Capitalism – My Mental Model

Taxing the Wealthy won’t work. A Crypocurrency might. (Part 1)

I spent 4 years working at a major bank in a role that effectively made me the personal CFO for wealthy families. It was my responsibility to coordinate all things finance, from their investment portfolios, to their tax planning, to their wills & estate. I really enjoyed what I did, and I only worked with clients that I chose to take on, so I really liked my clients too. Most of them were the ‘top 1%’ but almost all of them had come from humble beginnings, worked super hard, succeeded at their craft, were good to their families, and did plenty of philanthropy. If you didn’t know how much money they had, you’d have little conflict calling them good people. But in having worked so hard to get to where they were, and having little to no confidence in government spending, they weren’t interested in handing over their hard earned money back via tax dollars. For that reason, just about every client had a full tax plan done for them by high level accountants and tax lawyers. We used to counsel our clients that avoiding taxes is legal, while evading taxes is illegal. There were some grey areas, but we encouraged them to avoid those too. Even so, they barely paid any tax.

It was while I was working at the bank that I also first discovered just how uneven the distribution of wealth was. I grew up in a poor neighborhood so I generally assumed that everyone around me was always better off than I was, and I was just in the process of catching up. But then I found this YouTube video:

Using data from 2009, it painted a very real picture of how wealth is allocated in today’s America. As soon as I saw that, I knew that this was a very real problem and started trying to figure out what I could do to help. I knew that the lack of financial literacy in the bottom 90% was a big factor so I started holding financial literacy seminars in my neighborhood and teaching a finance class at my old high school. The data was collected in 2009. I was teaching these classes between 2013 and 2015. Today, things are much worse.

And I’m that much more motivated to come up with a solution to the problem.

When you see how much wealth the top 1% control, most people would agree that it’s an issue but I don’t think people fully understand why. Wealth is not the same as money. These billionaires don’t have billions of dollars in the bank. Cash is understood to be an asset, and if it’s just sitting around, it’s losing ground to inflation. So people tend to keep as little cash as possible, and leave the rest of their money sitting in a diversified portfolio of assets. For the billionaires, that’s real estate, businesses, stock portfolios, gold, art, and just about everything in between. The problem has little to with how wealthy they are or how much money they earn, it’s about how much of the nation’s resources they control.

One of the fundamental concepts within capitalism is competition. When capitalism is running as intended, there’s a diversity of thought, a competitive market place of ideas, and those who can execute on the best ideas tend to win. When the best ideas we can come up with are what become the businesses of our economy, we all win. But that’s not what we have today. What we have today is a failed capitalist state.

I’m someone with no shortage of business ideas and people often ask me why I don’t start my own business. Well… people usually save up for that right? Work a decent paying job for while, save up some money and open a business right? Well, in an economy where 80% of people are living from paycheck to paycheck, I guess saving up to start a business isn’t exactly an option that’s available to everyone.

Well what about getting a loan from the bank? Well the bank isn’t interested in giving people opportunities as much as it’s interested in guaranteeing that it’ll get it’s money back. Businesses don’t have any guarantee of success, so they’ll ask for a personal guarantee. Since most aspiring entrepreneurs today don’t have savings let alone assets, the banks aren’t interested in lending money to them. For those who have scraped enough together to own their own home, the bank will gladly lend you the money to start a business. They’ll also take your home if your business fails. 80% of small businesses fail within the 5 years year.

What about getting an investment from friends and family? Well most would want to see you put your own money in first. If you’ve managed to do that, you need friends and family who have enough money to make a high-risk investment into your venture. If you have both, chances are you’re closer to the 1% than you think.

What about getting investment dollars from a venture capital firm? Well most would like to see a business that’s up and running already. If you’ve managed to get that far and have one of the few businesses they’d like to invest in, they’re likely to take a predatory stake in the company to mitigate their risk. Congratulations, you’ve just circumvented the control that the top 1% has on our nations resources… by begging them for money, and then giving them a significant part of your business, on their terms. This is all wrong. When the top 1% control the vast majority of the country’s resources, they get to choose where that wealth goes and who has access to it. When you can’t compete without resources, that reduces competition. When there’s no ability to compete, people are less inclined to come up with great ideas… because it’s just too hard to get it past the idea phase. And that.. is a failure of capitalism.

So how do we fix it?

Some would think that the wealthy aren’t paying their fair share of taxes, so why don’t we just tax the wealthy? How about a 70% tax rate on income over $10 million? Or a tax on their assets? Or change the tax brackets… or something! When I see these ideas being put forward, I’m hearing someone who is working with the right motivations, but the wrong understanding.

A 70% tax rate on incomes over $10 million? Easy, just don’t pay yourself more than $10 million in income in any given year. When you’re a billionaire, your entire life can be structured as a company expense and you have very little need for personal income. A tax on assets? Easy, just move the ownership of the asset into a structure which isn’t subject to tax. None locally? All good, just move them off-shore. I don’t think the general public or the politicians appreciate just how well the tax system is designed for wealthy people who don’t want to pay tax. I wonder how that happened…

I think that when the general public sees this behavior, they get upset. Us normal people who are barely getting by are forced to pay our taxes, while these rich people who have more money than you can spend aren’t paying their fair share. Well.. why is that? I don’t think it’s just greed. Why would so many of the world’s high profile billionaires be giving away so much of their money if they were so greedy? At least part of it is that they don’t trust the ability of the government to spend effectively. All things considered, they’re probably right. If the government were to confiscate all the wealth from all of America’s billionaires, it would cover government expenses for less than a year. It’s like making a donation to a charity and finding out that most of that money goes to the people running the charity and not the cause which the charity is supporting. I can’t help but think that the wealthy know that the government works the same way and avoids giving them money because of it. At least with philanthropy, you have a little more control over how that money is spent.

The reality is that our current tax system is so complex and filled with so many loopholes, that the wealthy will always find a way to avoid paying taxes. And if we make things prohibitive locally, there’s no shortage of countries which are willing to show preferential treatment to someone who is willing to bring billions of dollars with them. Think about Amazon’s approach to finding a new ‘HQ’ and hunting for government subsidies. To make it worse, it’s these same billionaires who are funding the elections of what are supposed to be *our* elected representatives. That means that laws and regulations will continue to shift to their favor. There’s a joke that if American’s didn’t have estate tax, the wealthy would never pay tax at all. Well, it should come as no surprise that politicians, including our current president, are keen to eliminate that estate tax.

The first solution I had to this problem was tax reform. A complete overhaul of the system that would make taxes simple and easy to file on your own. Something that was so easy and obvious, that there would be no room for loopholes. I think there’s probably a way to do it… but it’s not something I’m capable of figuring out right now. Too complex. So what do I do when things are too complicated? I make them less complicated.

The real special sauce behind capitalism is a meritocracy, where the best ideas get the most resources. We want someone like Elon Musk to have all the support and resources he needs because what he’ll build with them will likely benefit us all. But not all of us are like Elon, and some of us have to give up a little, so someone like him can have a little extra. And it’s not because we think he should have bigger houses or fancier vacations. The little bit that each of us gives up, goes to someone developing things like solar energy, or electric cars, or space travel… because when they do, all of us win. So for all us to be best off, there must be an unequal distribution of resources. But how do we create systematic inequality, which truly benefits everyone?

What about a crytpocurrency? One which had a distribution curve built into it, and automatically rebalanced itself? What if the currency itself always assured that those on the low end of the spectrum could always afford a standard cost of living, and those on the high side received more resources than the average person? And that our best and brightest generally had everything that they needed?

Wouldn’t that be something… I’ll take a crack at mapping it out in Part 2.

A Social Crypto

I’ve often wondered what would be the catalyst for the next major recession. As cryptocurrencies went mainstream, it occurred to me that one way in which we could shift wealth would be through the adoption of a new currency. How amusing would it be for the 99% to develop a currency to use among themselves, while the top 1% ended up with monopoly money. As fun as that sounds, it’s not quite that easy. But something about this crypto.. maybe there’s something here.

Bare with me on this… what if we introduced a cryptocurrency with a built-in distribution algorithm?

Fundamentally, the first things we’d have to decide on is a fundamental stance on how we should distribute resources. My vote would be for a simple mandate that more resources should be awarded to those who contribute more. If we can all agree on this (which should be rather easy), then we would just have to decide on how exactly that distribution would play out. A while back, a Harvard professor asked what people thought was an fair distribution of wealth among Americans. The top 20% looked to occupy about 35% of the country’s wealthy while the bottom 20% occupied about 10% of the country’s wealth. The middle 60% occupied about 55%. Sure, why not.

Or maybe there’s a way to tie the bottom 20% to cost of living? If you were constantly tracking accurate statistics on cost of living, you could always make sure that the bottom 20% was a certain margin above the cost of living, ensuring that those at the lowest run of society were always afforded an opportunity to get ahead. From there, perhaps you could let the currency do as it may.

Either way, the idea here is that through poor governance, we’ve found ways to systematically shift wealth from the many to the few. Beyond the ethics of it, this actually creates a great deal of economic hardship. Whether it’s going to school, starting a family, buying your own house, or starting a business, it all costs money. Once upon a time, you could comfortably provide for a family on a single middle-class income. Where I live, the cost of a middle-class lifestyle is about $300,000 a year. So people maybe don’t go to school. People maybe don’t start a family. People maybe don’t start a business. And maybe we all take a step backwards.

I can’t help but think that the pursuit of power is a human instinct. If so, the pursuit of power will always be an element within governance. If true, government will always be susceptible to corruption because as we all remember, power corrupts. So if government can’t be trusted to maintain a fair distribution of wealth, how do you address this? You build it right into the currency.

So how do you go about getting people to adopt a currency like this? Imagine being the person who brings 10 million dollars to the currency, only to end up with 5 million because half was redistributed to all the people who signed up with way less? What would keep you from signing up with a single dollar, keeping the rest of your assets elsewhere as you accumulated ‘equality’. As soon as I thought I was on to a genius idea, I realized this was a rather daunting hurdle. But not an unsolvable one.

There’s something here… but I’m not quite there.

Analogies: Capitalism

a long time ago, someone designed a car. It was beautifully engineered and truly revolutionary. It was so well designed that it was pretty much built to last forever.

While the car was a something for the history books, the drivers were inconsistent. Some understood the mechanics and drove respectfully. Some showed less regard for the car and drove as it suited their agenda.

Along the way, drivers began allowing for more passengers. Some for altruistic reasons, some because they paid, and some for the sake of personal relationships.

The car was built well enough to handle a few extra passengers, but as passengers increased and time wore on, key parts of the car started to wear down. All the added weight was creating excessive pressure, leading to wear on parts that the car couldn’t function without.

Some of the older passengers are looking out the window saying the car looks just fine. They can tell that the ride is bumpier but it’s hard to notice in a cushy seat. They know that car was built to last and they know it’s gotten them this far.

Those who are more familiar see that the car is unsustainable. If we maintain this rate of passengers, the car will fail. If we want to reduce the amount of passengers, we can keep the car on the road.

Ironically, we’re so focused on the survival of old reliable, that we haven’t given any thought to the new models. Technology changes everything. As great as that car was, modern technology has changed how we get from point A to point B and it’s important to appreciate those changes. There are ideas which we didn’t have the technology to pull off before but could be more viable today.

It’s dangerous assuming there’s no room for improvement. Might be a good time to look at some options. Even better, why don’t we look at what we need from our car, learn from our peers, and build something new and inspiring from the ground up.