553: How To Think about Taxes

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If you’re paying a ton in taxes right now… It’s because you’re playing the wrong game.

Most people think taxes are about income. They’re not. They’re about behavior—more specifically, incentivizing behavior. The government is constantly telling you what it wants through the tax code, and once you stop looking at it emotionally, it’s actually pretty obvious.

It wants businesses. It wants jobs. It wants housing. It wants capital deployed in specific areas like energy and infrastructure. And when you do those things, it rewards you with lower taxes.

Now contrast that with the high-income W2 professional. You did everything right. You trained forever, built a career, and you’re producing at a high level—often doing a lot of good in the world. But the government doesn’t see working for someone else as something it needs to incentivize. In fact, as a high-earning professional, you often end up paying a higher effective tax rate than almost anyone else.

Not because you’re doing something wrong, but because you’re not doing what the system is designed to reward.

I know that doesn’t feel fair. But fairness isn’t really the point.

The people who seem like they’ve “figured out taxes” aren’t gaming the system. They’ve simply figured out what the government wants and aligned themselves with it.

If all your income is W2, you’re largely boxed in. But when you start owning assets—businesses, real estate—you step into a completely different framework. Now you’re not just earning income, you’re creating it. You have expenses, deductions, and depreciation that fundamentally change how that income is recognized. Same economic reality, very different tax outcome.

This is one of the biggest advantages of real assets over simply owning stocks and bonds. It’s not just about return—it’s about control over how you’re taxed.

And if you really think about it, you should be looking at your financial life like a business. You already have revenue in the form of your paycheck, and you have expenses. But your biggest expense, by far, is your tax bill. If you want to maximize your “profit,” you have to figure out how to reduce that expense. And the only real way to do that is to change your facts—change how you earn, what you own, and how your income shows up.

That shift—from focusing on how much you make to focusing on what you keep—is really what this whole conversation is about.

It’s also exactly where this week’s podcast goes. I had a conversation with Steven M. Sheffrin that digs into how tax systems actually work in the real world. Not in theory, but in terms of how people respond to them—psychologically and behaviorally—and why so many well-intended policies fail because they ignore that.

If you want a better mental model for thinking about taxes—and how to position yourself within the system—it’s worth a listen.

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Transcript

Disclaimer: This transcript was generated by AI and may not be 100% accurate. If you notice any errors or corrections, please email us at [email protected].

Let’s say they give me $10 and the the game is I can either keep the $10 or I could give you some fraction of that dollar. Uh, they find that if you give me $10, I’ll give you on average, like, say. $2 50 cents or $3. But there’s an interesting variant of that experiment, suppose that before I, I got the $10, I had to take a test and then ask how much money should I give you?

People tend to give nothing.

Welcome everybody. This is Buck Joffrey with the Wealth Formula Podcast coming to you from Montecito, California. So what are we gonna talk about today? We’re gonna talk about taxes, and you’re probably in the mood given the fact that, um, tax stays around the corner. Maybe you’ve extended or something. I certainly always extend anyway, but.

It does, uh, remind you that there’s this whole tax world that you have to deal with at least once a year. The thing is, if you’re paying a ton of taxes right now, it’s probably because you’re playing the wrong game, okay? Most people think about taxes in terms of just their income. You make more money, you pay more taxes, but the reality is that’s not true.

Taxes really are about behavior. More specifically, incentivizing behavior. The government is constantly telling you what it wants through the tax code, and once you stop looking at it emotionally, it’s actually pretty obvious. It wants businesses, it wants jobs, it wants housing, it wants capital deployed in specific areas like energy and infrastructure these days.

And when you do those things, you get rewarded with lower taxes. Now, unfortunately. Many of you are high income W2 professionals, and listen, there’s nothing wrong with that. You did everything right. You trained forever, you built a career. You’re producing at a high level, doing a lot of good for the world, but the government doesn’t really see that for you, right?

What they see is, well, you’re really not doing anything that we want you to do. You’re working for somebody else and well, hey, your employer, we’re gonna give them the incentives. As a result, you end up paying the highest percentage of taxes than anyone else, even more than the billionaires out there. It sucks, but you know, it’s, and it’s not because you’re doing something wrong, but it’s just the way the system is designed to reward.

Now there are those people out there and, and you may know some of them that seem to have figured out taxes. They’re playing in a different system as you, they’ve simply figured out. Something that everybody needs to know is that they are going to follow what the government wants and aligns themselves with.

Unfortunately, if you are a W2 income and that’s all you are, you’re largely boxed in. But when you start owning assets. Like businesses, real estate, stuff like that, you step into a completely different framework and now you’re not just earning income, you’re actually creating income, and that’s what the government wants.

You have expenses, deductions, and depreciation that fundamentally now change how the income is. And you may end up quote unquote making the same amount, but you’re paying a lot less in taxes and you get to keep it. Now, this is one of the biggest, again, one of the biggest advantages of real assets over simply owning stocks, bonds, uh, and mutual funds.

You know, it’s not just about the return, it’s how much you get to keep. And if you really think about it, you should be looking at your own financial life, kind of like a business. I mean, you already have revenue in the form of a paycheck. You have expenses, but your biggest expense by far is probably your tax bill.

And if you want to maximize your profits, what do you do? You gotta figure out how to reduce those expenses, and the only way to do that is to change your facts. Change how you earn. What you own and how your income shows up. And that shift from focusing on how much you make to focusing on what you keep is really what this whole conversation today is all about.

It’s a discussion about how to think about taxes in the big picture, and at the end of the day, understanding how the government taxes, or why the government taxes, why policies are the way they are, is gonna help you kind of put your own financial life into perspective. We’re gonna have that conversation after these messages.

But before that, I do wanna remind you that there is a website associated with this podcast that you should check out. It’s at wealthformula.com. Lots of things to do there, including sign up. For our accredited investor group. Okay, that is called Investor club. It’s where you’re gonna see private deal flow and you’re gonna see the types of tax mitigating investments that you can use to, you know, basically do what we’re talking about here.

Anyway. We’ll have that interview right after these messages.

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Welcome back to the Showy one today. My guest on Wealth Formula podcast is Professor Steven Sherin from Tulane University. He’s leading expert in behavioral economics and tax policy, and a former director at the California Franchise Tax Board. Uh, today we’re gonna dig into how people actually respond to taxes in the real world and what means for, uh, investors and business owners.

So, uh, welcome to this show, Steven. How are you?

I’m doing fine. Thank you for having me.

Yeah. So let’s start with something pretty basic. When we think about taxes, um, you know, people think in, in terms of rates and rules, but from your perspective, how much of tax policy is really about predicting and getting right human behavior?

I think quite a bit. I think when you design an actual tax system for it to last and be and work successfully, you really have to. Match, uh, the tax system has to match people’s psychology. Yeah, and there’s a number of different examples of that. Um, you’re in California, so you probably remember many years ago, prop 13 and why that exploded.

Right? And it was the case where you had a tax system that didn’t really match people’s psychology. That’s just one example.

Maybe you can explain that. ’cause a lot of our listeners are not in California.

Sure. Um, before Prop 13, California had a, uh, standard property tax system where the, uh, the property would be assessed and then, um, people would get a bill in the mail, um, and then the money supposedly would go to the government.

What happened, there was a period of inflation and people’s property value started rising real quickly. And instead of reducing the rates, uh, appropriately, uh, the government let those rates go up and all of a sudden people’s tax bills went up by. 30, 40, 50%. Uh, and it created a real revolt, but very, people were very unhappy.

So they had a referendum and they voted basically to restrict your property tax. You would, you couldn’t allow it to go up by more than 2% a year once you were in your home. Um, and that made sense because if your property bill went up and you didn’t vote on anything, you didn’t have any new spending, there was no connection between what the government was doing and your own taxes being paid.

That connection was severed and now at Prop 13, it’s not a perfect system, but there’s definitely a connection between, uh, what’s being spent to some degree and what your tax bill is, or at least your tax bill isn’t going up for, for reasons that you don’t understand.

Right, right. Speaking of, um, California, Steve, and I mean, uh, you know, I’m here, uh, in California again, most.

Most of the audience is not. Um, but there’s some interesting things going on here. Now, I’d love to get your comments on, for example, you know, we hear a lot about, um, some billionaire, uh, tax issues, taxes on essentially wealth taxes, meaning rather than taxing on income people are the, the thought is that a, at a certain level, that ultra wealthy should be taxed on sort of their net worth.

Um, unrealized gains and that kind of thing. Tell us a little bit about that and, you know, potentially, you know, some of the issues that are going along with that, that sort of, uh, reflect, uh, psychology.

Sure. Yeah, it’s a really interesting topic. I actually know some of the people, some of the economists who are involved with drafting that.

Um. So it’s a onetime, supposedly it’s a onetime 5% tax on people’s net worth, as you said, right? And it only, it applies to billionaires. So it’s a limited, uh, group of people. It applies to, but it applies to all their wealth. And all their wealth consists of, you know, all their assets in including, uh, including shares of stock, for example, uh, in companies, uh, and, uh.

It’s just the value of the stock. They actually had, they haven’t sold the stock, they didn’t realize the income. And so in our normal income tax system, in order to be taxed on, on stock, you have to actually either get a dividend from it or you have to actually sell the stock. You have to realize the stock.

So this is on unrealized gains. Um, and one of the. Difficulties with unrealized gains is that many times we really don’t know exactly what they are. That’s one difficulty,

right?

So if you have a private uh, company, we’d have to guess what your unrealized gains are. ’cause there’s no publicly traded assets.

The other thing is, even if, even if it’s publicly traded, your stock price could go up for all sorts of reasons, right? Um, suppose interest rates fall. Your company’s not any more profitable. Your earnings are still the same, but all of a sudden interest rates fall. Well, the value of your stock will just go up because the, the present value, if you will, of that, those earnings go up.

And so all of a sudden you’ll have a big fluctuations in your, in your, uh, value of your stock. These unrealized gains, uh, for no particular reason related to the profitability of the company. There’s been some psychology studies actually of this, uh, and they ask people, is fair tax unrealized gains or not?

And generally, uh, only email 20, 25% of people when they’re asked think it’s okay to tax unrealized gains. Moreover, those people are the ones who don’t own stock. So people who own stock or own property think it’s really patently unfair. And I, I personally think it’s because the, there’s no connection necessarily between the value of the unrealized gains and even your, your welfare in any sense.

Because again, as I said, the stock could go up and down just based on other factors. Uh, a rumor about, you know, interest rates about who’s gonna be the Fed chairman could have a, a very profound impact. And so I think that’s, that’s a big issue. The other issue in, in psychology is, is whether. What are the public opinion polls and what do people believe about the merits of taxing the very wealthy?

Right? So let’s just take an example. Many years ago, you, you probably remember this, uh, baseball player, Derek Jeter for New York, a piece, right? Mm-hmm. He signed a really big contract now by today’s standard, probably wasn’t that big contract, but back then it was a really big contract and it made him, you know, multi multimillionaire.

Um. The question is, did people object to that at all? Did people have any reason to object to that? There was not a peep. Right. Think about Michael Jordan. Yeah, right. Michael Jordan had all the endorsements, all the money, he earned all his shrewd investments over the years. He’s super wealthy, maybe not a billionaire, but he’s, you know, he’s up there in the hundreds of millions, uh, dollars.

No one really objects to that PE so people think in fact that it’s okay for that. Um, and so if you look at public opinion polls, what you find is that there are some, if you ask the question very abstractly. Should you, should the, you know, the high income people, a millionaires pay ’em more taxes. You’re gonna get about 50% say yes, but you’re gonna get around 50% say no.

Part of the reason is, and this goes back to kind of the Michael Jordan or Derek Cheater, there’s a sense of which they earn that money. Right. And, and in psychology there’s a, um, a notion called equity theory that is, if you earn it, it’s, it’s kind of yours and the government, that is a second part, the second gets a second bite of the apple on this and mm-hmm.

Um, that equity theory is very strong. It basically says that people, you know, um, deserve what they get. And if they don’t work. It’s not clear to deserve anything, so, so go back to welfare reform. Back in the old days when Bill Clinton came in and he changed the old welfare system where people just got money to a system where they had the earned income tax credit where when you work, we subsidize your earnings up to a certain point.

Well, people like that and they still like it. Republicans like it. Democrats like it because what you’re doing, you’re rewarding work, you’re rewarding effort. So it has this direct connection between the actions you take. Your, your efforts to secure income and the uh, uh, and the dollars you get and when you break that connection, people are very uncomfortable with that.

Another example is social security. Right? Social security is not, you have to actually work in order to get social security, the amount you get. Mm-hmm. The amount you get is related, not in any direct, you know, direct one-to-one fashion, but it’s definitely related to how many, how much you put into the system, uh, through your working years.

So this connection between effort and reward is very, very basic in psychology. And that limits the extent to which we think the government should tax things away because. If it’s your money, ’cause you earned it, then the government again is a second claimant, not the first claimant. And so that’s a very, that’s like a very profound idea I think, uh, uh, in taxation.

And that explains why people are kind of ambivalent. People, you know, do recognize that that rich people have more advantages and others and so forth. But that’s balanced off against this notion of, of equity theory and the notion that, you know, if you earn it, you know, in some sense you’re the first claimant, not the second claimant.

You know, um, when you talk about, um, you know, the, the next level of this is sort of behavioral and the impacts of that, um, you know, in California here, um, some of the wealthiest people in the state have moved because of the potential for that 5% tax, and I’m, I’m curious, you know, what impact that has had on, I mean, listen, even if you.

Did implement that law. Are you actually gaining anything long term? Because you’ve got some of the biggest, you know, revenue. People leaving the state. Can you, can you comment on that a little

bit? Sure. There was a recent study actually was done by, um, economists at Stanford as part of the, as part of a economic study.

And he looked at, he first, he looked at, he says, well, since the tax was announced, six. Uh, billionaires have already left California. Now, you could dispute that because as you know, living California, the, the franchise tax board will kind of track it down. There’s all sorts of complicated rules, but he claimed there were probably six people who, six billionaires who left well, that ended up cutting the revenue they could get from the tax itself, just the dollar revenue by about 30%.

But then you have to look, well, what’s gonna happen down the road to the income taxes? Those people would pay. Right. And um, if you take that and you say, well, the people leave once and for all right, they leave, they move to Florida, they move to Texas, you’re losing. Their income taxes forever. Right? And so you have to look at the whole stream of income taxes you’re losing and balance that.

And when you make that calculation, the amount of money you’re actually gonna get for, uh, outta this wealth tax is gonna be severely diminished. Now you could, you know, quibble with the study. Maybe they, you know, as may, maybe they think that, uh, um. You know, maybe they think that not, not six people left, or maybe they think they, there’s not that much income, uh, taxes will be lost.

But the general proposition’s correct. If people do leave, you’re losing just the other day. Um. The governor of New York was pleading for people in Miami to come back home to New York. Uh, had she? Yeah. And she was saying, you know, come, come back, come back, come back. And, and meanwhile, meanwhile, she’s sitting there and the mayor of New York is asking her to raise corporate and, and personal taxes.

And inheritance taxes and estate taxes. Uh, and she’s sitting there realize, she’s recognizing that these people are, are moving to New York. People moved out from Chicago and so forth. So I think this is a big behavioral issue. I think, um, you know, there’s not that many billionaires and the universe is small.

Uh, but you know, it does get to the point where a combination of higher income taxes on people earning, you know, let’s say the million dollars in California, you get a pretty high rate already, plus housing prices are high. All those are gonna tip in a, in a various direction. And, and I think you could see that, that the flight there.

Mark Zuckerberg just recently, uh, it’s not clear he avoided this particular tax that it’s enacted, but he just recently bought another place in Miami, right? And then other people have done that as well. So on the behavioral side, you definitely see, you know this, and this is conventional economics, right?

You raise taxes, people are gonna move. Um, and the uh, uh, authors of the proposal, there’s one economist and two tax lawyers and they try to say, oh, you know, that’s not gonna be a big deal. And so forth. Um. In Europe, they had a number of wealth taxes over the years, and what happened is maybe about 10, 15 years ago, about 10 countries, 11 countries had wealth taxes, and now there’s only three countries that have wealth taxes.

There’s Norways, Spain and France. And France is only own property. Not on general wealth and, and, uh, and Norways and Spain are pretty low. The reason that, uh, they ended those wealth taxes was that there just was a lot of flight within the eu in particular, and in eu. Yeah, it’s, you, you, you can’t restrict movement.

So they, they were doing that. So the authors of this tax. And there’s also a proposals for a worldwide billionaire tax from one of these economists. Um, is the notion, well, the billionaires, we get, you know, there’s, there’s fewer of them. Maybe we can find ways to kind of make, make sure they stay in the state and so forth.

But it’s a big behavioral issue and I think it’s a, I think it’s, uh, you know, uh, something that would be very bad for the California environment. The billionaires also are thinking, you know, you do this once and you know. Um, you do this once, then what’s gonna happen next year? Why, why not? Why not come back again?

Right. It’s not clear. It’s a credible, it, it’s a credible approach. No country has gotten rich by confiscating money from its wealthy. I think

Dan, it’s interesting to me that in general. Not only billionaires, but if you’re taking California in general because of, or New York, uh, where taxes are really high, I think, you know, taxes continue to go up or, you know, there’s policy suggesting, uh, higher taxes like you were talking about in New York.

Do you feel like these policy makers are generally underestimating how quickly people can change behavior and simply relocate or, you know, or is there just some sort of political motive of optics? There were. You know, you just want people to see what you’re doing. I mean, is that what’s going on with the mayor of New York?

Because like it’s hard to imagine that you can’t see the potential negative impacts of that.

I think there are. Ideological reasons, uh, here, and I think that the ideology can blind you. So I, I don’t pretend to be an expert on the psychology of the mayor of New York, but it’s, it’s clear the governor of New York understands this, right?

She understands, she hears this from business people all day. It’s not as if these, the governors don’t have friends who are donors and, and so forth and so on. Um, you know, the average person. Who’s making a salary? Um, it’s hard to move, right? There’s, you know, it takes a lot of effort to move and, you know, if you’re working for a firm in New York, it’s not clear you’re gonna easily move somewhere else.

Although, you know, a lot of the, the, I think one of the big, um, financial firms has more people in Texas than they do now in New York. I can’t remember which one, but, um, you know, it’s hard. Unless, unless your firm moves, right. But if you’re, if you’re someone who’s managing a hedge fund. You know, you’re very, very mobile and so I, I think ideology blinds people.

I think sometimes they, they extrapolate from what the middle class person having difficulty moving to. They’re very wealthy, but they’re very wealthy can move. There’s another issue too that’s important. Suppose you’re thinking of starting a company right? Where would, where would you wanna start it?

Right? Let’s say you graduate from Stanford, right? And you have all these connections. Well, it’s helpful to be around, but before I actually started my company, I would say, Hey, let’s go down to Austin, right? And let, let’s go down there and, and we’ll move, we’ll move our people, all my classmates from Stanford Business School and you know, in, in Stanford engineering, we’ll move down to Austin.

And so what happens is the companies don’t get started in California. And it’ll get, yeah, it’ll get started in New York.

Well, and and there’s been a big flight as well, right? Right. Big companies leaving California, which is also this sort of secondary and tertiary, uh, effects of that. To the economy.

Absolutely. And right. And so, you know, and there’s some people who aren’t gonna move, like people who own, who own just large, who are just wealthy from entertainment and bought property, you know, all over in the rich parts of California, you know, in LA and Santa Barbara. And, you know, in, in the. In, in San Francisco Bay area, they’re just living on their estate.

So they’re not gonna move. They have their money’s already made. But if you’re looking to see, well, where’s the new money gonna come from and where’s the new companies are gonna come from? That start the jobs, right. That create the engine. Right. Um, you know, you have, you have, you do have some. You know, some major schools like Stanford and Berkeley that churn out good people.

And, uh, and there’s again, really good potential in California. But, um, you know, when you’re, you’re thinking about starting your company, you’re gonna think twice. You’re gonna say, well, I’m maybe not gonna start it here. I’m gonna move to a place where the environment is, uh, is just a lot better. And if you can get enough people there, then the new agglomeration, if you will, starts there.

It is a, it is a, uh, you know, I think a, I think a serious issue, and I think California’s always, you know, itself has always relied heavily on, uh, their tax revenue from the very top. They, they rely a lot on the capital gains of people from Silicon Valley. The income tax in, in, in California is one of the most, uh.

You know, uh, bizarre in terms of they get so much money from capital gains, uh, and is very volatile for that reason. Over the years, they’ve had a number of financial, financial issues early two thousands, other times 2008, when all of a sudden the capital gains go down and, um, but they’re, they’re, they’re in fact very fragile like that.

And so I think in the long run it’s very dangerous to do that. And, uh, a broader base tax. Is this a lot more stable and you wanna attract the entrepreneurs in, you want ’em to stay put, you don’t want ’em to leave and just move out to Texas or Florida or wherever.

Just to, from an intuitive standpoint, people think higher tax rate, higher tax rates lead to higher revenue.

But is that true or is there some sort of tipping point or calibration point that. That ends up being the case.

Oh, there’s definitely a calibration point. I’ll just take one example, which has actually been quite well studied. Let’s just take regular capital gains, not un, just regular capital gains, right.

So, uh, right now the, the Brookings Institute, which is kind of liberal, the, uh, congressional Budget office, uh. Uh, just, you know, the government organization, other organizations, they estimate that if you raise capital gain rates above 28% or 29%, you’ll actually get less money in the long run. Right. So, you know, if, if I told you, for example, next year the capital gains rate’s gonna go up, you would sell a bunch of stock today and, and the the money would come in, but then you would lose that money going forward in the future.

But if you, let’s say we just maintain a, a capital gains rate of, of like 28 or 29%, that’s the maximum you could get. So if I go above that. If I go above that, then I’m gonna actually gonna lose money. And so what happens is people will stop selling their stock, right? And in the US of course, we have the rule, which is you, um, if you hold it on till you die, then you, you could, you, it’s not taxed upon death, right?

So, you know, you basically, you decide, well, I’m not gonna sell this stock. I’ll, I’ll put it in my estate. I’ll sell, I’ll sell other things, right? I won’t sell the stock. And so, in fact, you reached a limit there. Now, uh, from, for taxes on wages, it’s a little tougher, right? On taxes. On wages, you can probably get up to, you know, over 50, 55% before you see.

Before you see the, the base fall, no. No matter it’s still true that when you raise the rate, you get, there’s less income that’s subject to tax, but when you raise the rate for a while, you’ll get more revenue. But what, but once you raise it, you get less. So for, for, for like labor or wage income, it’s probably around 55%.

And if you think about. The federal taxes and state taxes right. In California and the fact now that the state taxes aren’t deductible, you know, in California, if you’re in the million, do you’re, you’re over a million dollars. You’re paying a, a marginal tax rate over 50%. Uh, we’re getting close to that point, right?

Uh, and so, you know, if, if, for example, a, uh. Uh, the Democratic US president was elected and they raised the, let’s say the income tax rate from 37% up to 45%, and California kept where it was. You’d be almost at the breaking point. Right. Yeah. Now people will dispute this. You, you know, there’s, there’s some debate about how high that is.

But for the capital gains tax, there’s no question that 20 28, 20 9% would be the massive one. Now, you could change that if you want, if you got rid of the, um, if you got rid of the, uh, rule that’s saying that, that you’re not taxed at death. That is, if, if capital gains were tax to death, then you could probably raise the capital gains rate a little bit higher because people have fewer alternatives.

Right. But, uh, unless you change that, there’s no way you could, you could raise the rate. So there are these limits about what you could do if you compare the, um, there’s a limit to what you could do with income taxes. And in the US we’re facing, the US is facing a real DA real dilemma. We know that our.

Government spending is, you know, unsustainable given our current tax base. And it’s not necessarily just military, it’s, it’s not even, it’s not even basic welfare. It’s, it’s largely, you know, healthcare, social security, all those things. Right? And, and we know we’re running larger deficits than we could sing the long run.

Um, and. Unless we cut those, which are hard to do, we’re gonna have to come up with some more revenue going forward. And there are two strategies that basically have been advocated over time. The first strategy is the the billionaire income tax strategy, right? Where you just go for the very wealthy, um.

We’ll call it the, uh, the wealth tax AMI strategy, right? You just go through the wealthy. Yeah. You think that they can solve all your problems by raising rates like that. We’ve already talked here now about the, the limits of that approach and, um, so that’s gonna be difficult to do. The other approach is, uh, a more diversified tax base.

So if you compare us to Europe. The one difference between Europe and the United States, obviously they have higher, higher revenues as a percentage, GDP, but their income tax aren’t all, and most places aren’t all that different. Their top rates. Some, some places are higher, some places are not. The bracket start earlier.

They do get more money from the income tax, but the main thing they do is they get a lot more money from the value out of tax. And so they’re getting more money from consumption taxes and

Right.

That’s easily, that’s easier to sustain. Uh, not, uh, a number of reasons. One, you’re, you’re choosing a different base, um, and people don’t recognize the VAT as much, right?

So they don’t, they don’t see it. If you’re thinking about working another hour, if the income tax rate’s 70%, you go, oh my God, I can’t do that. But if you, if you’re working another hour and you’re, that’s high, you don’t necessarily make the connection between your earnings and the amount you’re gonna, the amount of tax you spend when you buy some goods.

So, you know, other countries with very low income tax rates, like Hungary has like, you know, a 10 or 12% income tax rate, but they have like a 27% vap. Uh, great Britain has a 20% vap and their income tax rates aren’t that much higher than ours. Um, so we’re kind of, we’re at the limit, I think what we can do with the income tax.

And so, uh, the approach would be to more diversify it, I think. From a psychology point of view, people don’t necessarily connect the sales taxes, uh, or the value added taxes to their earnings as much. In fact, if you look to see which taxes are the most popular by public opinion polls, the worst, the least popular tax, the property tax doesn’t bear any connection to your efforts on a day-to-day basis, income tax is kind of, kind of next.

People don’t like them just ’cause it kind of hurts the work connection. And the last part, the, the more favored taxes are taxes on, um, um, our taxes or sales taxes. Sales taxes are actually fairly prop, uh, probably, uh, uh, you know, popular. That’s why, you know, taxes, California can get away. Uh. Florida, all of ’em get away with probably high sales taxes.

Uh, it just like, it doesn’t make the same connection ’cause it doesn’t affect your perception of your, of your work, if you will. Do

you think that in some regard, the Trump administration sees tariffs as a way of increasing consumption, taxes, and essentially doing what you’re saying right now?

Um, some economists have had, uh, had kind of wishful thinking about that, that, that, that they thought, well, Trump’s tariff policy was the secret way to get to a, a consumption tax for the us.

Um. Again, I’m not a study of the psychology of Trump, but I actually think he believes in tariffs. He believes there’s a sense that that, um, um, you know, when we’re, we’re, um, uh, uh, these people are ripping offs off when we have trade deficits, right? So he wants to kind of stop that. Uh, I think his views are inconsistent and of course I, I dis disagree with them, but, um.

Some people have argued that now, uh,

court, it raise quite a bit of revenue though.

It does bring, it does bring a revenue. It could, it would be a little less than that. We’ll see. We’ll see. Now after the Supreme Court case, what happens, and it’s also uneven, right? It’s only bringing revenue on certain goods.

Right? If you compare, compare, compare a tariff to a, a general consumption tax, like the vet. So let’s, let’s compare it to a European value. What would be the difference? The first difference would be the, the, the a tariff, its attacks on consumption, but only on good you import, right? So if you, if you consume a good is produced domestically, it’s not tax, it’s not taxed.

So that’s one difference, right? The other difference is that in, in a VAT system, when you export. Um, when you export goods, you get a vat rebate. You don’t pay VAT on the good, you export, right? And so, uh, we have just as a, a tax on just imported goods and that, and, and economists don’t like that. Presumably ’cause it distorts the, your consumption patterns.

It makes, you know, and, and that of course is Trump’s purpose. He wants you to consume domestic goods. And there, there are certain circumstances when that’s okay, but it’s still quite a distance from a, from a general consumption tax. So, and um, there have been proposals in Congress, uh, for. Moving, taking this tariff approach and moving it more in a direction of a, a general consumption tax.

And, uh, there have been a few bills from time to time that come up. Um, there have been a number of, uh, politicians who, who, who had proposals, which had the equivalent effect of that. Uh, I think when Ted Cruz ran for president 2016, he had a proposal, which looked like a corporate tax, but really was like a disguise consumption tax, which would have the same features as a.

Like a vat. So it, it’s still, it’s still a bit of ways, but I, I think your insight about tars is good in, in a sense that, um. The professoriate and the newspapers all complained about the tariffs, but you didn’t hear too much from the average person about the tariffs. Uh, part of it is they, people felt that they had the option, right?

Like in general with sales taxes, there’s, there’s an option. You don’t have to buy a good, that’s, you don’t have to buy the goods, right? You could buy some other goods that maybe aren’t taxed, and in the case of a tariff, you don’t have to buy the imported goods, right? So we, we put a tariff on wine. And, um, um, in import French wine.

Well, you can buy, you can buy some other wine. If the tariff is higher on French wine than Australian wine, New Zealand wine, you’ll buy that wine. Otherwise, you could buy, you know, US wine. You could buy it from Sonoma, Napa or wherever. You know, uh, you could buy domestically produced goods. So when you have that escape valve, uh, that reduces the psychological pressure for people.

And so I think that’s why. The tariffs didn’t create as much anxiety, you know, uh, among the public. It did create a lot of anxiety among the editorial writers. It created a lot of anxiety among the, um, uh, you know, among the, the economists and, and the professors. But I don’t think it created a lot of anxiety among the average person again, ’cause they had this escape valve.

Going back a little bit to psychology, uh, you know, policy is ultimately. Uh, in any given state gonna be the result of, uh, the, the people who elected those officials? In California, you often, or in with the Democrats, uh, in general. A lot of times you hear, um, you know, especially those, uh, more on the left say, we just, the rich just need to pay their fair share.

Mm-hmm.

This is interesting to me because what I heard you say earlier is that people don’t necessarily think that you know, people you know don’t deserve to be rich. So where does this notion where in California you’re already paying 50% or more? That they’re not paying their fair share. Where does that come from?

I mean, and is that legitimate or is that just politicians speak?

I well, there are a number of different kind of. Psychology principles that kinda work across purposes of one another. So, uh, I’ll give you an example there. There’s a, something called a, in psychology, they do something called a dictator game where I, um, let’s say they give me $10 and, and, and the, the game is I can either keep the $10 or I could give you some fraction of that dollar.

Of that money now the money’s just given to me. I can give it. And so what, what do people do? Well, when they run this experiment a number of times, right? Uh, they find that, um, that if you give me $10, I’ll give you on average, like say, uh, $2 50 cents or $3. There’s a sense in which I do wanna have some altruism I do want to share.

Right? And so that’s where, that’s kind of where the fair share come, comes, comes into the, into play a little bit. Sometimes some people, if you give ’em the $10 and they say, well, share it with your compatriot over there, they’ll give you, you know, they’ll um, they’ll actually give, you know, $5 they’ll give more.

So there is some of that kind of sharing, but there’s an interesting variant of that experiment. Suppose that before I, I got the $10 I had to take a test and if I, and in order to get $10, I had to get like all 10 questions right on that test. So in some sense I earned the money. If you run experiment that way, where you have to take a test ahead of time and then ask how much money should I give you?

People tend to give nothing because yeah, they feel they earned it and they don’t really feel, but have to give it. So, uh, there is, so I, I take from that. Two things going on. One, there is a sense of fairness and if, if, if people, if politicians can, can, you know, play on people’s emotions saying maybe the rich aren’t sharing enough, right?

So that, that’s where they get that rhetoric from. It’s not, it’s not. From nowhere because people do share, they share with their family, they’ll share with even with strangers, like in this particular game. But it’s also the case that when you, once you bring in work and effort and entitlement into it, the fact that you earn, you know, you have a, you have a, some connection to the money that you have, there’s less of an obligation to share.

And so that cut, that’s what’s cuts the other way. Uh, so I call this my own work. I call this qualified furious. We qualify it by the entitlements you have on your earnings. And so Republicans tend to estimate, they tend to emphasize the qualified part, and Democrats tend to emphasize just the, the kind of the fairness part.

Um, you know, I think if you look at it, there’s another argument that people make. Uh, which is that the extra dollar to the rich person isn’t worth as much as the extra dollar to the poor person that goes back. That’s an idea that goes back hundreds and hundreds of years. Right? And the economists call this the margin of utility that your margin of utility of an extra dollar.

Elon Musk gets $10, doesn’t mean anything to him. Person, you know, who, who needs a cup of coffee? $10 needs a lot. Right. So there’s that sense too. Um, but I, I, I think, you know, that underestimates the, that underestimates the scope to which people get accustomed to their, to their consumption level. You take someone who’s leading an upper middle class life, they have certain.

Uh, expectations about what they can do. He takes some funds away from them and all of a sudden they feel, they feel this is very important to them doing things they can’t do. Now they’re not doing the same things that the, the, the person with low money can do, but it’s still very important to them. But there’s that psychology idea that kind of plays in as well.

And, you know, if, if you dut value. The extra consumption of someone who’s making say a million dollars, then that’s another reason to try to take that away. Um, but if you ask people who are making just a million dollars, right? Uh, is the last a hundred thousand you made important to you? They would say, yeah, I, I’m able to do this.

I’m able to do that. I’m able to enjoy the life I want to do. And so, um, it’s that agency I think that matters to those people and that agency is valuable. And so, um. When you, when you’re redistributing money, you’re taking away people’s agency at all different levels. It’s not just physical. It’s not just enjoyment of a, of, you know, of a, a candy bar.

It’s actually the ability to conduct your life in the way you would like it. And that, and that’s the psychology of people who are, you know, in the upper middle class who are working hard, but feel that they’re under that big tax burden. Now, I’ll say another thing too, which is that, um. The people who are actually taxed the highest as a percent of their income are the people are not the billionaires.

Right. You know, a lot of the billion, the billionaires have ways to get around this. Right. So Warren Buffet, you know, famously said, I’m paying, uh, I’m paying, you know, a higher, uh, lower tax than my secretary. Well. And the thing about Warren Buffet, if you look at it, all the income he really earned, he earned his company, earned lots of money.

He just didn’t pay any dividends and he took very few di he just, he, he sold very few stocks. So he cashed very little outta his company. He paid income tax on that, but as a fraction of his net worth, he paid very, very little. Uh, and other, you know, Larry Ellison for example, you know, one. Richest people in the world has, you know, uh, lines of credit, hundreds and hundreds of millions of dollars.

And when you borrow money, you don’t pay taxes on the borrow money. So they, so they’re very, very rich, have found ways to get around, you know, paying income taxes. And the nugget of truth in that, in the California wealth tax is that the very, the billionaires had done a good job of avoiding regular income taxes, right?

Um, now the person who’s making, let’s say, let’s say you’re a, uh, a successful executive making, let’s say $4 million, you know, for a company. Okay. Uh, mm-hmm. A lot of your, what you’re getting is some of the SOC options, a lot of you’re getting is salary. That salary is gonna be taxed very high, right? And so, right.

You end up paying a lot of tax. And so, you know, it really depends on your frame. There are a few people, the very highest billionaires who do find ways around this, but if you look at the, the bulk of the rich people. The bulk of the rich people are actually paying a lot of tax. And so I think that’s, it’s a very unfair accusation to say that the rich are paying the, you can always find people who are finding ways around that, you know, if you live on inheritance and you’re not, you’re not, you’re just borrowing against your, your, your assets right?

Then you know that that is, that is an advantage and there, there are ways we could try to get around that. Um, the, you know, traditionally that’s been the estate and, uh, the estate tax, although we’ve kind of made that with so many loopholes, that’s very difficult for that to work. So there is this issue there, there is an issue out there that you can find a small group of people who probably aren’t paying anything proportionate to the same proportion that you’re hardworking.

Your CEO is paying or your hardworking salary worker or your professor, or your software engineer, or your real estate broker, right? They’re pay, they’re paying a lot, a lot in tax. And so there is a little resentment when people, um, get around loopholes, just like people who are tax innovators, right? And, and are blatant tax evasion, um, you know, uh, are not very popular.

You remember Leona Helmsley, you know, who was the, uh, um. A big real estate owner in New York owning little people, ta paid taxes, right? People didn’t like that. Uh, they, they didn’t like her, they didn’t like Bernie Madoff. They don’t like people who cheat the system, right? So to the extent that you associate people at the billionaire level who are cheating the system, and I don’t, but to the extent that you make that association, you can make the argument they don’t pay the fair tax.

But you’ve had real, obviously, a lot of real world experience. Uh, you run, uh, involved with the California, uh, franchise tax board, um, and, and you’ve, you’ve seen. A lot of what we’ve been talking about in real time migration, um, more tax planning, more use of, you know, entities and exotic things to, to, uh, to get away from ta.

What is, what would be the ideal system in your mind based on, you know, what you know from the academic side and from practical, real world vision. Like what would, what makes sense,

right. So if I had my druthers, there’s, uh, uh, I, I would, I would first, the, the one, the one tax reform I would make, which would deal with the, with the very wealthy, what I would, I would actually tax untaxed capital gains at.

So, uh, uh, and I, you know, you could, you could build this in so you could, you know, stretch it out for family farms or for businesses and so forth. You, you don’t have to liquidate all at once. But I would say at death, you, your capital gains, which you didn’t pay over your lifetime should be due. Right. Um, that would accomplish as, that would be easier to do than any type of wealth tax.

Uh, people’s a wealth tax, if you do it on a yearly basis, you have to value assets all the time. Uh. Even if you had a private business and you died, you could take a few years to figure out what that’s worth and you could, you have tax on that and you could stretch out, uh, over time. That would deal with a very, that would deal with a very, very, very rich people, and that would deal with one element of unfairness.

The other thing I would do with, I would couple that though with a more broad-based consumption tax, and there are various ways to, to structure broad-based consumption taxes. One way is just like a, a European style of that. Another way is, is basically to have a, have a system where. It would parallel your income tax system, so you would have a consumption tax, which would be parallel to your income tax system.

But if you put your money, if you don’t consume it as if you save, you put money into your account and don’t pull it out, then you’re not, then you’re not taxed. So it just like in real estate investment, like if you, if you like the 10 31 exchanges, right? Right, right. So if you are reinvesting your money back in, in real property, you’re not, you’re, you’re preserving your basis and you’re not, um, you’re not, um, um, you’re not being taxed right away.

You could set up a system like that, I think for the average person so they could build up funds tax free. Right. But when they pull the money out, it’s taxed. Right, right. But if, but if they save and put the money back in, then they don’t, they postpone that tax until much later. And so a system like that, um.

It’s a kind of a, well, it’s kind of a, it’s a consumption tax, not like a vat, but it, it would, it would definitely encourage people to say, so, you know, it’s very much like our 401k systems, you know, our ira, stuff like that, except you’d be able to pull the money out anytime you want, but you pull out, it’s taxed with no penalty.

So you could set that up parallel, if you will. That’s one possibility, set it up parallel to our basic income tax system. Now this hasn’t really been tried, but it, it’s something I think it’s worth exploring. Or if you don’t wanna do that,

would you, would you reduce the income tax at the same time though?

Or would, or would you

add Yes.

Yeah. Reduce the income tax.

Right.

Um, this actually was proposed during, during World War ii, uh, for different reasons. Uh, one of Roosevelt’s advisors thought people were consuming too much and there was a shortage of goods and so forth. He proposed attacks like this, where it was only for the very wealthy.

Uh, and, um, but if they reinvested their money, it wouldn’t, it wouldn’t be a tax. Um, and, um. But if you pulled your money out, it would be taxed. And, and they did that during World War ii ’cause they needed more money. But you could lo lower the income tax and have this ta have this run parallel to it. Right?

Or you could even combine it, combine these in the same way. So you know, it, it’s a little more complicated in a sense. You’d have to set up accounts where you measure the money going in, the money going out. Uh, but you know, these days our accounts are all, you know, between Vanguard and Fidelity and, you know, and t Ray or price.

They know where all your money is, right? So you can operate something like that. But it would reward saving, right? It would tax consumption. So I think if you tried to tax consumption both for the average person, also for the rich, rich people, and you got rid of that so-called loophole at death, right? The angel and death where you, you avoid capital gains, that would go quite a bit away.

That would raise some money, but it would also quite a bit away to deal with the un, with the perceived unfairness in the system. Right now it is, it is, you know, difficult because, you know, people who want, like will point to these in couple individuals and say, well, these individuals, well, even like Warren Buffet, bill Gates, right?

Well, they might give money to charity and so forth, but they’re not paying. They’re not paying in tax. I also personally think that we’re a little too generous with, with any estate tax, with money going to to charity. Uh, now on, on the individual, when you pay your income tax, you’re limited on the amount of tax deductions that you can take for charitable contributions, depending on the type of property.

But like, let’s say it’s a 50% limitation, you can’t reduce your income but below 50% by giving charitable contributions. But for the estate tax, there’s no limit, right? So if Bill Gates wants to avoid all estate tax, he just puts it all in his private foundation, he controls the foundation. Right foundation’s not, not personally going back pay to him, but he controls what he does with it.

So he’s still maintaining control of the money. It’s not going for the general purpose. And I, I think we could be a little tougher on that. We could put limits on the amount of, uh, charitable contribution deduction from the estate tax. Um, that way, you know, at least some money, either you give money to your heirs or some money would be in taxed by the government, uh, in that way.

Yeah. So I think, I think those are things which I would do, which I think would improve the tax fairness, but wouldn’t disrupt it. I think what you don’t want to do is start raising taxes on your upper middle class people, your middle class people, because that’s gonna be very pernicious. Dinky taxes, like the, like the wealth tax in California are probably the worst of all possible words.

Difficult to administer on a very narrow group of people, uh, based on envy and like ideas like that,

right? Professor Steven Sherin, uh, from Tulane University. Uh, Steven. How, where can people learn more? A little bit about the types of topics we’re talking about, uh, in your work.

I do have a book, it’s called Tax Fairness and Folk Justice, and it’s by, published by Cambridge Press and it’s available on kind.

Um, and so that’s, um, that’s, that’s the book where, where the psychology is. I think that’s probably the one best source to go to. And if you Google me, you could find some various articles. I have a couple talks I’ve given, um, about Talk Tax Fairness. If you Google me, you come up with these, with these talks as well.

But again, the book is Tax Fairness and Folk Justice, uh, by Cambridge Press, and it has all these ideas in it and plus some, some other case studies and some other ideas as well.

Thanks so much for being on the show today.

Thank you very much. I, I enjoyed it.

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