# 44

In Modeling A Wealth Tax, Paul Graham writes:

Even a 0.5% wealth tax would start to keep founders away from a state or country that imposed it.
The US, however, effectively already has a ~0.3%-0.4% wealth tax.

Specifically, the long-term capital gains rate in the US is 20% for high earners (like the startup founders Graham describes) and the IRS taxes nominal gains. This means that part of what they're taxing is real gains, but another part is imaginary gains due to inflation. This is not exactly the same curve as a percentage wealth tax, because while it starts at `total inflation * capital gains` it asymptotically approaches the capital gains tax rate. You can see this in the extreme: if inflation is high enough or you hold your money long enough, effectively everything you have is capital gains, and when you sell you'll be taxed at the capital gains rate.

Inflation is about 2.4% (the annual CPIAUCSL change from January 1990 to January 2020) and the long-term capital gains rate is 20%, so we have something close to a 0.4% wealth tax over 20y, or a 0.3% wealth tax over 50y:

(sheet; shows a real interest rate of 0% for illustration purposes)

To be concrete, imagine you had \$100 in 2000, and invested it in the US stock market. In 2020 it's worth \$250 and you sell it. Your nominal gain is \$150, and that's what the IRS will tax you on. But your real gain is only \$100; the rest is 2020 dollars being about 2/3 as valuable as 2000 dollars. Taxing this difference is taxing wealth.

This makes me think that Graham is overstating his claim, since the US is very popular for startups and has a wealth tax nearly as high as he discusses.

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If we interpret his claim as an additional 0.5% wealth tax do you still think he is overstating his claim?

Capital gains has important differences to wealth tax. It's a tax on net-wealth-disposed-of-in-a-tax-year, or perhaps the last couple for someone with an accountant.

So your proverbial founder isn't taxed a penny until they dispose of their shares.

Someone sitting on a massive pile of bonds won't be paying capital gains tax, but rather enjoying the interest on them.

Most Western countries levy some form of CGT; to avoid it, you'd need to move to a low-tax jurisdiction like Switzerland or Singapore. It's certainly possible for founders and investors to do that, but it's a pretty big life change.

Moving from one US state to another, on the other hand, is pretty easy.

One thing I think that's missed here is that the inflation rate isn't independent of the investment returns. On average, investments generate a certain amount of real returns, so if inflation rises it will tend on average also to raise the nominal investment returns, cancelling out the effect of the inflation-related capgains "wealth tax."

^Not always true, but true often enough that it definitely bears mentioning.

If you invest in an asset that you expect to have a 0% real return and therefore hand you an after-tax real loss, and then you complain the tax system is handing you an after-tax real loss, there's something wrong there- is it with the tax system?

One can avoid a wealth tax by living in another country. One can't avoid the inflation tax on US assets by moving to another country.

One can avoid a wealth tax by living in another country.

I don't understand why this is necessarily true. What would stop the US from levying a wealth tax on US persons living abroad?

He is not overstating.

• Any wealth tax is on top of inflation. One cannot ban inflation without disastrous economic consequences (or so I'm lead to believe).
• Invested capital tends to appreciate along with inflation, which makes sense if you think about it, otherwise it means it's losing value. Non-inflation adjusted returns on the stock market are much higher when the inflation is high. Also there is no reason not to stash all your money in the safest possible asset to avoid inflation.

I think you made a very good point on why Paul Graham's example in itself is not as strong as it may seem: there are already investors and founders who are paying something similar in the form of inflation and capital gains tax.

I think you also made a not entirely fair comparison: founders of companies and stock investors are not in the same position.

For a stock investor it might not be a such a great difference if you pay your tax in one portion after 15 years or if you pay the same distributed to 15 distinct tax years.*

However, for a founder of a not-yet-public-company this is not the case. Imagine if you own 10% of a startup after you receive venture capital of 100 M USD for 50% of all stocks. That gets your 10% valued at 10 M. Still, it is entirely possible that you have hardly any cashflow and and can barely make ends meet, yet now with a 0,5% wealth tax you owe 50,000 a year to IRS. You have to get that 50k for each year until your company goes public and you can actually sell your shares, which might be 5-10 years down the road, if you ever get there.

*of course, even as a public market investor you would face additional transaction costs of converting your assets to cash when tax payment is due.

If everyone knew that this was how things worked, then in raising money from investors the startup founders would put aside a small amount of the investment round to pay wealth taxes. VCs would not object, because unlike a startup founder pulling a massive salary, this isn't any sort of bad sign.

It sounds like you create a dynamic where a startup is less likely to be able to skip rounds because it has it's own revenue.

Most wealth doesn't get held as money. Inflation in dollars won't make your stocks, real estate or expensive artwork less valuable.

The situation is not that inflation makes your savings less valuable, it is that your non-dollar assets become nominally more valuable partly due to inflation, and that nominal-only gain is taxed.

Say you bought a famous painting for \$10 million in 1990 money, and sold it for \$20 million in 2020 money. The IRS sees (and taxes) a gain of \$10 million, but actually your painting didn't gain at all: dollars just became less valuable.

Uh, you can't escape the implied inflation wealth tax by going to a different country, while you could escape a wealth tax by doing so. [Edit: Oops, already said]

Having said that, I agree with you that at .5% it wouldn't make much of a difference, though Graham might be right that even that little is still enough to start people thinking about changing their behavior due to the tax. Also Elizabeth Warran's implied 6% on billionaires accounting for the extra amount charged to cover her healthcare plan would have definitely driven people who were expecting to ever get huge startup wealth away.