With all of the talk about what the ramifications of a wealth tax may involve, we’ve neglected to address the issue of how to measure it, especially with stock positions.
The very fact that people may have to liquidate assets in order to pay taxes that are due is a scary enough prospect. There is more to this then just having people transfer assets to someone else who is not affected by the tax, with the government seizing the money that changed hands for their own purposes.
We’ve spoken about the challenges of such a tax in previous articles, but there’s one issue that isn’t being spoken about, and it’s as basic a question as there is when it comes to taxing assets. How are we to properly measure the value of these assets for taxation purposes?
It is not that this hasn’t been considered, but we are still approaching the real question quite superficially, this is especially the case when it comes to valuing wealth held in stocks. This is nowhere near as simple of a matter as it may appear, for instance multiplying how many shares that someone owns by the price that this stock last traded at and taxing that number, but as it turns out, this is actually a very inaccurate way to do it.
This problem arises from the way we understand the value of stock holdings in general. This starts with our current concept of market capitalization, which is a handy guide to compare the size of the equity a company has out there but really doesn’t tell us much about how much all these shares are worth collectively.
We do the same thing when we look to calculate the net worth of individuals, and while we may not be too bothered by how accurate this may be, when it comes to assessing the value of shares for wealth tax purposes, we can’t get away with calculations this flawed lest we over-tax wealth.
The fundamental problem with what we call the mark-to-market calculation of stock value is that it only values the marginal value of shares and does not really speak to the value of shares not at the margin.
There are several issues with applying a wealth tax to a mark-to-market calculation of wealth, and all come down to this not being a fair and accurate calculation of the actual value of the stocks one controls. This mistake goes well beyond wealth tax calculations though, as we use this in any area that we look to determine what a stock’s value is, what the value of an individual’s holdings may be, what the total equity of a company may work out to, and even what the aggregate value of all stocks are.
The first and most obvious flaw with this is that when we see a stock trading at a certain price, this may just represent a tiny portion of the inventory out there of the stock, 1000 shares or even as few as 100. It is not the last traded price that even matters in fact, because this would require that we not only are looking to sell this small amount, it also requires that we both travel back in time to when this trade occurred and make the market for it, in other words be the seller that the person bought their small amount of shares from.
While we can look at the last traded price with a stock to get an idea of where the price is moving, if we’re looking to sell shares, or buy them for that matter, we need to look at the current market and the price that they are being bid at for various quantities.
At any given time, there is an order book with bids at the best bid and at many levels beneath it. There are usually only a few shares with a bid offer at the best price, and the more you want to move, the less you will get for them.
Let’s just say that you own $50 billion worth of stock and you suddenly owe 3% of that. You now need to sell $1.5 billion worth of your company’s stock to pay the bill. Anyone who thinks that you’ll get the last traded price or the best bid or anything remotely close to this under these circumstances grossly misunderstands how stocks and the stock market works.
We Have to Sell a Lot More when we Get a Lot Less Than Their Alleged Value
While the potential economic harm of a wealth tax is out there for debate, we really haven’t thought that much about how something like this would play out in the stock market. You owe 3% of this $50 billion, but we need to ask who we are going to sell this stock to and at what price?
At any given point in time, there are parties that are interested in buying stock, at various prices, but this demand is quite limited. Even if someone wanted to buy all that stock, they would not want to do it at once and would need to spread this out over time or find someone who really wants to buy it in huge lots where a private deal may be negotiated between brokers.
It is likely that no matter how much stock you have to sell, you could sell it pretty quickly if you needed to, as there are always people who will buy them at some price, and very low ones if the quantity is of the size that this tax would require.
People may think that a lot of this could be moved with private deals, and we’ve seen a few of those but the wealth tax didn’t exist then, and these opportunities are few and far between at the best of times. Institutional investors usually take weeks or longer moving much smaller amounts of inventory, because they need to work with the demand present at any given time, which is very limited compared to the amount that they want to sell.
With a wealth tax, there presumably will be a settlement date for the tax, in all likelihood December 31, and the vast amount of stock that needs to be sold to pay for this tax will be a crushing amount.
No one is even sure how bad this would be, but the best-case scenario will almost certainly involve what we would have to call a crash, whether that be during a week, a month, a quarter, or even spread the bloodletting more evenly and move down every month.
The important thing to realize is that this mark-to-market valuation will not play out in the real world, especially with those who are under the foot of a wealth tax controlling such a high percentage of the market. Fat cats can sell to each other at times, but when they are all forced to sell, this is a scary scenario indeed.
Whether at once or over time, the price that you will get for the vast amount of stock will be at a serious discount over what the stock trades at normally. We then need to ask ourselves what the true value of the wealth that was taxed was, and you can count on politicians using the pre-school calculation and therefore grossly overestimating the real-world value of this stock.
With this massive amount of mark-to-market positions coming due every year, assuming this accounting is correct and applying the tax to that amount would quickly produce some gross inaccuracies. If you are assumed to be worth $50 billion, and you sell off 3% of this and only end up with 1.5% worth, we have clearly overestimated the value of these shares by at least 2 times.
The stocks affected would become much more of a bargain, and while this would result in people stepping up to help by buying these stocks at depressed prices, this will require that they exit some of their other positions to raise the capital. The stock market simply doesn’t have this much money available and this would extend to all stocks and put a real hurt on the overall value of the market measured the way that we now do.
A Wealth Tax Will Also Cause a Huge Outflow of Wealth
If we do see some big money step in to take this stock off of the hands of Americans at a big discount, given that all the mega-wealthy people in the U.S. are scrambling to save themselves, we may see a line form on the other side of the ball comprised of very wealthy foreigners, who can liquidate positions to be able to take advantage of this fire sale without having to worry about being stung themselves by such a tax at home.
If you are only getting 50% of the mark-to-market value that is being used to assess your tax, this means that you will have to liquidate twice as much stock, all things being equal, although doing this would serve to further increase the discount rate on your stock, meaning that even this amount will not be enough.
Once the slaughter comes to an end, it will now be time for the price of these stocks to appreciate. The sellers can’t participate in this, and common investors don’t even have that much to invest collectively, because they only represent such a small portion of the market, so this will once again mean foreigners will be stepping up and benefiting.
Even Elizabeth Warren’s wealth tax lite will result in not only a massive bear market but a transfer in wealth not only to the government but to foreign investors as well. A wealth tax will place the big players in the U.S. at a tremendous disadvantage and this will cause a huge outflow of wealth out of the country.
There is no real way that we could implement a wealth tax without causing a great deal of harm, not just the stock market but business and the economy as well, but using book value instead of mark-to-market value would make our calculations of wealth more accurate.
Stocks trade at about 3.5 times their book value these days, with book value being multiplied by the perceived future value of companies and their stocks. The part above the book value consists purely of the additional amount that people are willing to bet on the future. Taxing based upon future value is ridiculous enough, but taxing based upon the future value assigned at the upper margin of these bettors is even more so.
If you own 10% of a company, and you want to know what the present value of this share in it is, the only sensible way to do this is to multiply this percentage by the value of a company’s assets, what the company is actually worth in real terms and not by way of what people think it may be years from now.
This is how we’d be doing it with a private company, and if we use mark-to-market with public companies, this will cause affected parties to have a big preference toward private investment. This is not what we want at all, due to the effects this would have on public stocks, severely impacting the retirement plans of the majority of people, the people that these politicians are supposed to be helping somehow by all this.
A wealth tax represents the nuclear option economically, although this is on the other hand not such a good comparison, because we know how dangerous nuclear weapons are and will practice a lot of restraint. This nuclear weapon remains grossly understood by some of our politicians, and the fact that anyone would even consider using such a thing marks them guilty of this, because no one in their right mind would knowingly choose a road to catastrophe.
The only way to ever use such a thing without bringing on a crisis would to be to tax realized wealth, where we end up not only taxing the earned income of these people but also tax the sales of their assets, but only when there is wealth is commuted
We do not tax people based upon their owning stocks, and force them to sell off a portion every year to pay tax owing, we tax them when they realize the value of their investments. This would be a much more sensible approach to put a lot bigger squeeze on the wealthiest without having this take us all down in its wake.
This is not something that wouldn’t do real damage but at least it would be contained, and we wouldn’t be creating a permanent bear market in the process. You just can’t have this much money taken out of the stock market year after year without beating it to the ground year after year. This should excite no one.