Generation Tax Alpha

The US tax code was written by wealthy people for wealthy people. I’ve heard that many times. You probly have, too. 

I used to roll my eyes at the notion. Figgering that the person expressing it really just hated paying taxes and thought that wealthy people avoided taxes by using obscure tactics unknown to us riff raff. 

I later learned that those folks were right. . . . With the caveats that they probably did hate paying taxes. And had no knowledge as to what the wealthy actually were doing. Just that they must’ve been doing something others could not.

Why the change? Cuz I actually learned about the tax code, how easy lots of tax optimization is, and how that optimization overwhelmingly focuses on wealthy people.

The professor is in

Fast forward to a few months ago, when this interview of tax law professor Ray Madoff discussing her newly published book, The Second Estate: How the Tax Code Made an American Aristocracy, came across my YouTube feed. Go ahead and watch it. No, seriously, do it. Don’t make me ask again! Watch it fer cryin’ out loud! Oh, come on. Please? Pretty please? Thank you!

I’d never heard of Madoff. Now that you’ve watched the video (thanks again!), I think you’ll agree that on the surface, she comes across at worst as mild mannered. If you muted the volume, you’d think she was maybe discussing something mundane like knitting, or gardening, or mah jong. 

But if you had the volume playing (And I know you did Dear Reader!), you know that wasn’t the case. Instead, she lobbed not just a few bombs. Aimed squarely at the ultrawealthy. 

The tl;dr is that Madoff thinks the US tax code has been mutated to the point of impotence as to the ultrawealthy. Don’t confuse wealthy people with high-income individuals, many of whom are getting taxed most of all. Rather, as Madoff succinctly explains, “. . . [O]ur income tax system has effectively written out the wealthiest Americans because they can avoid salaries and we let them avoid taxes on their inheritances and investments.” Boom! Bombs Shots fired! 

Madoff contends that this phenomenon is 40-ish years in the making, explaining that for about the preceding 65 years before that wealthy people were reined in from accumulating and passing on mass wealth in no small part by: (1) a robust estate tax, and (2) the fact that the main way by which companies used to be able to share profits with shareholders was via dividends (subject to the recipient’s marginal tax rate), but now, it’s often strategically driven high(er) share prices (reasons explained in the video) (subject to (often lower) capital gains taxes, and then only upon a sale of the shares). What’s more, following the buy-borrow-die strategy allows much of those capital gains to be avoided during the owner’s lifetime, too, and the step-up in basis on inherited shares that the recipient ultimately gets wipes out the gain from the initial point of purchase, and thus the (capital gains) tax on it. 

I’ve since watched other videos of Madoff mild-manneredly speaking shouting from the proverbial rafters. She’s hopping mad disappointed.

A pain in the assets

Fast forward a few months later, when I watched Scott Galloway’s interview of Gary Stevenson. Both are whip smart, very wealthy . . . and furious about the state of tax affairs from which they themselves benefit. I’d heard Galloway address the subject before. But not Stevenson. Hoo boy! He’s spitting-fire angry!

Stevenson frames the issue in a way I’d never considered. The tl;dr being that government efforts focused mostly or totally on ultrawealthy persons’ income will have a minimal effect. Because their annual income is but a fraction of their annual net worth/assets growth. As Stevenson explains: if Jeff Bezos’ has $300 billion invested and it grows five percent/year (far less than it likely actually grows) then his net worth grows by $15 billion/year. Bezos might spend lavishly. But not to the tune of $15 billion annually. And he famously takes little if any income. So, the wealth grows and grows . . . and grows. And Bezos would pay a mere pittance in taxes on income. 

I’m as nauseated by all this as Madoff, Galloway, and Stevenson. But I (and The Missus) live in the world that is, not the one we’d like to see. So do Thing One (The Elder) and Thing Two (The Younger).

I’m not one who believes that my generation (or any specific generation) has/had it tougher than every other generation. Each generation has its own challenges. And opportunities. Humans, being a resourceful sort, have from time immemorial handled them all. After all, we’re still here as a species, and my country—the United States—is still a going concern.

But I also think that people early in the workforce, or soon to enter it, are facing some new challenges (even if they rhyme with old ones). A major one—which Madoff, Galloway, and Stevenson are bringing light to—being that in much of the Western world, income has become a far slower and less effective driver of financial security than income derived from wealth. Absent major changes as to curbing wealth and incentivized tax-efficient generational transfers of it, this’ll even more increasingly become the case. Most people won’t realize this and will grind. Some will and will grind far less. Maybe even coast. 

As I’ve often told Things One and Two, revenue coming from a job is in many ways the worst type of money. First, you have to work for it. Nothing against work. I think it’s an invaluable thing to engage in. But work . . . takes work. Second, it’s usually far more highly taxed than other sources of revenue, such as investment gains, which take no work at all. 

And while most generations face difficult job markets at one or more points, I think people now early in the workforce, or soon to enter it, face a difficult set of circumstances. Still-evolving post-COVID working conditions, a confusing-at-best economy, and the early days of artificial intelligence (AI) (which likely will create lotsa new jobs, but we can’t know when or how fast, or how many jobs—especially entry-level ones—it’ll destroy in the meantime) are just a few reasons for my thinking. 

Transfer portal

I dunno if The Missus and I are 100% financially secure ad infinitum. But our net worth has grown since I FIREd, our spending is well in check (with little prospect it’ll rocket significantly higher) and we’ll soon enough be able to collect Social Security for the two of us and a modest pension for The Missus, and possibly inherit some dough. We could be doing worse.  

Nevertheless, I wouldn’t classify us as ultrawealthy. I mean, there’s no chance our net worth grows by $15 billion/year. Or even $15 million/year. Not even close. But we’re definitely now (able to be) powered by our assets, not income—and, so, in the group that Madoff, Galloway, Stevenson . . . and I . . . are railing against). What’s more, given my tax code knowledge, what income we do receive, we optimize taxwise. 

Bottom line: Things One and Two are poised to realize a great significant generational wealth transfer benefits. On top of any money we gift them during our lifetimes, Die With Zero-style. Put another way, if investment growth is the main driver of wealth building and becoming more so absent any tax code reform, Things One and Two are sitting pretty, independent of anything they do or don’t do. 

Even better for them, they’re positioned to benefit from income-driven financial security. That’s at worst a great hedge against tax reform-driven erosion or elimination of advantageous generational wealth transfers. And at best another way to build more wealth, faster. Thing One soon will graduate in a year with highly marketable degrees in a well-paying field. Thing Two should be in the same position when he graduates college. Both of them should be in demand. 

In short, The Family won’t realize anything like what the ultrawealthy will in terms of numbers of dollars by way of the current wealth-related tax regime. But it should benefit for many of the same reasons. 

Do I think that’s fair? No. No, I don’t. But do I recognize that the rules are the rules, that we’re all but incentivized to take advantage of them, and that I have the knowledge and desire to take advantage of them. Yes. Yes, I do.

And in the end . . . 

The tax code wasn’t written by us. But as of this writing, it sure as heck appears to have been written for us. And although we don’t necessarily intend to leave a huge bequest to Things One and Two, someday, what’s left will all be theirs.