.330 align:middle line:84% The first are your cash flow costs, like the wages you pay. 00:40:16.330 --> 00:40:18.170 align:middle line:84% Those are pretty easy to measure. 00:40:18.170 --> 00:40:21.530 align:middle line:84% So cash flow costs are pretty easy to measure. 00:40:21.530 --> 00:40:24.290 align:middle line:90% The second is interest payments. 00:40:24.290 --> 00:40:27.160 align:middle line:84% We call an interest payment you make an expense. 00:40:27.160 --> 00:40:28.910 align:middle line:84% And those are also pretty easy to measure. 00:40:28.910 --> 00:40:33.330 align:middle line:84% They're measured by when you have a bond that's public, 00:40:33.330 --> 00:40:35.050 align:middle line:90% what you're paying in interest. 00:40:35.050 --> 00:40:40.570 align:middle line:84% So cash flow is easy to measure and interest is easy to measure. 00:40:40.570 --> 00:40:42.850 align:middle line:84% The harder part to measure is what 00:40:42.850 --> 00:40:49.890 align:middle line:84% we call depreciation, which is the fact that your capital 00:40:49.890 --> 00:40:54.570 align:middle line:84% assets are getting less valuable over time. 00:40:54.570 --> 00:40:58.208 align:middle line:84% And that is a economic loss to you, 00:40:58.208 --> 00:41:00.750 align:middle line:84% that your capital assets are getting less valuable over time. 00:41:00.750 --> 00:41:02.490 align:middle line:90% It's an economic loss to you. 00:41:02.490 --> 00:41:09.690 align:middle line:84% When you hire a worker, when I hire Valerie for a year, 00:41:09.690 --> 00:41:11.410 align:middle line:84% I'm paying her a wage, effectively 00:41:11.410 --> 00:41:13.113 align:middle line:90% renting Valerie for the year. 00:41:13.113 --> 00:41:15.030 align:middle line:84% But when I buy a building, I'm not renting it. 00:41:15.030 --> 00:41:16.090 align:middle line:90% I'm buying it. 00:41:16.090 --> 00:41:17.950 align:middle line:84% And that building gets crummier over time. 00:41:17.950 --> 00:41:20.470 align:middle line:90% And I got to fix it. 00:41:20.470 --> 00:41:22.170 align:middle line:90% That is a loss to me. 00:41:22.170 --> 00:41:23.363 align:middle line:90% Just renting the building. 00:41:23.363 --> 00:41:25.530 align:middle line:84% Think of it this way, if I was renting the building, 00:41:25.530 --> 00:41:28.050 align:middle line:84% I deduct from my taxes every year's rent. 00:41:28.050 --> 00:41:30.750 align:middle line:84% The fact I'm buying it doesn't mean it's suddenly no expense. 00:41:30.750 --> 00:41:32.730 align:middle line:84% The expense is the depreciation of the value 00:41:32.730 --> 00:41:35.010 align:middle line:90% of that building over time. 00:41:35.010 --> 00:41:38.890 align:middle line:90% The problem is-- yeah? 00:41:38.890 --> 00:41:41.850 align:middle line:84% AUDIENCE: Is there depreciation as well as the money 00:41:41.850 --> 00:41:44.490 align:middle line:84% that you pay to fix the building as an expense? 00:41:44.490 --> 00:41:47.750 align:middle line:84% PROFESSOR: So let's talk about the general concept, 00:41:47.750 --> 00:41:49.610 align:middle line:90% what is economic depreciation? 00:41:49.610 --> 00:41:52.250 align:middle line:84% Economic depreciation writ large is 00:41:52.250 --> 00:41:56.450 align:middle line:84% the drop in the value of the asset each year. 00:41:56.450 --> 00:42:00.330 align:middle line:84% So if I buy an asset for $100,000, and one year later, 00:42:00.330 --> 00:42:04.210 align:middle line:84% I sell it for $90,000 without putting a penny into it, 00:42:04.210 --> 00:42:07.330 align:middle line:84% then that is a $10,000 depreciation. 00:42:07.330 --> 00:42:10.210 align:middle line:84% That is a technically correct measure of depreciation. 00:42:10.210 --> 00:42:12.690 align:middle line:84% Literally, if we could measure the value of every good 00:42:12.690 --> 00:42:14.690 align:middle line:84% every year, depreciation would be 00:42:14.690 --> 00:42:18.330 align:middle line:84% the change in the value of the good from year to year. 00:42:18.330 --> 00:42:19.790 align:middle line:90% That's technically correct. 00:42:19.790 --> 00:42:21.430 align:middle line:84% The problem is, we can't do that. 00:42:21.430 --> 00:42:23.150 align:middle line:84% Just like we can't tax capital gains and accruals, 00:42:23.150 --> 00:42:25.483 align:middle line:84% it's pretty hard to measure these things year over year. 00:42:25.483 --> 00:42:29.130 align:middle line:84% So what we do instead is we have engineering approximations 00:42:29.130 --> 00:42:29.990 align:middle line:90% to depreciation. 00:42:29.990 --> 00:42:31.950 align:middle line:84% We have what's called depreciation schedules. 00:42:31.950 --> 00:42:34.810 align:middle line:84% There's a monster book which for all classes, 00:42:34.810 --> 00:42:38.650 align:middle line:84% all assets in America lists the rate at which we've 00:42:38.650 --> 00:42:40.570 align:middle line:90% estimated the depreciate. 00:42:40.570 --> 00:42:45.820 align:middle line:84% And you can then take that off of your taxes. 00:42:45.820 --> 00:42:47.240 align:middle line:90% Now how do you do that? 00:42:47.240 --> 00:42:49.200 align:middle line:84% Well, there's multiple ways to do it. 00:42:49.200 --> 00:42:53.020 align:middle line:84% The typical way would be you would basically say, look-- 00:42:53.020 --> 00:42:56.420 align:middle line:84% so let's take a simple example. $100,000 building, 00:42:56.420 --> 00:43:00.382 align:middle line:84% it's going to depreciate not 10% a year but $100,000 a year 00:43:00.382 --> 00:43:01.840 align:middle line:84% because percents are tricky, right? 00:43:01.840 --> 00:43:06.220 align:middle line:84% Let's say it's going to depreciate $10,000 a year. 00:43:06.220 --> 00:43:08.780 align:middle line:84% It's a weird schedule, but just make the math easier. 00:43:08.780 --> 00:43:11.420 align:middle line:84% Then, basically, say every year, you deduct $10,000 from 00:43:11.420 --> 00:43:12.740 align:middle line:90% your taxes. 00:43:12.740 --> 00:43:15.740 align:middle line:90% Now that is one schedule. 00:43:15.740 --> 00:43:18.260 align:middle line:84% However, in some times, the government 00:43:18.260 --> 00:43:21.002 align:middle line:84% want to incentivize people to invest. 00:43:21.002 --> 00:43:22.460 align:middle line:84% And one way to do it is by offering 00:43:22.460 --> 00:43:24.975 align:middle line:90% accelerated depreciation. 00:43:24.975 --> 00:43:26.600 align:middle line:84% How does accelerated depreciation work? 00:43:26.600 --> 00:43:30.220 align:middle line:84% It means you can depreciate faster than the estimated life. 00:43:30.220 --> 00:43:33.180 align:middle line:84% So you would say you could deduct $20,000 a year for five 00:43:33.180 --> 00:43:34.660 align:middle line:90% years. 00:43:34.660 --> 00:43:35.812 align:middle line:90% Why is that more valuable? 00:43:35.812 --> 00:43:37.020 align:middle line:90% Because of net present value. 00:43:37.020 --> 00:43:39.860 align:middle line:84% Remember, pushing taxes off is good. 00:43:39.860 --> 00:43:43.880 align:middle line:84% So by depreciating more upfront, you push taxes off, OK? 00:43:43.880 --> 00:43:45.720 align:middle line:84% So the more you can depreciate upfront, 00:43:45.720 --> 00:43:48.280 align:middle line:84% the more value it is net present value. 00:43:48.280 --> 00:43:50.620 align:middle line:84% Think of depreciation as a gift from the government. 00:43:50.620 --> 00:43:52.020 align:middle line:84% Think of it someone's going to buy the asset anyway, 00:43:52.020 --> 00:43:54.260 align:middle line:84% come along and, by the way, here's a gift for you 00:43:54.260 --> 00:43:55.640 align:middle line:90% of depreciation allowance. 00:43:55.640 --> 00:43:57.765 align:middle line:84% Well, the sooner that depreciation allowance comes, 00:43:57.765 --> 00:43:59.180 align:middle line:90% the more valuable it is to me. 00:43:59.180 --> 00:44:03.260 align:middle line:84% Indeed, in the limit, you can allow what's called expensing. 00:44:03.260 --> 00:44:05.180 align:middle line:84% Expensing is you can literally deduct 00:44:05.180 --> 00:44:09.060 align:middle line:84% the entire cost of the purchase the year you purchase it. 00:44:09.060 --> 00:44:13.380 align:middle line:84% It's super depreciation, where literally it's deduction. 00:44:13.380 --> 00:44:16.820 align:middle line:84% That's called expensing investment. 00:44:16.820 --> 00:44:18.940 align:middle line:84% So the key thing is that, basically, 00:44:18.940 --> 00:44:23.780 align:middle line:84% the more rapidly you allow depreciation, 00:44:23.780 --> 00:44:26.300 align:middle line:90% the more valuable it is. 00:44:26.300 --> 00:44:28.380 align:middle line:84% Now the trick, of course, is these schedules 00:44:28.380 --> 00:44:30.580 align:middle line:90% are very hard to measure. 00:44:30.580 --> 00:44:32.258 align:middle line:84% In fact, there's a really novel study 00:44:32.258 --> 00:44:34.300 align:middle line:84% because there's actually one market in which it's 00:44:34.300 --> 00:44:37.020 align:middle line:84% pretty easy to measure real depreciation, which 00:44:37.020 --> 00:44:40.457 align:middle line:90% is the market for PCs. 00:44:40.457 --> 00:44:42.540 align:middle line:84% Because people are always selling PCs at different 00:44:42.540 --> 00:44:43.700 align:middle line:90% vintages all the time. 00:44:43.700 --> 00:44:47.380 align:middle line:84% So you can actually measure economic depreciation. 00:44:47.380 --> 00:44:49.300 align:middle line:84% And this study, economic depreciation 00:44:49.300 --> 00:44:51.260 align:middle line:84% of PCs, found the interesting thing, 00:44:51.260 --> 00:44:54.340 align:middle line:84% was the depreciation is exponential not linear. 00:44:54.340 --> 00:44:56.780 align:middle line:84% Every year you hold a PC, it drops by 50% 00:44:56.780 --> 00:44:58.945 align:middle line:90% of its previous year's value. 00:44:58.945 --> 00:45:00.320 align:middle line:84% There's exponential depreciation. 00:45:00.320 --> 00:45:02.300 align:middle line:90% Every year is 50%. 00:45:02.300 --> 00:45:07.340 align:middle line:84% So essentially by the fifth year, PCs are worthless. 00:45:07.340 --> 00:45:12.500 align:middle line:84% Now you might think, gee, my PC kind of holds up pretty well. 00:45:12.500 --> 00:45:16.460 align:middle line:90% Why is there a 50% depreciation? 00:45:16.460 --> 00:45:19.000 align:middle line:84% Let's say you treat your PC pristinely, 00:45:19.000 --> 00:45:20.400 align:middle line:90% why is 50% depreciation? 00:45:20.400 --> 00:45:20.980 align:middle line:90% Yeah? 00:45:20.980 --> 00:45:22.100 align:middle line:84% AUDIENCE: Because better technology-- 00:45:22.100 --> 00:45:23.600 align:middle line:84% PROFESSOR: Because better technology 00:45:23.600 --> 00:45:25.180 align:middle line:90% is coming along at low prices. 00:45:25.180 --> 00:45:29.300 align:middle line:84% So essentially, one year later, you 00:45:29.300 --> 00:45:31.980 align:middle line:84% can get a much better PC for the same price. 00:45:31.980 --> 00:45:33.938 align:middle line:84% Therefore, effectively, your PC is depreciated. 00:45:33.938 --> 00:45:34.813 align:middle line:90% That's the key thing. 00:45:34.813 --> 00:45:36.320 align:middle line:84% It's not just physical breakdown. 00:45:36.320 --> 00:45:37.340 align:middle line:90% It's the value. 00:45:37.340 --> 00:45:39.770 align:middle line:84% So you get a much better PC for the same price. 00:45:39.770 --> 00:45:42.095 align:middle line:84% Your PC is essentially worth less. 00:45:42.095 --> 00:45:44.470 align:middle line:84% There's a second issue, which is new software comes along 00:45:44.470 --> 00:45:46.983 align:middle line:84% that won't run on your old PC, which appreciates it further. 00:45:46.983 --> 00:45:48.650 align:middle line:84% So this is not physically breaking down. 00:45:48.650 --> 00:45:50.630 align:middle line:84% It's software-wise breaking down because it 00:45:50.630 --> 00:45:52.910 align:middle line:84% can't run all the new software that's coming along. 00:45:52.910 --> 00:45:53.790 align:middle line:90% Yeah? 00:45:53.790 --> 00:45:56.730 align:middle line:84% AUDIENCE: So if I buy a PC in the first year, 00:45:56.730 --> 00:45:58.410 align:middle line:90% I can deduct that as an expense. 00:45:58.410 --> 00:46:01.950 align:middle line:84% And then as that PC depreciates, I can also-- 00:46:01.950 --> 00:46:04.430 align:middle line:84% PROFESSOR: No, it depends on the depreciation schedule. 00:46:04.430 --> 00:46:06.350 align:middle line:84% But if the depreciation schedule was this one, 00:46:06.350 --> 00:46:09.630 align:middle line:84% it's 50% exponential, we'd say, if you buy $1,000 PC 00:46:09.630 --> 00:46:13.030 align:middle line:84% at the beginning of the year, you can deduct $500 this year, 00:46:13.030 --> 00:46:16.350 align:middle line:84% $250 next year, $125 the year after, et cetera. 00:46:16.350 --> 00:46:20.010 align:middle line:84% You have to deduct the value of the depreciation. 00:46:20.010 --> 00:46:21.510 align:middle line:84% Only if there's expensing we deduct 00:46:21.510 --> 00:46:23.230 align:middle line:90% the whole thing this year. 00:46:23.230 --> 00:46:25.630 align:middle line:84% You deduct the depreciation, which 00:46:25.630 --> 00:46:28.450 align:middle line:84% is 50% of the previous year's value. 00:46:28.450 --> 00:46:28.950 align:middle line:90% Yeah? 00:46:28.950 --> 00:46:30.367 align:middle line:84% AUDIENCE: Why would the government 00:46:30.367 --> 00:46:32.803 align:middle line:84% allow for expensing outside of a macro? 00:46:32.803 --> 00:46:34.470 align:middle line:84% PROFESSOR: The main reason for expensing 00:46:34.470 --> 00:46:37.350 align:middle line:84% is to encourage investment, is basically 00:46:37.350 --> 00:46:38.810 align:middle line:90% as an investment encouragement. 00:46:38.810 --> 00:46:42.030 align:middle line:84% And we'll come back to why that might make sense later actually, 00:46:42.030 --> 00:46:43.630 align:middle line:90% AUDIENCE: Wages are [INAUDIBLE]. 00:46:43.630 --> 00:46:46.730 align:middle line:84% PROFESSOR: Well, wages are a cash flow. 00:46:46.730 --> 00:46:48.910 align:middle line:84% Everything you pay every year just gets deducted. 00:46:48.910 --> 00:46:50.730 align:middle line:84% The thing is, investments are different. 00:46:50.730 --> 00:46:52.522 align:middle line:84% You don't deduct the investment as expenses 00:46:52.522 --> 00:46:55.070 align:middle line:84% because you depreciate the investment. 00:46:55.070 --> 00:47:00.270 align:middle line:84% Now with the corporate tax, I want to talk about two things. 00:47:00.270 --> 00:47:01.830 align:middle line:90% The first is incidence. 00:47:01.830 --> 00:47:04.110 align:middle line:84% And we've covered this already, which 00:47:04.110 --> 00:47:06.690 align:middle line:84% is, what is the incidence of the corporate tax? 00:47:06.690 --> 00:47:09.910 align:middle line:84% Well that depends on the relative elasticities 00:47:09.910 --> 00:47:12.250 align:middle line:84% of the factors that are subject to that corporate tax. 00:47:12.250 --> 00:47:14.030 align:middle line:90% Go back to chapter 19. 00:47:14.030 --> 00:47:16.310 align:middle line:84% Well, a corporation is not a thing. 00:47:16.310 --> 00:47:18.690 align:middle line:84% A corporation is an agglomeration of factors. 00:47:18.690 --> 00:47:20.750 align:middle line:84% Think of them as labor and capital. 00:47:20.750 --> 00:47:23.590 align:middle line:84% So the corporate tax is a tax on those two factors. 00:47:23.590 --> 00:47:25.190 align:middle line:84% Well, who will bear that tax depends 00:47:25.190 --> 00:47:28.270 align:middle line:84% on what's most elastic and inelastic, remember? 00:47:28.270 --> 00:47:32.230 align:middle line:84% Well, labor, if you think about a tax on the US 00:47:32.230 --> 00:47:35.830 align:middle line:84% corporate sector, labor is going to be pretty inelastic, not 00:47:35.830 --> 00:47:37.190 align:middle line:90% perfectly inelastic. 00:47:37.190 --> 00:47:39.630 align:middle line:84% Because remember, we also produce things in America 00:47:39.630 --> 00:47:41.470 align:middle line:90% through a non-corporate sector. 00:47:41.470 --> 00:47:43.290 align:middle line:84% So there is some potential for elasticity. 00:47:43.290 --> 00:47:46.350 align:middle line:84% I can move to the non-corporate sector, which is just 00:47:46.350 --> 00:47:48.630 align:middle line:84% self-employment and things like that, 00:47:48.630 --> 00:47:51.470 align:middle line:84% but it would be pretty inelastic. 00:47:51.470 --> 00:47:56.990 align:middle line:84% So we think in the short run, most of a corporate tax 00:47:56.990 --> 00:48:00.810 align:middle line:90% will be borne by laborers. 00:48:00.810 --> 00:48:06.402 align:middle line:84% On the other hand, capital is super mobile. 00:48:06.402 --> 00:48:08.110 align:middle line:84% Actually, no, I'm getting this backwards. 00:48:08.110 --> 00:48:08.902 align:middle line:90% Hold on one second. 00:48:08.902 --> 00:48:11.130 align:middle line:90% Let me back up. 00:48:11.130 --> 00:48:13.150 align:middle line:90% I got this backwards. 00:48:13.150 --> 00:48:14.930 align:middle line:84% Labor is somewhat inelastic because it 00:48:14.930 --> 00:48:15.930 align:middle line:90% can move across sectors. 00:48:15.930 --> 00:48:17.490 align:middle line:84% Capital, in the short run, is totally inelastic. 00:48:17.490 --> 00:48:19.190 align:middle line:84% You've already invested in the corporate sector. 00:48:19.190 --> 00:48:20.982 align:middle line:84% You've already made that investment, right? 00:48:20.982 --> 00:48:22.827 align:middle line:90% You've invested in GM. 00:48:22.827 --> 00:48:24.410 align:middle line:84% There's nothing you can do about that. 00:48:24.410 --> 00:48:25.310 align:middle line:90% It's inelastic. 00:48:25.310 --> 00:48:27.750 align:middle line:84% Labor is somewhat elastic, so it'll 00:48:27.750 --> 00:48:29.990 align:middle line:84% be shared between capital and labor. 00:48:29.990 --> 00:48:33.790 align:middle line:84% Over time, we think labor will necessarily 00:48:33.790 --> 00:48:36.330 align:middle line:84% get more elastic over time, maybe a little bit, 00:48:36.330 --> 00:48:38.470 align:middle line:84% as people reorganize production society 00:48:38.470 --> 00:48:39.930 align:middle line:84% towards the non-corporate sector. 00:48:39.930 --> 00:48:41.990 align:middle line:84% But capital will be very elastic over time. 00:48:41.990 --> 00:48:44.870 align:middle line:84% Over time, capital can easily flee. 00:48:44.870 --> 00:48:47.970 align:middle line:84% So over time, we think of, in the long run, 00:48:47.970 --> 00:48:49.590 align:middle line:84% the incidence of corporate taxes could 00:48:49.590 --> 00:48:53.310 align:middle line:84% be a lot on workers, not a lot on capital. 00:48:53.310 --> 00:48:56.310 align:middle line:84% However, once we get to general equilibrium tax, 00:48:56.310 --> 00:48:57.990 align:middle line:90% incidence gets complicated. 00:48:57.990 --> 00:49:01.230 align:middle line:84% Because when that capital flees, where does it go? 00:49:01.230 --> 00:49:03.410 align:middle line:84% It goes to the non-corporate sector. 00:49:03.410 --> 00:49:05.910 align:middle line:84% What happens when capital flees to the non-corporate sector? 00:49:05.910 --> 00:49:10.190 align:middle line:84% Supply of capital goes up, so the return to capital goes down. 00:49:10.190 --> 00:49:12.670 align:middle line:84% So actually, the incidence of taxation 00:49:12.670 --> 00:49:15.590 align:middle line:84% is going to be somewhat on capital. 00:49:15.590 --> 00:49:21.230 align:middle line:84% It'll be on, in particular, overall capital will suffer. 00:49:21.230 --> 00:49:24.070 align:middle line:84% And in particular-- this is a very important point-- when 00:49:24.070 --> 00:49:26.350 align:middle line:84% you tax corporations, capitalists 00:49:26.350 --> 00:49:28.250 align:middle line:84% in the non-corporate sector suffer. 00:49:28.250 --> 00:49:28.750 align:middle line:90% Why? 00:49:28.750 --> 00:49:30.500 align:middle line:84% Because capital flees the corporate sector 00:49:30.500 --> 00:49:31.813 align:middle line:90% to the non-corporate sector. 00:49:31.813 --> 00:49:33.480 align:middle line:84% More capital in the non-corporate sector 00:49:33.480 --> 00:49:36.000 align:middle line:84% raises or lowers the rate of return to capital. 00:49:36.000 --> 00:49:38.600 align:middle line:84% So through general equilibrium tax incidence, 00:49:38.600 --> 00:49:43.980 align:middle line:84% there's taxation on the non-corporate sector. 00:49:43.980 --> 00:49:47.400 align:middle line:84% So in the long run, we think that the incidence of taxation 00:49:47.400 --> 00:49:50.940 align:middle line:84% will be shared to some extent by workers, by corporate capital, 00:49:50.940 --> 00:49:52.280 align:middle line:90% by non-corporate capital. 00:49:52.280 --> 00:49:54.520 align:middle line:84% And we're not really sure what proportions. 00:49:54.520 --> 00:49:56.513 align:middle line:84% And that's why we love empirically-- yeah? 00:49:56.513 --> 00:49:57.180 align:middle line:90% AUDIENCE: Sorry. 00:49:57.180 --> 00:49:58.460 align:middle line:84% Just to make sure I understand what you're saying. 00:49:58.460 --> 00:50:00.335 align:middle line:84% You're saying that when you tax corporations, 00:50:00.335 --> 00:50:01.780 align:middle line:84% it harms the non-corporate sector? 00:50:01.780 --> 00:50:02.200 align:middle line:90% PROFESSOR: Yeah. 00:50:02.200 --> 00:50:03.492 align:middle line:90% AUDIENCE: Self-employed people? 00:50:03.492 --> 00:50:04.400 align:middle line:90% PROFESSOR: Yeah. 00:50:04.400 --> 00:50:06.880 align:middle line:84% Because, basically, think of it as self-employed people 00:50:06.880 --> 00:50:09.260 align:middle line:84% need to raise money to buy their equipment. 00:50:09.260 --> 00:50:13.380 align:middle line:90% 00:50:13.380 --> 00:50:15.240 align:middle line:84% Not self-employed people, people who invest 00:50:15.240 --> 00:50:17.180 align:middle line:90% in those self-employed people. 00:50:17.180 --> 00:50:21.400 align:middle line:84% So in other words, I'm a guy who loans money to dentists 00:50:21.400 --> 00:50:23.000 align:middle line:90% to build office buildings. 00:50:23.000 --> 00:50:25.368 align:middle line:84% And I can charge the dentist this high rate of interest 00:50:25.368 --> 00:50:27.660 align:middle line:84% because not many people want to loan money to dentists. 00:50:27.660 --> 00:50:29.240 align:middle line:84% Suddenly, all this capital comes flooding in 00:50:29.240 --> 00:50:30.300 align:middle line:90% from the corporate sector. 00:50:30.300 --> 00:50:32.060 align:middle line:84% And they're like, we'll loan you the lower rate of interest. 00:50:32.060 --> 00:50:34.080 align:middle line:84% That hurts me as the guy who loaned to dentists. 00:50:34.080 --> 00:50:35.938 align:middle line:84% So the capital in the non-corporate sector 00:50:35.938 --> 00:50:37.480 align:middle line:84% will see a fall in its rate of return 00:50:37.480 --> 00:50:39.180 align:middle line:90% through the increase in supply. 00:50:39.180 --> 00:50:39.680 align:middle line:90% Yeah? 00:50:39.680 --> 00:50:42.600 align:middle line:84% AUDIENCE: What about capital fleeing to different countries? 00:50:42.600 --> 00:50:43.540 align:middle line:84% PROFESSOR: Then there's the other thing, 00:50:43.540 --> 00:50:45.680 align:middle line:84% which is capital can flee to different countries. 00:50:45.680 --> 00:50:48.233 align:middle line:84% So basically, in theory-- once again, 00:50:48.233 --> 00:50:49.900 align:middle line:84% general equilibrium incidence is tricky. 00:50:49.900 --> 00:50:51.180 align:middle line:84% In theory, if you're a big enough country, 00:50:51.180 --> 00:50:54.000 align:middle line:84% you could affect the worldwide rate of return to capital. 00:50:54.000 --> 00:50:58.600 align:middle line:84% Small country, you would think that it should all just flee. 00:50:58.600 --> 00:50:59.700 align:middle line:90% In practice, it doesn't. 00:50:59.700 --> 00:51:02.000 align:middle line:84% In practice, capital is surprisingly sticky. 00:51:02.000 --> 00:51:04.720 align:middle line:84% So in practice, there's striking immobility of capital 00:51:04.720 --> 00:51:05.820 align:middle line:90% across countries. 00:51:05.820 --> 00:51:08.600 align:middle line:84% So almost everyone in every country in the world 00:51:08.600 --> 00:51:11.600 align:middle line:84% holds a much too big share of their portfolio in their home 00:51:11.600 --> 00:51:13.160 align:middle line:90% country. 00:51:13.160 --> 00:51:14.880 align:middle line:84% It's a universal factor that investors 00:51:14.880 --> 00:51:16.460 align:middle line:84% in every country around the world 00:51:16.460 --> 00:51:18.860 align:middle line:84% almost always, from an optimal portfolio theory, 00:51:18.860 --> 00:51:21.520 align:middle line:84% hold too much of their capital in their home country. 00:51:21.520 --> 00:51:24.280 align:middle line:84% AUDIENCE: It seems to make sense for America, for big country-- 00:51:24.280 --> 00:51:28.560 align:middle line:84% PROFESSOR: But small countries, people in-- 00:51:28.560 --> 00:51:32.440 align:middle line:84% I don't know, in Israel hold too much money in Israel. 00:51:32.440 --> 00:51:34.880 align:middle line:84% People in Thailand hold too much money 00:51:34.880 --> 00:51:37.440 align:middle line:84% in Thailand-- it's bigger-- hold too much money in Thailand. 00:51:37.440 --> 00:51:39.820 align:middle line:84% So basically, capital is not as mobile internationally. 00:51:39.820 --> 00:51:41.000 align:middle line:84% Now, there could be an optimality 00:51:41.000 --> 00:51:43.400 align:middle line:84% of this, which is maybe I know my investment opportunity is 00:51:43.400 --> 00:51:44.460 align:middle line:90% better in my local country. 00:51:44.460 --> 00:51:46.543 align:middle line:84% So there's an optimal reason all my capital there. 00:51:46.543 --> 00:51:48.460 align:middle line:84% So it's not necessarily a huge mystery, 00:51:48.460 --> 00:51:50.252 align:middle line:84% but there's not as much international flows 00:51:50.252 --> 00:51:50.960 align:middle line:90% as you'd think. 00:51:50.960 --> 00:51:53.140 align:middle line:84% But the bottom line is, it's a very complicated. 00:51:53.140 --> 00:51:54.700 align:middle line:84% I mean, your head is spinning at this point. 00:51:54.700 --> 00:51:55.700 align:middle line:90% That's the bottom line. 00:51:55.700 --> 00:51:57.140 align:middle line:90% It's very complicated. 00:51:57.140 --> 00:51:59.280 align:middle line:90% Workers are getting hit. 00:51:59.280 --> 00:52:00.680 align:middle line:84% Corporate capital is getting hit. 00:52:00.680 --> 00:52:01.347 align:middle line:90% It has to leave. 00:52:01.347 --> 00:52:02.888 align:middle line:84% Non-corporate capital is getting hit. 00:52:02.888 --> 00:52:04.780 align:middle line:84% Maybe international capital is getting hit. 00:52:04.780 --> 00:52:07.550 align:middle line:90% It's very complicated. 00:52:07.550 --> 00:52:09.300 align:middle line:84% So that's why we have empirical economics. 00:52:09.300 --> 00:52:10.500 align:middle line:90% What's the bottom line? 00:52:10.500 --> 00:52:12.960 align:middle line:84% The bottom line is that the best estimates 00:52:12.960 --> 00:52:15.920 align:middle line:84% are that for every dollar in tax cuts, about half 00:52:15.920 --> 00:52:19.437 align:middle line:84% gets borne by capitalists and half gets borne by workers. 00:52:19.437 --> 00:52:21.020 align:middle line:84% I would say that's the best estimates. 00:52:21.020 --> 00:52:24.520 align:middle line:90% There's some range. 00:52:24.520 --> 00:52:27.310 align:middle line:84% It's certainly not what most people assume, 00:52:27.310 --> 00:52:28.810 align:middle line:84% which is a corporate tax cut is just 00:52:28.810 --> 00:52:30.110 align:middle line:90% going to benefit capitalists. 00:52:30.110 --> 00:52:30.670 align:middle line:90% That's not true. 00:52:30.670 --> 00:52:32.378 align:middle line:84% A corporate tax cut will benefit workers. 00:52:32.378 --> 00:52:35.010 align:middle line:84% And that was a large selling point of the Trump tax cut. 00:52:35.010 --> 00:52:37.690 align:middle line:84% That would raise wages through this-- 00:52:37.690 --> 00:52:39.928 align:middle line:84% he didn't teach my model-- but basically, 00:52:39.928 --> 00:52:41.970 align:middle line:84% through this idea that corporations will benefit, 00:52:41.970 --> 00:52:42.870 align:middle line:84% and they'll pay their workers more. 00:52:42.870 --> 00:52:44.310 align:middle line:90% And that's not a crazy theory. 00:52:44.310 --> 00:52:46.410 align:middle line:84% And in fact, the evidence is about a 50% incidence 00:52:46.410 --> 00:52:47.930 align:middle line:90% on workers. 00:52:47.930 --> 00:52:50.150 align:middle line:90% So what's the fairness effect? 00:52:50.150 --> 00:52:52.330 align:middle line:84% Well, it's a corporate tax cut is 00:52:52.330 --> 00:52:55.650 align:middle line:84% less fair than an individual tax cut, which 00:52:55.650 --> 00:52:58.010 align:middle line:90% is borne all by workers. 00:52:58.010 --> 00:53:00.225 align:middle line:84% Because remember, the supply is fairly inelastic. 00:53:00.225 --> 00:53:01.850 align:middle line:84% So if you cut individual taxes, workers 00:53:01.850 --> 00:53:04.870 align:middle line:84% are going to benefit from all of that. 00:53:04.870 --> 00:53:07.530 align:middle line:84% But it's not as regressive as you 00:53:07.530 --> 00:53:11.210 align:middle line:84% might think because some of it is borne by workers. 00:53:11.210 --> 00:53:15.230 align:middle line:90% Now that's the equity part. 00:53:15.230 --> 00:53:17.050 align:middle line:90% What about the efficiency part? 00:53:17.050 --> 00:53:19.610 align:middle line:84% Remember, we don't have a pure profits tax. 00:53:19.610 --> 00:53:21.590 align:middle line:84% As a result, if we tax corporations, 00:53:21.590 --> 00:53:24.090 align:middle line:84% it will impact their economic decisions. 00:53:24.090 --> 00:53:26.050 align:middle line:84% And now we come to maybe what is the hardest 00:53:26.050 --> 00:53:28.410 align:middle line:90% model of the semester. 00:53:28.410 --> 00:53:31.110 align:middle line:84% So here we are, the last full week. 00:53:31.110 --> 00:53:32.990 align:middle line:84% And we'll go through a very hard model. 00:53:32.990 --> 00:53:35.690 align:middle line:84% This is the effect of how corporate taxes impact 00:53:35.690 --> 00:53:37.370 align:middle line:90% corporate investment. 00:53:37.370 --> 00:53:39.470 align:middle line:84% So I'm going to go through this slowly, 00:53:39.470 --> 00:53:41.070 align:middle line:84% but please stop me and ask questions. 00:53:41.070 --> 00:53:44.890 align:middle line:84% We'll get through this before the end of class. 00:53:44.890 --> 00:53:47.810 align:middle line:84% Think about a firm making an investment decision. 00:53:47.810 --> 00:53:50.330 align:middle line:90% That firm is going to invest $1. 00:53:50.330 --> 00:53:52.650 align:middle line:84% And for every dollar of investment-- 00:53:52.650 --> 00:53:59.370 align:middle line:90% 00:53:59.370 --> 00:54:01.490 align:middle line:84% for every $1 of investment, they're 00:54:01.490 --> 00:54:08.170 align:middle line:84% going to get MP sub k of return, the marginal product of capital. 00:54:08.170 --> 00:54:11.210 align:middle line:84% So in other words, the marginal product of capital is 0.1. 00:54:11.210 --> 00:54:13.530 align:middle line:84% That says for every dollar I invest, every year, 00:54:13.530 --> 00:54:15.950 align:middle line:90% I get $0.10 back. 00:54:15.950 --> 00:54:17.970 align:middle line:84% That's the marginal rate of return 00:54:17.970 --> 00:54:21.050 align:middle line:84% to that investment, the marginal product of capital. 00:54:21.050 --> 00:54:25.970 align:middle line:84% Now, let's also say that every period, that investment 00:54:25.970 --> 00:54:28.030 align:middle line:84% depreciates by some amount delta. 00:54:28.030 --> 00:54:29.030 align:middle line:90% Two things are going on. 00:54:29.030 --> 00:54:30.350 align:middle line:90% I'm investing. 00:54:30.350 --> 00:54:32.810 align:middle line:84% I'm making MPK, but the value of my investment 00:54:32.810 --> 00:54:35.690 align:middle line:90% is falling by delta. 00:54:35.690 --> 00:54:37.230 align:middle line:90% I'm assuming delta is linear. 00:54:37.230 --> 00:54:39.188 align:middle line:84% You can imagine it's non-linear, but let's just 00:54:39.188 --> 00:54:41.312 align:middle line:84% assume it's linear to make life easy. 00:54:41.312 --> 00:54:42.270 align:middle line:90% Assume delta is linear. 00:54:42.270 --> 00:54:44.810 align:middle line:90% MPK is not necessarily linear. 00:54:44.810 --> 00:54:48.800 align:middle line:84% Now third factor, the firm, if they want to make an investment, 00:54:48.800 --> 00:54:49.550 align:middle line:90% has to finance it. 00:54:49.550 --> 00:54:50.870 align:middle line:90% Forget retained earnings. 00:54:50.870 --> 00:54:52.030 align:middle line:90% They have to finance it. 00:54:52.030 --> 00:54:55.270 align:middle line:84% Let's imagine the firm finances it by borrowing money. 00:54:55.270 --> 00:54:57.690 align:middle line:90% And the rate of return is rho. 00:54:57.690 --> 00:54:59.747 align:middle line:84% That's the rate of return they have to pay. 00:54:59.747 --> 00:55:00.830 align:middle line:90% There's multiple channels. 00:55:00.830 --> 00:55:03.080 align:middle line:84% Let's just summarize them as saying, roughly speaking, 00:55:03.080 --> 00:55:04.730 align:middle line:84% through all the channels firms use, 00:55:04.730 --> 00:55:08.490 align:middle line:84% the cost of financing, of borrowing $1, 00:55:08.490 --> 00:55:11.950 align:middle line:90% of getting $1 to invest is rho. 00:55:11.950 --> 00:55:12.950 align:middle line:90% It could be from a bank. 00:55:12.950 --> 00:55:14.150 align:middle line:90% It could be through stocks. 00:55:14.150 --> 00:55:16.250 align:middle line:90% Whatever it is, it's rho. 00:55:16.250 --> 00:55:21.420 align:middle line:84% So what that means is that every year, firms 00:55:21.420 --> 00:55:25.940 align:middle line:84% pay out delta plus rho in costs for every dollar of investment 00:55:25.940 --> 00:55:27.580 align:middle line:90% they make. 00:55:27.580 --> 00:55:29.383 align:middle line:84% They're paying the interest back. 00:55:29.383 --> 00:55:31.300 align:middle line:84% I'll call it interest, but it's just a summary 00:55:31.300 --> 00:55:32.620 align:middle line:90% of the cost of capital. 00:55:32.620 --> 00:55:34.900 align:middle line:90% And they're paying depreciation. 00:55:34.900 --> 00:55:37.580 align:middle line:84% That is the cost of paying it every year 00:55:37.580 --> 00:55:39.220 align:middle line:90% on this investment they make. 00:55:39.220 --> 00:55:43.220 align:middle line:90% And they're getting MPK. 00:55:43.220 --> 00:55:45.180 align:middle line:90% They're getting MP sub k. 00:55:45.180 --> 00:55:47.820 align:middle line:84% So to think about this, let's assume 00:55:47.820 --> 00:55:50.760 align:middle line:90% delta equals rho equals 0.1. 00:55:50.760 --> 00:55:52.300 align:middle line:90% Delta equals 0.1. 00:55:52.300 --> 00:55:54.520 align:middle line:90% Rho equals 0.1, 10%. 00:55:54.520 --> 00:55:56.380 align:middle line:90% Let's just make life easy. 00:55:56.380 --> 00:56:01.300 align:middle line:90% So now let's go to figure 24.2. 00:56:01.300 --> 00:56:02.200 align:middle line:90% Let's draw this. 00:56:02.200 --> 00:56:08.880 align:middle line:84% So what we have is on the x-axis is investment, k. 00:56:08.880 --> 00:56:10.300 align:middle line:90% On the x, investment k. 00:56:10.300 --> 00:56:13.980 align:middle line:90% On the y-axis is dollars. 00:56:13.980 --> 00:56:16.500 align:middle line:90% The y-axis is dollars. 00:56:16.500 --> 00:56:22.140 align:middle line:84% And we have a line at $0.20, 0.2. 00:56:22.140 --> 00:56:29.220 align:middle line:84% This is delta plus rho, which equals the marginal cost. 00:56:29.220 --> 00:56:32.270 align:middle line:84% We'll call it MC1, the marginal cost of investment. 00:56:32.270 --> 00:56:34.020 align:middle line:84% Every period, that's what you have to pay. 00:56:34.020 --> 00:56:34.840 align:middle line:90% We're assuming it's linear. 00:56:34.840 --> 00:56:37.132 align:middle line:84% It doesn't have to be linear, but assuming it's linear. 00:56:37.132 --> 00:56:39.860 align:middle line:84% That for whenever you invest $1, you're paying $0.20 every period 00:56:39.860 --> 00:56:41.820 align:middle line:90% to invest that dollar. 00:56:41.820 --> 00:56:43.320 align:middle line:90% What is the benefit investment? 00:56:43.320 --> 00:56:48.420 align:middle line:84% Well, it's some marginal product of capital MPK, which 00:56:48.420 --> 00:56:50.620 align:middle line:90% equals the marginal benefit. 00:56:50.620 --> 00:56:52.040 align:middle line:90% MPK is downward sloping. 00:56:52.040 --> 00:56:52.980 align:middle line:90% Why? 00:56:52.980 --> 00:56:54.120 align:middle line:90% Someone tell me. 00:56:54.120 --> 00:56:54.620 align:middle line:90% Yeah? 00:56:54.620 --> 00:56:55.860 align:middle line:90% AUDIENCE: You depreciate. 00:56:55.860 --> 00:56:57.360 align:middle line:84% PROFESSOR: No, depreciation is here. 00:56:57.360 --> 00:56:58.920 align:middle line:90% Why is MPK downward sloping? 00:56:58.920 --> 00:57:00.980 align:middle line:90% AUDIENCE: [INAUDIBLE] 00:57:00.980 --> 00:57:02.540 align:middle line:84% PROFESSOR: Well, no, because the more 00:57:02.540 --> 00:57:04.613 align:middle line:84% you invest, the less productive it is. 00:57:04.613 --> 00:57:06.780 align:middle line:84% We have diminishing marginal products in production, 00:57:06.780 --> 00:57:07.738 align:middle line:90% just like we have this. 00:57:07.738 --> 00:57:10.662 align:middle line:84% Going back to your old-school 1401, lecture 5. 00:57:10.662 --> 00:57:13.120 align:middle line:84% Just like with diminishing marginal utility of consumption, 00:57:13.120 --> 00:57:15.693 align:middle line:84% we have diminishing marginal product of production. 00:57:15.693 --> 00:57:17.360 align:middle line:84% So marginal product of labor diminishes. 00:57:17.360 --> 00:57:19.110 align:middle line:84% The marginal product of capital diminishes 00:57:19.110 --> 00:57:20.280 align:middle line:90% over the relevant rate. 00:57:20.280 --> 00:57:21.400 align:middle line:84% There may be ranges where it goes up. 00:57:21.400 --> 00:57:23.483 align:middle line:84% But we think in the relevant range for production, 00:57:23.483 --> 00:57:26.765 align:middle line:84% we think there's decreasing returns to scale. 00:57:26.765 --> 00:57:28.640 align:middle line:84% We think in the relevant range of production, 00:57:28.640 --> 00:57:30.723 align:middle line:84% there's a diminishing marginal product of capital. 00:57:30.723 --> 00:57:32.180 align:middle line:84% Otherwise, you just grow forever. 00:57:32.180 --> 00:57:34.255 align:middle line:84% Without diminishing marginal product of capital, 00:57:34.255 --> 00:57:35.880 align:middle line:84% we'd have one firm running the economy. 00:57:35.880 --> 00:57:38.252 align:middle line:84% Now maybe we do, but the bottom line 00:57:38.252 --> 00:57:40.460 align:middle line:84% is we think in the relevant range of marginal product 00:57:40.460 --> 00:57:42.442 align:middle line:90% of capital is diminishing. 00:57:42.442 --> 00:57:43.400 align:middle line:90% This is very important. 00:57:43.400 --> 00:57:45.900 align:middle line:84% It's just like marginal utility of consumption and tuition. 00:57:45.900 --> 00:57:50.260 align:middle line:84% Each additional dollar of capital 00:57:50.260 --> 00:57:54.340 align:middle line:84% is less productive than the previous one. 00:57:54.340 --> 00:57:56.540 align:middle line:90% Now, what does that mean? 00:57:56.540 --> 00:57:59.620 align:middle line:84% That means that the optimal level of investment 00:57:59.620 --> 00:58:02.340 align:middle line:90% is at this intersection. 00:58:02.340 --> 00:58:04.040 align:middle line:90% And we're going to call this K1. 00:58:04.040 --> 00:58:07.260 align:middle line:90% 00:58:07.260 --> 00:58:08.700 align:middle line:90% Think about the intuition here. 00:58:08.700 --> 00:58:12.978 align:middle line:84% If the marginal product of capital is above $0.20, 00:58:12.978 --> 00:58:14.020 align:middle line:90% then you're making money. 00:58:14.020 --> 00:58:15.308 align:middle line:90% You should keep investing. 00:58:15.308 --> 00:58:16.850 align:middle line:84% What happens when you keep investing? 00:58:16.850 --> 00:58:18.470 align:middle line:90% You move down this line. 00:58:18.470 --> 00:58:20.810 align:middle line:84% If the marginal product of capital is below $0.20, 00:58:20.810 --> 00:58:22.470 align:middle line:90% you are losing money. 00:58:22.470 --> 00:58:23.690 align:middle line:90% So you should invest less. 00:58:23.690 --> 00:58:26.150 align:middle line:84% You move up here, and that's the optimal point. 00:58:26.150 --> 00:58:29.030 align:middle line:84% So the optimal point is where the return 00:58:29.030 --> 00:58:31.310 align:middle line:84% to the next dollar of investment is 00:58:31.310 --> 00:58:35.030 align:middle line:84% equal to the cost of that dollar of investment. 00:58:35.030 --> 00:58:37.910 align:middle line:90% Now let's complicate things. 00:58:37.910 --> 00:58:40.350 align:middle line:90% Now let's add taxation. 00:58:40.350 --> 00:58:43.070 align:middle line:90% What does taxation do? 00:58:43.070 --> 00:58:45.790 align:middle line:84% Let's just say there's a pure corporate tax, nothing 00:58:45.790 --> 00:58:49.730 align:middle line:84% fancy, just a pure, I'm going to tax your income. 00:58:49.730 --> 00:58:52.575 align:middle line:90% I'm going to tax your income. 00:58:52.575 --> 00:58:54.950 align:middle line:84% Well, what that does is that means that instead of taking 00:58:54.950 --> 00:58:59.190 align:middle line:84% home MP sub K, you take home MP sub k times 1 minus-- 00:58:59.190 --> 00:59:01.190 align:middle line:90% what am I calling it-- 00:59:01.190 --> 00:59:05.430 align:middle line:84% 1 minus tau, where tau is the corporate tax rate. 00:59:05.430 --> 00:59:07.150 align:middle line:90% What does that do to this graph? 00:59:07.150 --> 00:59:12.550 align:middle line:84% That shifts in the marginal benefit curve. 00:59:12.550 --> 00:59:17.390 align:middle line:84% Now the marginal benefit curve is MPK times 1 minus tau. 00:59:17.390 --> 00:59:20.430 align:middle line:90% That equals MB2. 00:59:20.430 --> 00:59:23.670 align:middle line:84% It shifts in the marginal benefit curve. 00:59:23.670 --> 00:59:27.670 align:middle line:84% What does that do to the optimal level of investment? 00:59:27.670 --> 00:59:29.750 align:middle line:90% It lowers it. 00:59:29.750 --> 00:59:32.870 align:middle line:84% It lowers the optimal level of investment to K2. 00:59:32.870 --> 00:59:33.990 align:middle line:90% Why? 00:59:33.990 --> 00:59:37.210 align:middle line:84% Because since the next dollar is going to yield less, 00:59:37.210 --> 00:59:39.270 align:middle line:84% you don't want to invest as many dollars 00:59:39.270 --> 00:59:42.070 align:middle line:84% because each dollar investing is less and less productive. 00:59:42.070 --> 00:59:45.150 align:middle line:84% So an investment that was productive here-- 00:59:45.150 --> 00:59:48.910 align:middle line:84% this investment was productive before tax because MPK exceeded 00:59:48.910 --> 00:59:50.190 align:middle line:90% delta plus rho-- 00:59:50.190 --> 00:59:55.470 align:middle line:84% is no longer productive after tax because MP times 1 minus tau 00:59:55.470 --> 00:59:59.590 align:middle line:90% is below rho plus delta. 00:59:59.590 --> 01:00:00.703 align:middle line:90% Questions about that? 01:00:00.703 --> 01:00:02.370 align:middle line:84% Once again, stop me if this isn't clear. 01:00:02.370 --> 01:00:04.310 align:middle line:90% It's only going to get harder. 01:00:04.310 --> 01:00:07.470 align:middle line:84% So the bottom line is, once again, your key intuition 01:00:07.470 --> 01:00:09.990 align:middle line:84% is diminishing marginal product of capital. 01:00:09.990 --> 01:00:11.630 align:middle line:84% And that's going to say corporate tax 01:00:11.630 --> 01:00:14.390 align:middle line:84% will lower the level of investment. 01:00:14.390 --> 01:00:16.550 align:middle line:84% Now, here's where it gets tricky, 01:00:16.550 --> 01:00:20.070 align:middle line:84% which is corporate taxation does not just impact 01:00:20.070 --> 01:00:24.710 align:middle line:90% MPK because of depreciation. 01:00:24.710 --> 01:00:27.350 align:middle line:84% When there's depreciation allowances, 01:00:27.350 --> 01:00:31.750 align:middle line:84% the higher corporate tax rate means a higher value 01:00:31.750 --> 01:00:34.150 align:middle line:90% depreciation allowances. 01:00:34.150 --> 01:00:38.490 align:middle line:84% In particular, when we buy an asset, 01:00:38.490 --> 01:00:40.135 align:middle line:84% think of buying an asset as it comes-- 01:00:40.135 --> 01:00:41.510 align:middle line:84% you know those refrigerators that 01:00:41.510 --> 01:00:43.328 align:middle line:90% have the energy facts on them? 01:00:43.328 --> 01:00:44.870 align:middle line:84% Think about that as any asset you buy 01:00:44.870 --> 01:00:47.150 align:middle line:84% comes with a coupon that says, here's 01:00:47.150 --> 01:00:50.630 align:middle line:84% the value of depreciation allowances with this asset. 01:00:50.630 --> 01:00:56.710 align:middle line:84% So if it's pure economic depreciation, the value is 0. 01:00:56.710 --> 01:00:58.085 align:middle line:84% Because, basically, truly, you're 01:00:58.085 --> 01:00:59.627 align:middle line:84% just getting back from the government 01:00:59.627 --> 01:01:00.990 align:middle line:90% what it's actually depreciating. 01:01:00.990 --> 01:01:04.190 align:middle line:84% But if it's better than economic depreciation, 01:01:04.190 --> 01:01:06.070 align:middle line:90% it's a positive value. 01:01:06.070 --> 01:01:10.750 align:middle line:90% So basically, z-- 01:01:10.750 --> 01:01:11.370 align:middle line:90% I'm sorry. 01:01:11.370 --> 01:01:12.750 align:middle line:90% Scratch the 0. 01:01:12.750 --> 01:01:13.990 align:middle line:90% Let me back up. 01:01:13.990 --> 01:01:15.610 align:middle line:90% It's simply not 0. 01:01:15.610 --> 01:01:16.990 align:middle line:90% Let me redefine it differently. 01:01:16.990 --> 01:01:23.510 align:middle line:84% It's the NPV of the depreciation relative to the purchase price. 01:01:23.510 --> 01:01:27.830 align:middle line:84% So we're going to call z, to make life easy, 01:01:27.830 --> 01:01:29.810 align:middle line:90% z is between 0 and 1. 01:01:29.810 --> 01:01:33.870 align:middle line:90% 01:01:33.870 --> 01:01:37.230 align:middle line:84% 0 would be you don't get depreciated at all. 01:01:37.230 --> 01:01:39.210 align:middle line:90% 1 would be expensing. 01:01:39.210 --> 01:01:41.110 align:middle line:90% You depreciate it today. 01:01:41.110 --> 01:01:44.870 align:middle line:84% In between, it's depreciation that happens over time, 01:01:44.870 --> 01:01:47.630 align:middle line:84% but the slower you get it, the less it's worth. 01:01:47.630 --> 01:01:49.390 align:middle line:84% So depreciation, which says, I'll 01:01:49.390 --> 01:01:51.910 align:middle line:84% let you appreciate this over 100 years 01:01:51.910 --> 01:01:53.967 align:middle line:90% is worth not very much to you. 01:01:53.967 --> 01:01:55.550 align:middle line:84% Because by five or six years from now, 01:01:55.550 --> 01:01:56.290 align:middle line:90% that's not worth a lot. 01:01:56.290 --> 01:01:57.690 align:middle line:84% And you've still got 95 years to go. 01:01:57.690 --> 01:01:59.570 align:middle line:84% Depreciation, which says you can appreciate over three years 01:01:59.570 --> 01:02:00.710 align:middle line:90% is worth more to you. 01:02:00.710 --> 01:02:05.043 align:middle line:84% So the more rapid is the depreciation, the higher is z. 01:02:05.043 --> 01:02:07.710 align:middle line:84% If I literally let you deduct it today, which we call expensing, 01:02:07.710 --> 01:02:10.760 align:middle line:90% z is 1. 01:02:10.760 --> 01:02:14.400 align:middle line:84% So what that means, with that concept z, 01:02:14.400 --> 01:02:22.060 align:middle line:84% what that means is that this is, essentially, something you get. 01:02:22.060 --> 01:02:25.200 align:middle line:84% We say you get to deduct from your taxes z. 01:02:25.200 --> 01:02:28.240 align:middle line:84% For every dollar you invest, you get z. 01:02:28.240 --> 01:02:32.960 align:middle line:84% You get a tax break that's worth tau z to you 01:02:32.960 --> 01:02:35.280 align:middle line:84% because it's deduction, not a credit. 01:02:35.280 --> 01:02:37.020 align:middle line:90% So you get a tax break of tau z. 01:02:37.020 --> 01:02:38.640 align:middle line:84% For every dollar you invest, you're 01:02:38.640 --> 01:02:42.600 align:middle line:84% going to get tau z tax break because you're going to deduct z 01:02:42.600 --> 01:02:45.600 align:middle line:90% at a corporate tax rate of tau. 01:02:45.600 --> 01:02:49.440 align:middle line:90% So what does that mean? 01:02:49.440 --> 01:02:53.480 align:middle line:84% That means that, basically, for example, if the depreciation 01:02:53.480 --> 01:02:59.920 align:middle line:84% allowance is worth 50%, if z is 0.5 and the tax rate is 20%, 01:02:59.920 --> 01:03:02.625 align:middle line:90% then that's 10% off price. 01:03:02.625 --> 01:03:03.500 align:middle line:90% Think of it that way. 01:03:03.500 --> 01:03:08.822 align:middle line:84% I was going to buy this building for $100,000. 01:03:08.822 --> 01:03:10.280 align:middle line:84% The value of depreciation allowance 01:03:10.280 --> 01:03:12.560 align:middle line:90% is 0.5 and present value. 01:03:12.560 --> 01:03:14.800 align:middle line:84% The tax rate is 20%, so I'm going 01:03:14.800 --> 01:03:20.420 align:middle line:84% to get to deduct 10% of the value of this. 01:03:20.420 --> 01:03:25.140 align:middle line:84% So it's essentially $10,000 off, the price of buying it. 01:03:25.140 --> 01:03:26.505 align:middle line:90% Let me stop there. 01:03:26.505 --> 01:03:27.380 align:middle line:90% Questions about that? 01:03:27.380 --> 01:03:28.000 align:middle line:90% Yeah? 01:03:28.000 --> 01:03:31.360 align:middle line:84% AUDIENCE: I'm still confused on what the difference is between z 01:03:31.360 --> 01:03:34.080 align:middle line:90% and the depreciation of 0.1. 01:03:34.080 --> 01:03:35.740 align:middle line:84% PROFESSOR: Oh, totally different thing. 01:03:35.740 --> 01:03:36.865 align:middle line:90% Oh, actually not different. 01:03:36.865 --> 01:03:37.800 align:middle line:90% Great point. 01:03:37.800 --> 01:03:42.760 align:middle line:84% In a perfect world, z would be delta. 01:03:42.760 --> 01:03:44.420 align:middle line:90% It's a great question actually. 01:03:44.420 --> 01:03:49.200 align:middle line:84% In a world of economic depreciation, z equals delta. 01:03:49.200 --> 01:03:52.672 align:middle line:84% So z is what the schedule gives you, 01:03:52.672 --> 01:03:54.880 align:middle line:84% which is different than delta because we can't really 01:03:54.880 --> 01:03:56.360 align:middle line:90% measure economic depreciation. 01:03:56.360 --> 01:03:58.620 align:middle line:84% If we measure economic depreciation, z would be delta. 01:03:58.620 --> 01:03:59.162 align:middle line:90% AUDIENCE: OK. 01:03:59.162 --> 01:04:02.800 align:middle line:84% So that's why you do the tau z instead of the tau-- 01:04:02.800 --> 01:04:06.020 align:middle line:84% PROFESSOR: Well, no, go back to this formula. 01:04:06.020 --> 01:04:09.000 align:middle line:84% The reason I do the tau is because inside this equation, 01:04:09.000 --> 01:04:10.600 align:middle line:90% it's part of expenses. 01:04:10.600 --> 01:04:11.420 align:middle line:90% It's a deduction. 01:04:11.420 --> 01:04:12.780 align:middle line:90% Remember, we did chapter 18. 01:04:12.780 --> 01:04:15.320 align:middle line:84% Deductions are only worth as high as your tax-- with a tax 01:04:15.320 --> 01:04:17.560 align:middle line:90% rate of 0, deductions worthless. 01:04:17.560 --> 01:04:21.000 align:middle line:84% So deduction of $1,000 is only worth your tax rate times 01:04:21.000 --> 01:04:22.320 align:middle line:90% $1,000. 01:04:22.320 --> 01:04:26.840 align:middle line:84% That's why I multiply by tau But it's a great question. 01:04:26.840 --> 01:04:29.400 align:middle line:84% Z should be delta in a perfect world. 01:04:29.400 --> 01:04:34.320 align:middle line:84% We're saying z is something else. 01:04:34.320 --> 01:04:38.000 align:middle line:90% So now what does that mean? 01:04:38.000 --> 01:04:49.200 align:middle line:84% That means that, basically, now your cost is delta plus rho. 01:04:49.200 --> 01:04:53.600 align:middle line:84% So every dollar of investment is costing you delta plus rho. 01:04:53.600 --> 01:04:58.120 align:middle line:90% 01:04:58.120 --> 01:05:05.250 align:middle line:84% but you can, basically, offset against that cost 01:05:05.250 --> 01:05:09.850 align:middle line:84% delta plus rho times 1 minus tau z, 01:05:09.850 --> 01:05:12.810 align:middle line:84% is basically your net cost of investing. 01:05:12.810 --> 01:05:18.630 align:middle line:84% So basically, if you're getting 10% back, 01:05:18.630 --> 01:05:23.170 align:middle line:84% you're only paying 90% as much as if you were before. 01:05:23.170 --> 01:05:27.370 align:middle line:84% So that is essentially your net cost of investing. 01:05:27.370 --> 01:05:31.290 align:middle line:84% Now there's one extra complication. 01:05:31.290 --> 01:05:33.130 align:middle line:84% There's one extra complication, which 01:05:33.130 --> 01:05:38.930 align:middle line:84% is we also have something called an investment tax credit, which 01:05:38.930 --> 01:05:42.530 align:middle line:84% I actually forgot to mention before. 01:05:42.530 --> 01:05:45.970 align:middle line:84% We have these tax credits here in part of this equation. 01:05:45.970 --> 01:05:48.210 align:middle line:84% What's the investment tax credit? 01:05:48.210 --> 01:05:51.327 align:middle line:84% Remember, credits are after your tax bill is computed. 01:05:51.327 --> 01:05:53.410 align:middle line:84% It's literally money the government gives you back 01:05:53.410 --> 01:05:54.830 align:middle line:90% for every dollar you invest. 01:05:54.830 --> 01:05:57.610 align:middle line:84% So an investment tax credit of 10% is literally for every 01:05:57.610 --> 01:06:01.690 align:middle line:84% dollar you invest, I'm going to send you a check for $0.10, 01:06:01.690 --> 01:06:02.613 align:middle line:90% so it's a credit. 01:06:02.613 --> 01:06:04.530 align:middle line:84% So that means that your net cost of investment 01:06:04.530 --> 01:06:08.170 align:middle line:84% is really delta plus rho times 1 minus tau z minus alpha. 01:06:08.170 --> 01:06:10.310 align:middle line:84% Alpha is the investment tax credit rate. 01:06:10.310 --> 01:06:12.370 align:middle line:90% Call it 10%. 01:06:12.370 --> 01:06:14.010 align:middle line:90% So what does that mean? 01:06:14.010 --> 01:06:18.970 align:middle line:84% If you go to figure 24.4, what that means 01:06:18.970 --> 01:06:22.090 align:middle line:90% is that the cost has fallen. 01:06:22.090 --> 01:06:25.850 align:middle line:84% Your marginal cost is no longer delta plus rho. 01:06:25.850 --> 01:06:29.570 align:middle line:84% It's this more complicated delta plus rho times 1 minus tau times 01:06:29.570 --> 01:06:30.490 align:middle line:90% z minus alpha. 01:06:30.490 --> 01:06:33.210 align:middle line:90% 01:06:33.210 --> 01:06:37.190 align:middle line:84% So basically, what that's doing is, essentially-- 01:06:37.190 --> 01:06:37.690 align:middle line:90% I'm sorry. 01:06:37.690 --> 01:06:39.190 align:middle line:84% The alpha is inside the parentheses. 01:06:39.190 --> 01:06:40.010 align:middle line:90% I'm sorry. 01:06:40.010 --> 01:06:45.150 align:middle line:84% What that's doing is that's saying that tax systems, 01:06:45.150 --> 01:06:48.250 align:middle line:84% they lower the return to the activity, 01:06:48.250 --> 01:06:50.890 align:middle line:84% but they also lower the cost of the activity. 01:06:50.890 --> 01:06:53.050 align:middle line:84% They lower the return to investment, 01:06:53.050 --> 01:06:56.630 align:middle line:84% but they also lower the cost of investment 01:06:56.630 --> 01:06:58.610 align:middle line:84% Lower the return investment, but they also 01:06:58.610 --> 01:07:00.730 align:middle line:90% lower the cost of investment. 01:07:00.730 --> 01:07:07.410 align:middle line:84% And so the net effect, K3, is below K1 but higher than K2. 01:07:07.410 --> 01:07:10.710 align:middle line:90% So taxes deter investment. 01:07:10.710 --> 01:07:15.250 align:middle line:84% The bottom line is, taxes deter investment. 01:07:15.250 --> 01:07:18.650 align:middle line:84% But how much it does so depends on things 01:07:18.650 --> 01:07:23.370 align:middle line:84% like depreciation allowances and the investment tax credit. 01:07:23.370 --> 01:07:24.590 align:middle line:90% How do we put this together? 01:07:24.590 --> 01:07:26.507 align:middle line:84% The way we put this together is the following. 01:07:26.507 --> 01:07:30.330 align:middle line:84% We say, look, we know what the corporate tax rate is, 21%. 01:07:30.330 --> 01:07:32.170 align:middle line:90% But that's irrelevant. 01:07:32.170 --> 01:07:36.050 align:middle line:84% What's relevant is, how does taxation change your incentive 01:07:36.050 --> 01:07:37.930 align:middle line:90% to invest? 01:07:37.930 --> 01:07:39.873 align:middle line:84% Well, that's a function of both the rate 01:07:39.873 --> 01:07:42.290 align:middle line:84% and things like depreciation allowances and investment tax 01:07:42.290 --> 01:07:43.090 align:middle line:90% credits. 01:07:43.090 --> 01:07:46.690 align:middle line:84% So what we say is we calculate an effective tax rate-- 01:07:46.690 --> 01:07:50.210 align:middle line:84% we calculate something called the effective tax rate, which 01:07:50.210 --> 01:07:55.570 align:middle line:84% is the marginal product of capital 01:07:55.570 --> 01:08:00.980 align:middle line:84% after tax minus the marginal product of capital 01:08:00.980 --> 01:08:06.880 align:middle line:84% before tax over the marginal product of capital after tax. 01:08:06.880 --> 01:08:11.942 align:middle line:90% 01:08:11.942 --> 01:08:12.900 align:middle line:90% Ignore the denominator. 01:08:12.900 --> 01:08:15.540 align:middle line:84% Pay attention to the numerator for a minute. 01:08:15.540 --> 01:08:18.279 align:middle line:84% The effective tax rate is-- think of it this way. 01:08:18.279 --> 01:08:19.779 align:middle line:90% This is the key intuition. 01:08:19.779 --> 01:08:24.899 align:middle line:84% What is the wedge between what you get from $1 of investment 01:08:24.899 --> 01:08:27.380 align:middle line:90% due to taxes? 01:08:27.380 --> 01:08:29.140 align:middle line:84% What is the wedge between what you get 01:08:29.140 --> 01:08:31.700 align:middle line:90% for $1 investment due to taxes? 01:08:31.700 --> 01:08:37.859 align:middle line:84% If the tax rate is 0, the effective tax rate is 0. 01:08:37.859 --> 01:08:44.660 align:middle line:84% If the tax rate was 100%, and z was 0, and alpha was 0, then 01:08:44.660 --> 01:08:48.859 align:middle line:84% the factor tax rate would be 100%. 01:08:48.859 --> 01:08:50.260 align:middle line:90% So let's think of it this way. 01:08:50.260 --> 01:08:53.500 align:middle line:90% 01:08:53.500 --> 01:09:00.260 align:middle line:84% Imagine a world where z is 1, where depreciation allowance-- 01:09:00.260 --> 01:09:05.939 align:middle line:84% where z is 1, where you deduct the entire cost 01:09:05.939 --> 01:09:08.490 align:middle line:84% of your investment from your taxes. 01:09:08.490 --> 01:09:10.740 align:middle line:84% Can anyone give me an intuition what the effective tax 01:09:10.740 --> 01:09:15.660 align:middle line:90% rate would be then, if z was 1? 01:09:15.660 --> 01:09:19.779 align:middle line:84% So every year, I get to expense my investment. 01:09:19.779 --> 01:09:22.380 align:middle line:84% What is the effective tax rate on that investment? 01:09:22.380 --> 01:09:24.300 align:middle line:90% Well, think about the trade-off. 01:09:24.300 --> 01:09:28.260 align:middle line:84% On the one hand, I'm paying tax on return from that investment. 01:09:28.260 --> 01:09:32.700 align:middle line:84% On the other hand, I'm deducting the cost of that investment. 01:09:32.700 --> 01:09:35.260 align:middle line:90% So in net, it's a 0 tax rate. 01:09:35.260 --> 01:09:37.779 align:middle line:84% It's essentially, all the tax I'm paying, 01:09:37.779 --> 01:09:39.779 align:middle line:90% I'm deducting at the same time. 01:09:39.779 --> 01:09:42.580 align:middle line:84% So in other words, I'm making all this money off it, 01:09:42.580 --> 01:09:44.180 align:middle line:84% but I'm getting a full tax deduction 01:09:44.180 --> 01:09:45.640 align:middle line:90% for all that investment. 01:09:45.640 --> 01:09:49.340 align:middle line:84% So at the end of the day, it's a 0 effective tax rate. 01:09:49.340 --> 01:09:56.380 align:middle line:84% So with z equals 0, if z equals 0 and alpha equals 0, 01:09:56.380 --> 01:10:04.940 align:middle line:84% the effective tax rate equals the statutory tax rate. 01:10:04.940 --> 01:10:07.160 align:middle line:84% Then it's just like, look, at the end of the day, 01:10:07.160 --> 01:10:10.220 align:middle line:84% if it's 35% tax rate, there's a 35% reduction incentive 01:10:10.220 --> 01:10:12.420 align:middle line:90% to invest. 01:10:12.420 --> 01:10:18.700 align:middle line:84% But if z equals 1 and alpha equals 0, 01:10:18.700 --> 01:10:23.180 align:middle line:84% then the effective tax rate is 0. 01:10:23.180 --> 01:10:26.640 align:middle line:84% Because basically, at the end of the day, 01:10:26.640 --> 01:10:28.860 align:middle line:84% I'm deducting just as much as I'm paying, 01:10:28.860 --> 01:10:31.240 align:middle line:84% all the income I'm making, I'm going to then deduct. 01:10:31.240 --> 01:10:33.980 align:middle line:84% So at the end of the day, I'm indifferent. 01:10:33.980 --> 01:10:39.900 align:middle line:84% Now what if z equals 1 and alpha is positive? 01:10:39.900 --> 01:10:42.300 align:middle line:84% Then the net effective tax rate is negative. 01:10:42.300 --> 01:10:46.500 align:middle line:84% That is, there's a net incentive to invest from the tax code. 01:10:46.500 --> 01:10:49.500 align:middle line:84% That is, let's say I let you fully expect your investments, 01:10:49.500 --> 01:10:52.260 align:middle line:84% and I give you an investment tax credit. 01:10:52.260 --> 01:10:56.710 align:middle line:84% Then on net, I'm actually paying you to invest. 01:10:56.710 --> 01:11:00.670 align:middle line:90% That is what the US did in 1981. 01:11:00.670 --> 01:11:03.330 align:middle line:84% We actually set up a system where for many sectors, 01:11:03.330 --> 01:11:06.870 align:middle line:84% the effective tax rate was actually negative. 01:11:06.870 --> 01:11:13.070 align:middle line:84% And because we both allowed very rapid depreciation 01:11:13.070 --> 01:11:14.678 align:middle line:84% and investment tax credit, we actually 01:11:14.678 --> 01:11:16.470 align:middle line:84% ended up in 1981 with the system with a lot 01:11:16.470 --> 01:11:18.170 align:middle line:90% of negative effective tax rates. 01:11:18.170 --> 01:11:19.470 align:middle line:90% Why the hell did we do that? 01:11:19.470 --> 01:11:21.710 align:middle line:90% To promote investment. 01:11:21.710 --> 01:11:24.030 align:middle line:84% The idea is they want to promote investment. 01:11:24.030 --> 01:11:26.862 align:middle line:84% And the more rapidly you allow people to depreciate 01:11:26.862 --> 01:11:28.570 align:middle line:84% and the bigger the investment tax credit, 01:11:28.570 --> 01:11:29.903 align:middle line:90% the more you promote investment. 01:11:29.903 --> 01:11:32.270 align:middle line:84% The more you take this effective tax rate to 0, 01:11:32.270 --> 01:11:34.790 align:middle line:90% the more you promote investment. 01:11:34.790 --> 01:11:36.270 align:middle line:90% Now two comments. 01:11:36.270 --> 01:11:37.210 align:middle line:90% OK, let me stop there. 01:11:37.210 --> 01:11:39.530 align:middle line:84% Questions about that or or it's hard you have to look it over. 01:11:39.530 --> 01:11:40.150 align:middle line:90% Yeah? 01:11:40.150 --> 01:11:42.870 align:middle line:84% AUDIENCE: What was the overall consensus about [INAUDIBLE]? 01:11:42.870 --> 01:11:43.870 align:middle line:84% PROFESSOR: Well, basically, there's 01:11:43.870 --> 01:11:45.210 align:middle line:90% a couple of reactions to that. 01:11:45.210 --> 01:11:48.510 align:middle line:84% First of all, it did promote investment. 01:11:48.510 --> 01:11:50.470 align:middle line:84% So it's true that, in particular, 01:11:50.470 --> 01:11:53.430 align:middle line:84% things like the investment tax credit and accelerated 01:11:53.430 --> 01:11:55.730 align:middle line:84% depreciation do promote investment. 01:11:55.730 --> 01:11:57.670 align:middle line:90% You're making it cheaper. 01:11:57.670 --> 01:12:00.010 align:middle line:84% Firms, when you make stuff cheaper, they do more of it. 01:12:00.010 --> 01:12:02.590 align:middle line:90% That's good. 01:12:02.590 --> 01:12:10.910 align:middle line:84% Second, it led to an enormous amount of, actually, 01:12:10.910 --> 01:12:15.030 align:middle line:84% excess investment in tax efficient but economically 01:12:15.030 --> 01:12:16.902 align:middle line:84% inefficient investments, in things 01:12:16.902 --> 01:12:19.110 align:middle line:84% that could generate big tax breaks without generating 01:12:19.110 --> 01:12:20.410 align:middle line:90% a lot of actual revenue. 01:12:20.410 --> 01:12:22.990 align:middle line:84% And I'll come back to that in chapter 25. 01:12:22.990 --> 01:12:26.332 align:middle line:84% But the third thing it does is raise the overarching issue 01:12:26.332 --> 01:12:27.790 align:middle line:84% that you need to keep in mind is we 01:12:27.790 --> 01:12:29.350 align:middle line:84% have this next debate over the next couple of years 01:12:29.350 --> 01:12:31.310 align:middle line:84% about the Trump tax cuts, which is 01:12:31.310 --> 01:12:35.750 align:middle line:84% to think about we have three tools that affect investment. 01:12:35.750 --> 01:12:38.380 align:middle line:90% We have tau. 01:12:38.380 --> 01:12:41.870 align:middle line:90% We have z, and we have alpha. 01:12:41.870 --> 01:12:45.750 align:middle line:84% Those are the three tools we have to effect investment. 01:12:45.750 --> 01:12:47.870 align:middle line:90% Here's the key point. 01:12:47.870 --> 01:12:54.550 align:middle line:84% Z and alpha-- if I change z or introduce alpha, 01:12:54.550 --> 01:12:57.830 align:middle line:90% it's an incentive to invest. 01:12:57.830 --> 01:13:02.590 align:middle line:84% Going forward, investments are more valuable. 01:13:02.590 --> 01:13:06.430 align:middle line:84% If I change tau, it's an incentive to invest 01:13:06.430 --> 01:13:09.590 align:middle line:84% and a reward to all the past investments. 01:13:09.590 --> 01:13:12.150 align:middle line:84% Because income you earn is based on past investments. 01:13:12.150 --> 01:13:14.600 align:middle line:84% Remember I talked about the prospective capital gains tax, 01:13:14.600 --> 01:13:16.350 align:middle line:84% talked about how if we cut a capital gains 01:13:16.350 --> 01:13:20.370 align:middle line:84% tax starting today, then we wouldn't reward old investments. 01:13:20.370 --> 01:13:22.070 align:middle line:84% We would only reward new investments. 01:13:22.070 --> 01:13:23.910 align:middle line:84% Well, think about alpha in particular. 01:13:23.910 --> 01:13:26.630 align:middle line:84% Alpha is saying for every dollar you invest starting today, 01:13:26.630 --> 01:13:28.470 align:middle line:84% I'm going to give you a tax break. 01:13:28.470 --> 01:13:30.970 align:middle line:84% But if you invest in the past and are making money off that, 01:13:30.970 --> 01:13:33.310 align:middle line:84% well, you're still going to pay high taxes on that. 01:13:33.310 --> 01:13:34.972 align:middle line:84% And it's the same with depreciation. 01:13:34.972 --> 01:13:36.430 align:middle line:84% It's saying the next thing you buy, 01:13:36.430 --> 01:13:38.170 align:middle line:84% I'm going to give you a good deal on it. 01:13:38.170 --> 01:13:40.837 align:middle line:84% But all the old stuff you bought that's generating your old MPK, 01:13:40.837 --> 01:13:43.150 align:middle line:90% you're getting taxed on that. 01:13:43.150 --> 01:13:47.540 align:middle line:84% So the point is, if we really want to incentivize investment, 01:13:47.540 --> 01:13:49.040 align:middle line:84% tools like the investment tax credit 01:13:49.040 --> 01:13:51.390 align:middle line:84% and accelerated depreciation are a great way 01:13:51.390 --> 01:13:53.150 align:middle line:90% to incentivize investment. 01:13:53.150 --> 01:13:57.170 align:middle line:84% If we want to just reward guys who hold stock in corporations, 01:13:57.170 --> 01:13:59.110 align:middle line:90% tau is a good way to do that. 01:13:59.110 --> 01:14:03.267 align:middle line:84% So if we think about purely the investment margin, 01:14:03.267 --> 01:14:05.350 align:middle line:84% then cutting the corporate tax rate doesn't really 01:14:05.350 --> 01:14:09.910 align:middle line:84% make sense compared to other tools we could use. 01:14:09.910 --> 01:14:13.190 align:middle line:84% Other tools would have a much bigger effect incentivizing 01:14:13.190 --> 01:14:14.870 align:middle line:90% investment. 01:14:14.870 --> 01:14:17.570 align:middle line:84% Indeed, what's quite striking is the following. 01:14:17.570 --> 01:14:19.445 align:middle line:84% The higher the corporate tax rate, 01:14:19.445 --> 01:14:21.070 align:middle line:84% the more you incentivize new investment 01:14:21.070 --> 01:14:22.653 align:middle line:84% by things like depreciation allowances 01:14:22.653 --> 01:14:23.997 align:middle line:90% because they're worth more. 01:14:23.997 --> 01:14:25.830 align:middle line:84% So in some sense, you could imagine a system 01:14:25.830 --> 01:14:28.230 align:middle line:84% with a high corporate tax rate and a big depreciation allowance 01:14:28.230 --> 01:14:29.813 align:middle line:84% would incentivize a lot of investment, 01:14:29.813 --> 01:14:33.390 align:middle line:84% while penalizing people who held previous investments. 01:14:33.390 --> 01:14:35.770 align:middle line:84% So that's the important distinctions. 01:14:35.770 --> 01:14:40.070 align:middle line:84% Once again, this old versus new capital, 01:14:40.070 --> 01:14:43.030 align:middle line:84% new investment versus previous investments 01:14:43.030 --> 01:14:44.762 align:middle line:84% is really the critical distinction 01:14:44.762 --> 01:14:46.220 align:middle line:84% you want to be thinking about here. 01:14:46.220 --> 01:14:47.345 align:middle line:90% There's a lot of math here. 01:14:47.345 --> 01:14:49.330 align:middle line:84% You're not held responsible for this. 01:14:49.330 --> 01:14:50.580 align:middle line:90% So you can take a deep breath. 01:14:50.580 --> 01:14:53.220 align:middle line:84% You don't have to memorize this, figure this out. 01:14:53.220 --> 01:14:54.980 align:middle line:84% We have to figure it out because it's good intellectually. 01:14:54.980 --> 01:14:55.940 align:middle line:84% It's a good intellectual exercise. 01:14:55.940 --> 01:14:57.190 align:middle line:90% You don't have to memorize it. 01:14:57.190 --> 01:14:59.520 align:middle line:84% The key thing I want you to take away from this 01:14:59.520 --> 01:15:03.560 align:middle line:84% is that when you hear something called the corporate tax rate, 01:15:03.560 --> 01:15:05.740 align:middle line:84% that is not what you care about, the statutory. 01:15:05.740 --> 01:15:08.080 align:middle line:84% You care about the effective tax rate. 01:15:08.080 --> 01:15:10.880 align:middle line:84% The effective tax rates are much more complicated beast. 01:15:10.880 --> 01:15:14.120 align:middle line:84% So in the US, while our statutory rate 01:15:14.120 --> 01:15:19.400 align:middle line:84% was 35% before Trump, our effective rate was 24%. 01:15:19.400 --> 01:15:24.200 align:middle line:84% So firms, on average, paid a lot less than a 35%. 01:15:24.200 --> 01:15:25.683 align:middle line:84% So basically, that's the key thing. 01:15:25.683 --> 01:15:27.600 align:middle line:84% The key thing I want you to know from all this 01:15:27.600 --> 01:15:29.320 align:middle line:84% is to realize that taxes interact 01:15:29.320 --> 01:15:31.760 align:middle line:84% with the system in complicated ways because of things 01:15:31.760 --> 01:15:34.600 align:middle line:90% like depreciation allowances. 01:15:34.600 --> 01:15:38.720 align:middle line:84% So now last question to motivate what 01:15:38.720 --> 01:15:41.962 align:middle line:90% we're going to do next time. 01:15:41.962 --> 01:15:43.920 align:middle line:84% Last question, what we're going to do next time 01:15:43.920 --> 01:15:48.432 align:middle line:84% is then why we cut the corporate tax. 01:15:48.432 --> 01:15:50.140 align:middle line:84% Why don't just have a high corporate tax? 01:15:50.140 --> 01:15:53.880 align:middle line:90% 01:15:53.880 --> 01:15:56.600 align:middle line:84% If we cared about US domestic investment, 01:15:56.600 --> 01:15:58.800 align:middle line:84% it seems like I've just made an argument 01:15:58.800 --> 01:16:01.460 align:middle line:84% that cutting the corporate tax is a pretty blunt instrument. 01:16:01.460 --> 01:16:02.380 align:middle line:90% Why would we do that? 01:16:02.380 --> 01:16:07.080 align:middle line:90% 01:16:07.080 --> 01:16:09.080 align:middle line:84% I'm looking to my students from around the world 01:16:09.080 --> 01:16:10.100 align:middle line:90% on this question. 01:16:10.100 --> 01:16:13.120 align:middle line:90% 01:16:13.120 --> 01:16:17.280 align:middle line:84% Why are we worried about a high corporate tax rate in the US? 01:16:17.280 --> 01:16:18.140 align:middle line:90% Yeah, in the back. 01:16:18.140 --> 01:16:20.053 align:middle line:90% AUDIENCE: [INAUDIBLE] 01:16:20.053 --> 01:16:20.720 align:middle line:90% PROFESSOR: Yeah. 01:16:20.720 --> 01:16:22.970 align:middle line:84% Because we're worried about the elasticity of mobility 01:16:22.970 --> 01:16:25.012 align:middle line:90% of companies, of capital. 01:16:25.012 --> 01:16:26.720 align:middle line:84% Remember, the corporate tax rate is borne 01:16:26.720 --> 01:16:28.320 align:middle line:90% at least partly by capital. 01:16:28.320 --> 01:16:30.620 align:middle line:90% And they bear it by leaving. 01:16:30.620 --> 01:16:33.120 align:middle line:84% So the reason why we're worried about the high corporate tax 01:16:33.120 --> 01:16:36.052 align:middle line:84% rate, people say it's because it deters investment. 01:16:36.052 --> 01:16:38.260 align:middle line:84% but the truth is, if we want to encourage investment, 01:16:38.260 --> 01:16:40.040 align:middle line:84% there's more effective tools to do that. 01:16:40.040 --> 01:16:41.457 align:middle line:84% The real reason we care is because 01:16:41.457 --> 01:16:43.080 align:middle line:90% of international competition. 01:16:43.080 --> 01:16:46.040 align:middle line:84% The reason why we care about tau is because the high tau will 01:16:46.040 --> 01:16:48.960 align:middle line:84% mean people won't want to come here 01:16:48.960 --> 01:16:51.720 align:middle line:84% because, ultimately, they won't make as much money being here. 01:16:51.720 --> 01:16:54.040 align:middle line:84% And that is really what drove a lot of the debate 01:16:54.040 --> 01:16:57.680 align:middle line:84% over the corporate tax, was essentially 01:16:57.680 --> 01:17:02.360 align:middle line:84% the issues about international competition. 01:17:02.360 --> 01:17:04.760 align:middle line:90% And that's, next time-- yeah? 01:17:04.760 --> 01:17:10.920 align:middle line:84% AUDIENCE: Would shifting z and alpha be sufficient [INAUDIBLE]? 01:17:10.920 --> 01:17:12.660 align:middle line:90% PROFESSOR: They would help. 01:17:12.660 --> 01:17:16.280 align:middle line:84% But in some sense, if I'm moving a company here 01:17:16.280 --> 01:17:18.680 align:middle line:84% that's not a new company, then I've 01:17:18.680 --> 01:17:22.160 align:middle line:84% got all this old capital that's going to get taxed at tau. 01:17:22.160 --> 01:17:25.000 align:middle line:84% So for a new company setting up, they'd all work equally. 01:17:25.000 --> 01:17:27.042 align:middle line:84% For new companies setting up, all they care about 01:17:27.042 --> 01:17:28.980 align:middle line:90% is the effective tax rate. 01:17:28.980 --> 01:17:31.340 align:middle line:84% But if I'm an old company moving here, 01:17:31.340 --> 01:17:33.843 align:middle line:84% then those investments help, but I've still got to pay-- 01:17:33.843 --> 01:17:35.760 align:middle line:84% Let's say I go from paying a 10% corporate tax 01:17:35.760 --> 01:17:38.733 align:middle line:84% rate to 35% corporate tax rate on all my old investments, 01:17:38.733 --> 01:17:41.150 align:middle line:84% that's not going to be very attractive to move to America. 01:17:41.150 --> 01:17:43.770 align:middle line:84% AUDIENCE: And they don't count as new investments [INAUDIBLE]? 01:17:43.770 --> 01:17:45.310 align:middle line:84% PROFESSOR: But if you move the company here, 01:17:45.310 --> 01:17:47.060 align:middle line:84% you've still got the old-- well, actually, 01:17:47.060 --> 01:17:49.130 align:middle line:84% it's a great segue to the very complicated world 01:17:49.130 --> 01:17:50.890 align:middle line:84% of international tax law, which we'll 01:17:50.890 --> 01:17:55.130 align:middle line:84% dip our toes in next time, which can be an entire semester at law 01:17:55.130 --> 01:17:56.830 align:middle line:90% school, tax law. 01:17:56.830 --> 01:17:58.410 align:middle line:84% But this is a great setup for what 01:17:58.410 --> 01:17:59.650 align:middle line:84% we're talking about next time, which 01:17:59.650 --> 01:18:01.570 align:middle line:84% is what do we do when companies that are nationally mobile? 01:18:01.570 --> 01:18:03.610 align:middle line:84% And how do we do taxation in that case? 01:18:03.610 --> 01:18:05.330 align:middle line:84% And then after that, in 15 minutes, 01:18:05.330 --> 01:18:05.810 align:middle line:84% I'll teach you everything you need to know 01:18:05.810 --> 01:18:06.950 align:middle line:90% about corporate finance. 01:18:06.950 --> 01:18:09.530 align:middle line:84% So you can skip all those course 15 courses. 01:18:09.530 --> 01:18:11.310 align:middle line:90% So we'll do that next time. 01:18:11.310 --> 01:18:14.890 align:middle line:84% And then we're going to start on chapter 25 next time. 01:18:14.890 --> 01:18:16.370 align:middle line:90% We'll get about halfway through. 01:18:16.370 --> 01:18:18.210 align:middle line:84% And then, remember, the last lecture 01:18:18.210 --> 01:18:19.750 align:middle line:90% is Friday-- two announcements. 01:18:19.750 --> 01:18:20.430 align:middle line:90% Don't go yet. 01:18:20.430 --> 01:18:23.450 align:middle line:84% Last lecture is Friday, 12:00 to 1:30. 01:18:23.450 --> 01:18:24.570 align:middle line:90% Please be there. 01:18:24.570 --> 01:18:27.030 align:middle line:84% It will be recorded, and it will be available. 01:18:27.030 --> 01:18:29.450 align:middle line:84% But I hope you found the interaction in class 01:18:29.450 --> 01:18:30.030 align:middle line:90% are valuable. 01:18:30.030 --> 01:18:30.630 align:middle line:90% You'll learn a lot. 01:18:30.630 --> 01:18:32.588 align:middle line:84% It'll be the last chance for us to be together, 01:18:32.588 --> 01:18:35.080 align:middle line:84% so I hope you'll show up, if at all possible. 01:18:35.080 --> 01:18:40.000 align:middle line:90%