Perhaps we shouldn’t tax vapourware

An interesting paper about taxing unrealised capital gains:

We show that a combination of realization-based capital gains and cash flow taxes implements the optimal allocation regardless of the source of asset-price fluctuations. Moreover, the capital gains tax avoids distortions in portfolio choice (the socalled lock-in effect) by targeting total net trades rather than gains from selling individual assets. These results stand in contrast to the classic Haig-Simons comprehensive income tax concept as well as recent proposals for wealth or accrual-based capital gains taxes.

That’s about as close as an academic paper gets to saying “Don’t”.

Given that we are more interested in the growth maximising, not revenue nor equality maximising, tax rate we’d suggest not taxing capital nor capital gains at all. When such are diverted to consumption then yes, sure, but while invested in making the future richer, no. But then that’s us reading optimal taxation theory and understanding it.

But something else interesting on the sidelines of this paper:

…founders receive zero exit value after more than 80% of US venture capital deals.

The vast majority of those fortunes disappear before crystallisation. There’s nothing there but a few hopes and dreams to be taxed that is. Basing our revenue system on taxing vapourware seems to contain more than a few problems.

You know, as close as proper academic thought gets to saying “Don’t”.

Tim Worstall