Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: the coming (maybe) capital-gains-tax disaster, a GameStop winner, (Boris) Johnson’s green dream, Biden’s green dream, and “sleepminting.” To sign up for the Capital Note, follow this link. Higher Capital-Gains-Tax Rates Penalize Success, Disincentivize Business Formation, and Discourage Investment: An Unusual Formula for Growth From the New York Times yesterday: Mr. Biden will propose several tax increases he included in his campaign’s “Build Back Better” agenda. That starts with raising the top marginal income tax rate to 39.6 percent from 37 percent, the level it was cut to by President Donald J. Trump’s tax overhaul in 2017. Mr. Biden would also raise taxes on capital gains — the proceeds of selling an asset like a stock or a boat — for people earning more than $1 million, effectively increasing the rate they pay on that income to 39.6 percent from 20 percent. The president will also propose eliminating a provision of the tax code that reduces taxes for wealthy heirs who sell assets they inherit, like art or property, that have gained value over time. And he would raise revenue by increasing enforcement at the Internal Revenue Service to bring in more money from wealthy Americans who evade taxes. Administration officials were debating other possible tax increases that could be included in the plan this week, like capping deductions for wealthy taxpayers or increasing the estate tax on wealthy heirs. All of the tax provisions would keep with Mr. Biden’s campaign promise not to raise taxes on individuals or households earning less than $400,000 a year. The Tax Foundation’s Jared Walzcak tweets: Top all-in capital gains tax rates under Biden’s proposal: New York, NY: 58.176% Portland, OR: 57.3% California: 56.7% I do not know why this news should have come as a surprise, but the stock market did not like what it heard: CNBC: U.S stocks fell to session lows in a swift fashion on Thursday after reports that President Joe Biden is slated to propose much higher capital gains taxes for the rich… “Biden’s proposal effectively doubles the capital gains tax rate on $1mm income earners,” said Jack Ablin, Cresset Capital Management’s founding partner and CIO. “That’s a sizable cost increase to long-term investors. Expect selling this year if investors sense the proposal has a chance of becoming law next year.” Growth stocks, which could come under selling pressure on higher capital gains taxes, led the intraday decline on Thursday with shares of Tesla and Amazon falling. The iShares S&P 500 Growth ETF fell 0.5%, more than its value counterpart. “Markets are highly concentrated in a small number of growth names,” said Mark Yusko, CEO & CIO of Morgan Creek Capital Management. “Those stocks have driven most of the gains over the past few years and many investors have significant gains at current prices. Fear of higher capital gains rate could motivate selling of those names and trigger market correction, so some investors will try and front run that potential move by selling or hedging through short selling.” The S&P, NASDAQ, and Dow all closed down on the day. Increasing the tax on capital-gains tax to this degree (or, indeed at all) is a move that, if approved, will be both economically disastrous as well as, in an age when “fairness” is meant to count, thoroughly inequitable. To start with the latter point — that an increase in capital-gains tax would be inequitable — the traditional starting point for such an argument is that it is often a tax on the proceeds generated by after-tax income, and so, in some respects, a form of double taxation. Secondly, it is a tax on nominal, rather than real gains. Some maintain that inflation ought not to be much of a consideration when it has been low for a relatively long period of time. The people who make that argument forget (or choose to forget) two things. The first is that even small rates of inflation compound significantly over the years. A $1 in 2000 is worth around $0.65 now. Over that period the average inflation rate has been 2.07 percent a year. That means that the investor who had turned his or her $0.65 investment in 2000 into $1 now would have to pay tax on a $0.35 “profit” that is entirely illusory. Now consider what happens to the math if we see (as I would expect) a significant uptick in inflation and an increase in capital-gains taxes. Lenin is often said to have said that “the way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” As with quite a number of Lenin’s quotations, he may or may not have actually said it, but he certainly felt that way. But, you may say, this higher rate will only affect the rich, “for people earning more than $1 million.” Well, to start with, those who think that threshold will keep pace with inflation are likely to be disappointed. To take one example, the federal capital-gains-tax exemption (per person) on the sale of a primary residence is $250,000. This was fixed in (checks notes) 1997, and it has not been changed since. $250,000 in 1997 is worth around $412,000 today. Then there’s something else. What if someone had spent his or her life building up a business, perhaps taking a low income to do so. They then sell that business for, say, $3,000,000 (a gain that will be unadjusted for inflation). For that year, they will be treated as “rich” and (at least on the basis of that New York Times report) be taxed accordingly. The next year, well, too bad . . . Another thing to bear in mind is that the administration, twisting the knife still further, is proposing to end the capital-gains “step-up” for inherited goods, again, only for the wealthy, but . . . Daniel Pilla explained how that will work in a recent article for Capital Matters here. And, while we’re still looking at the position of individuals, it’s worth thinking about those who live in blue (and, like everywhere else since the Trump tax overhaul, low SALT deduction) states. Increasing the capital-gains tax to levels reaching the heights described by Jared Walzcak is not going to encourage the wealthy to stay, say, in New York City. If we look at Gotham, in 2018 (and so after the Trump tax changes) the top 1 percent of New Yorkers paid 42.5 percent of the total income tax collected by the city. Capital gains, incidentally, in New York, whether long term or short term, are treated, for tax purposes, as ordinary income. State income taxes, again for the rich, are also set to rise. If New York and states like it, some of which are centers of entrepreneurial activity, are committing fiscal suicide, the Biden administration may well end up making their demise an assisted suicide, a disaster with effects that will not be confined to those places. But then Biden and the Democrats seem to be either unaware of, or uncaring about, the effect that tax hikes of this nature are going to have on the broader economy. I don’t know how much extra revenue will be generated by a capital-gains-tax hike of this size. There is a long-standing debate over how much money is raised by capital-gains-tax increases, but if I had to guess, it will be less than expected. People respond to incentives — and disincentives — and change their behavior accordingly. Beyond that, increases in capital-gains taxes must increase the cost of capital, at least to the extent that it is dependent on individual investors, who would, I expect, look at expected post-tax returns before putting their money to work. The same, of course, will be true of the way that they look at the stock market, whether directly or through mutual funds/ETFs. There are all sorts of reasons why the economy ought to see good growth in the next year or so, but looking further out, Biden’s policies (penalizing success, discouraging investment, encouraging malinvestment and heaping regulatory burden on regulatory burden) do not seem to me to be an ideal prescription for long-term economic growth. Around the Web Say what you will about GameStop, it is the story that just doesn’t stop giving: Reuters: GameStop Corp (GME.N) chief executive George Sherman can step down this summer with a $179 million windfall that dwarfs CEO salaries at many larger corporations thanks to a sweetheart deal that was turbocharged by this year’s furious meme stock rally, compensation experts said. GameStop said on Monday that Sherman would step down by July 31. The struggling U.S. videogame retailer has been seeking a new leader to work on its e-commerce transition with chairman Ryan Cohen, the billionaire co-founder and former chief executive of online pet supplies retailer Chewy Inc (CHWY.N). GameStop decoupled some of Sherman’s pay from his performance last year in the early months of the COVID-19 pandemic and granted him stock when its shares were worth a tiny fraction of their current value, according to a Reuters review of security filings and interviews with compensation consultants. As a condition of his exit, GameStop is speeding up the time frame for Sherman to receive the shares, generating the award. Someone got to the moon. Johnson’s Green Dream A cautionary tale from the U.K. Ross Clark in The Spectator: As if Covid hadn’t caused a big enough disruption to the economy and investors, along comes another shocker: the government’s announcement of an even-tighter target for reducing carbon emissions. Britain has now been put on a legally-binding commitment to reduce carbon emissions by 78 per cent on 1990 levels by 2035. What does it mean for your money? Quite a lot. For one thing it means that it is more likely that the government will adopt the proposal by the Committee on Climate Change to ban the sale of all homes by 2028 unless they achieve a ‘C’ rating in an Energy Performance Certificate. That potentially exposes millions of homeowners to bills of £20,000 or more for insulation and other energy improvements. At present, just 10 million of Britain’s 29 million homes qualify for a ‘C’ rating. Many – especially the 7.8 million homes with solid walls – may have to be fitted with external or internal wall insulation at a cost of £10,000 to £15,000 as well as with heat pumps (another £10,000 if you are lucky). Solid Victorian homes which form a huge part of the country’s housing stock, could become a financial burden. Then there is the stock market. We have become used to former Bank of England governor Mark Carney and others warning about ‘stranded assets’ in the oil and coal industries. But the new target will have far more serious implications than that, not least because, for the first time, the target will include emissions from aviation and shipping. We don’t as yet have any means for running passenger planes without fossil fuel, so either it will require the development of new technology (which could prove elusive) or it will mean flights becoming wildly more expensive as they are forced, perhaps, to offset emissions through very expensive carbon capture and storage. Airlines, already laid low by Covid, could take another massive hit . . . Needless to say, there’s more. Biden’s Green Dream Bjorn Lomborg, writing in The Daily Telegraph: When Biden’s National Climate Advisor Gina McCarthy warns us that climate is the “most significant public health challenge of our time” that ignores much bigger health problems. The leading causes of death in the US are cardiovascular disease and cancer. The world’s poor battle with much greater challenges like starvation, poverty, dying from easily curable diseases and lack of education. And these challenges have solutions where each dollar can help much more. We could do phenomenally much better at much lower cost helping children out of malnutrition or improving learning in schools. We could address most of the world’s top issues with a fraction of what we’re spending on climate. Earth Day reaffirms that we should care about the planet and its inhabitants and reminds us that we should tackle climate change. But we need to do so smarter and more effectively. We shouldn’t continue and certainly not ramp up our massive subsidies to inefficient solar, wind and electric cars. Unfortunately, this constitutes much of Biden’s unaffordable multi-billion climate promise. Instead, we need to spend much more on green innovation — this is by far the smart part of Biden’s plan. If we can innovate the price of future green energy down below fossil fuels, everyone — including China, India and Africa — will switch to green energy. Let us make Earth Day not about exaggerated climate alarmism but about straightforward, effective solutions. Random Walk “Sleepminting” and NFTs Artnet: In the opening days of April, an artist operating under the pseudonym Monsieur Personne (“Mr. Nobody”) tried to short-circuit the NFT hype machine by unleashing “sleepminting,” a process that complicates, if not corrodes, one of the value propositions underlying non-fungible tokens. His actions raise thorny questions about everything from coding, to copyright law, to consumer harm. Most importantly, though, they indicate that the market for crypto-collectibles may be scaling up faster than the technological foundation can support. Debuted as part of an ongoing project titled NFTheft, sleepminting serves as a benevolent but alarming crypto-counterfeiting exercise. It aims to show that an artist can be made to unconsciously assert authorship on the Ethereum blockchain just as surely as a sleepwalking disorder can compel someone to waltz out of their bedroom while in a deep doze. Remember, to “mint” an NFT means to register a particular user as its creator and initial owner. Theoretically, this becomes the first link in a verified, unbreakable chain of custody tethered to an NFT for the life of the underlying blockchain network. Thanks to this perfectly complete, perfectly secure, and eternally checkable data record, the argument goes, potential buyers can trust non-fungible tokens without necessarily having to trust their owners or sellers. These traits add a valuable layer of security that traditional artworks could never rival with their eternally dubious off-chain certificates of authenticity and provenance documents. Personne may have found a way to dynamite this argument for much of the art NFT market. Sleepminting enables him to mint NFTs for, and to, the crypto wallets of other artists, then transfer ownership back to himself without their consent or knowing participation. Nevertheless, each of these transactions appears as legitimate on the blockchain record as if the unwitting artist had initiated them on their own, opening up the prospect of sophisticated fraud on a mass scale. To prove his point, on April 4, Personne sleepminted a supposed “second edition” of Beeple’s record-smashing Everydays: The First 5,000 Days, the digital work and accompanying token that sold for a vertigo-inducing $69.3 million via Christie’s less than a month earlier. (My emails to Beeple and his publicist about the situation went unanswered.) In our ensuing email exchange, Personne claimed he then gifted the sleepminted Beeple (Token ID 40914, for the real crypto-heads) to a user with the suspiciously appropriate handle Arsène Lupin, an homage to the famous “gentleman thief” created by Maurice Leblanc and recently reincarnated in a hit Netflix show . . . — A.S. To sign up for the Capital Note, follow this link.