WEBVTT 00:00:00.000 --> 00:00:03.899 Picture this scenario. It's a rainy Sunday afternoon. 00:00:04.139 --> 00:00:05.940 You're up in the attic, finally getting around 00:00:05.940 --> 00:00:08.300 to clearing out those dusty boxes that have been 00:00:08.300 --> 00:00:10.060 sitting there since, I don't know, since you 00:00:10.060 --> 00:00:12.400 moved in. You're sifting through old college 00:00:12.400 --> 00:00:16.019 textbooks, broken kitchen appliances, maybe some 00:00:16.019 --> 00:00:19.300 questionable fashion choices from the 90s. The 00:00:19.300 --> 00:00:22.199 archaeology of your own life. Exactly. And then 00:00:22.199 --> 00:00:25.859 you spot it. A long white cardboard box tucked 00:00:25.859 --> 00:00:28.160 away in the corner. You open it up and inside, 00:00:28.300 --> 00:00:30.879 preserved in a plastic sleeve, is a comic book. 00:00:31.359 --> 00:00:34.500 Let's say it's Amazing Fantasy hashtag 15. Ooh, 00:00:34.600 --> 00:00:37.380 the Holy Grail. The Holy Grail. The first appearance 00:00:37.380 --> 00:00:39.640 of Spider -Man. You remember buying this, or 00:00:39.640 --> 00:00:41.659 maybe your grandfather bought it, for, what, 00:00:41.780 --> 00:00:44.399 12 cents at a newsstand? You pull out your phone, 00:00:44.460 --> 00:00:45.960 your hands are shaking a little bit, and you 00:00:45.960 --> 00:00:47.759 check the market price. And your jaw hits the 00:00:47.759 --> 00:00:50.259 floor. It hits the floor. It is worth a fortune. 00:00:50.380 --> 00:00:53.100 We are talking a life -changing amount of money. 00:00:53.200 --> 00:00:55.179 It's like a winning lottery ticket that's been 00:00:55.179 --> 00:00:58.219 sitting under a pile of old winter coats for 00:00:58.219 --> 00:01:00.750 40 years. That is the dream, isn't it? You know, 00:01:00.750 --> 00:01:02.850 the unexpected windfall, the hidden treasure. 00:01:03.149 --> 00:01:05.890 It is the absolute dream. So you go through the 00:01:05.890 --> 00:01:08.769 whole process. You find a reputable auction house. 00:01:08.829 --> 00:01:10.790 You get it graded. The marketing ramps up. And 00:01:10.790 --> 00:01:14.189 finally, the gavel bangs. You sell it. You are 00:01:14.189 --> 00:01:17.049 ready to collect your millions and, I don't know, 00:01:17.230 --> 00:01:20.090 sail off into the sunset. But then. But then 00:01:20.090 --> 00:01:23.939 the realization hits you. That profit. It isn't 00:01:23.939 --> 00:01:27.219 entirely yours. No, it is not. There is a silent 00:01:27.219 --> 00:01:29.700 partner in the room, a partner who took zero 00:01:29.700 --> 00:01:32.799 risk, who didn't preserve the comic, who didn't 00:01:32.799 --> 00:01:35.120 buy it at the newsstand, but who is standing 00:01:35.120 --> 00:01:37.180 there with their hand out waiting for their cut. 00:01:37.579 --> 00:01:39.420 And depending on where you live on this planet, 00:01:39.540 --> 00:01:41.620 that cut could be massive. And that silent partner, 00:01:41.640 --> 00:01:43.799 of course, is the government. Today, we are diving 00:01:43.799 --> 00:01:46.200 deep into the world of capital gains tax, or 00:01:46.200 --> 00:01:48.019 CGT for short. Now, I know what you're thinking. 00:01:48.700 --> 00:01:51.060 Taxes. Really, I'm going to tune out. But let 00:01:51.060 --> 00:01:53.260 me stop you right there. Please do. Because this 00:01:53.260 --> 00:01:56.480 isn't really about filling out forms or crunching 00:01:56.480 --> 00:01:58.819 boring percentages. It's not. This is about a 00:01:58.819 --> 00:02:01.079 mechanism that fundamentally changes how human 00:02:01.079 --> 00:02:03.700 beings behave. It changes when we sell our houses, 00:02:03.760 --> 00:02:06.760 how we invest in the stock market, and even whether 00:02:06.760 --> 00:02:09.419 we decide to, you know, cheat the system and 00:02:09.419 --> 00:02:12.020 become criminals. It creates market distortions. 00:02:12.020 --> 00:02:15.099 It locks trillions of dollars in place, freezing 00:02:15.099 --> 00:02:18.139 them in the economy. And as we will see, it is 00:02:18.139 --> 00:02:20.419 handled wildly differently depending on where 00:02:20.419 --> 00:02:22.650 you stick a pin in the map. So our mission for 00:02:22.650 --> 00:02:25.370 this deep dive is to move beyond the boring definitions. 00:02:26.050 --> 00:02:29.050 We want to figure out why selling a house or 00:02:29.050 --> 00:02:32.310 a stock is so complicated. We have a massive 00:02:32.310 --> 00:02:34.550 stack of research here. We're talking historical 00:02:34.550 --> 00:02:37.150 data from Japan, policy shifts in Kenya, and 00:02:37.150 --> 00:02:39.509 some heavy -hitting economic studies on tax evasion. 00:02:39.650 --> 00:02:42.169 Let's unpack this. Let's get into it. First things 00:02:42.169 --> 00:02:43.710 first, we need to lay the groundwork. We need 00:02:43.710 --> 00:02:45.990 a working definition so we're all on the same 00:02:45.990 --> 00:02:49.259 page. What exactly is a capital gains tax? Based 00:02:49.259 --> 00:02:50.979 on the source material we have, the definition 00:02:50.979 --> 00:02:52.759 is actually quite specific, and every single 00:02:52.759 --> 00:02:56.379 word matters. A capital gains tax is a tax on 00:02:56.379 --> 00:02:59.219 the profits realized on the sale of a non -inventory 00:02:59.219 --> 00:03:01.860 asset. Okay, there are two really heavy concepts 00:03:01.860 --> 00:03:05.780 in that sentence. Realized and non -inventory. 00:03:06.219 --> 00:03:08.539 Let's start with non -inventory. What does that 00:03:08.539 --> 00:03:10.659 even mean? So this is the distinction between 00:03:10.659 --> 00:03:13.379 a business running its daily operations and an 00:03:13.379 --> 00:03:16.939 investment. If you run a shoe store and you sell 00:03:16.939 --> 00:03:19.900 a pair of sneakers to a customer, that is your 00:03:19.900 --> 00:03:22.099 inventory. Right. The stuff you sell. The stuff 00:03:22.099 --> 00:03:24.580 you sell. That is regular business income. You 00:03:24.580 --> 00:03:26.800 buy shoes, you sell shoes. That's your job. The 00:03:26.800 --> 00:03:28.800 profit you make there is taxed as income. Okay. 00:03:28.900 --> 00:03:31.740 That makes sense. But if you as an individual 00:03:31.740 --> 00:03:35.199 buy a stock or a bond or a piece of precious 00:03:35.199 --> 00:03:37.699 metal or a rental property and you hold on to 00:03:37.699 --> 00:03:40.900 it. That is a capital asset. You aren't in the 00:03:40.900 --> 00:03:42.840 business of selling that specific item every 00:03:42.840 --> 00:03:44.759 day. It's an investment, not a job. Exactly. 00:03:44.819 --> 00:03:47.080 So when you eventually do sell it for more than 00:03:47.080 --> 00:03:50.340 you bought it for, that profit isn't income in 00:03:50.340 --> 00:03:52.419 the traditional sense. It is a capital gain. 00:03:52.620 --> 00:03:55.099 So the government effectively treats the money 00:03:55.099 --> 00:03:57.860 I make from working my labor differently than 00:03:57.860 --> 00:04:00.979 the money I make from, well, from waiting. From 00:04:00.979 --> 00:04:04.300 my money making money. Essentially, yes. And 00:04:04.300 --> 00:04:06.620 that brings us to the second word, which is arguably 00:04:06.620 --> 00:04:08.780 the most important word in this entire deep dive. 00:04:09.620 --> 00:04:12.479 Realized. Realized. Yeah. This is the idea that 00:04:12.479 --> 00:04:15.139 paper wealth isn't real wealth, at least not 00:04:15.139 --> 00:04:17.899 to the tax man. Correct. Let's go back to your 00:04:17.899 --> 00:04:20.420 Spider -Man comic book. Let's say you found it 00:04:20.420 --> 00:04:23.540 10 years ago. You checked the price then, and 00:04:23.540 --> 00:04:25.540 it was worth, I don't know, $500 ,000. Okay. 00:04:25.939 --> 00:04:28.180 Today, you check it again, and it's worth a million. 00:04:28.720 --> 00:04:31.519 On paper, you made half a million dollars while 00:04:31.519 --> 00:04:33.800 it sat in the box. Your net worth went up. You 00:04:33.800 --> 00:04:36.560 are, for all intents and purposes, richer. Right. 00:04:36.720 --> 00:04:39.839 But the tax man doesn't come knocking. Not yet. 00:04:39.980 --> 00:04:41.459 Because I haven't sold it. I don't have the cash 00:04:41.459 --> 00:04:43.779 in my pocket. It's still just a comic book. Exactly. 00:04:44.199 --> 00:04:47.360 You haven't realized the game. The tax event 00:04:47.360 --> 00:04:49.540 is only triggered when the transaction happens. 00:04:49.980 --> 00:04:53.199 When you exchange the asset for money. Which 00:04:53.199 --> 00:04:55.120 seems logical, right? I mean, I can't tear off 00:04:55.120 --> 00:04:56.680 a corner of the comic book and mail it to the 00:04:56.680 --> 00:04:59.300 IRS to pay the bill. I need the liquidity from 00:04:59.300 --> 00:05:02.439 the sale to pay the tax. It is logical, and it 00:05:02.439 --> 00:05:05.040 solves a very real liquidity problem for taxpayers. 00:05:06.060 --> 00:05:08.620 But, and this is a huge we're going to get into, 00:05:08.779 --> 00:05:12.620 that simple rule taxation upon realization creates 00:05:12.620 --> 00:05:15.819 a massive psychological loophole. A loophole. 00:05:15.980 --> 00:05:18.079 It creates what economists call the locked -in 00:05:18.079 --> 00:05:21.220 effect. It essentially gives you a massive financial 00:05:21.220 --> 00:05:24.759 incentive to never, ever sell. We're definitely 00:05:24.759 --> 00:05:26.959 going to deep dive into that locked in concept 00:05:26.959 --> 00:05:29.399 because it sounds like a trap. But sticking to 00:05:29.399 --> 00:05:32.139 the mechanics for just a second, is every single 00:05:32.139 --> 00:05:35.680 dollar of profit taxed? Like if I sell an old 00:05:35.680 --> 00:05:38.500 bicycle at a garage sale for 50 bucks, am I committing 00:05:38.500 --> 00:05:41.310 tax fraud if I don't report it? Generally, no. 00:05:41.470 --> 00:05:42.889 I mean, the government isn't interested in your 00:05:42.889 --> 00:05:45.230 garage sale or your used toaster. Good to know. 00:05:45.269 --> 00:05:47.310 They usually set thresholds or boundaries. They're 00:05:47.310 --> 00:05:48.930 looking for the big fish, generally speaking. 00:05:49.209 --> 00:05:51.790 If your profit is below a certain limit, it might 00:05:51.790 --> 00:05:53.810 be tax -free. And the calculation is usually 00:05:53.810 --> 00:05:55.589 straightforward, at least on paper. On paper. 00:05:55.689 --> 00:05:58.189 It's the sold price minus the purchase price. 00:05:58.529 --> 00:06:00.629 And that purchase price, the official term, is 00:06:00.629 --> 00:06:02.670 the cost basis. The difference is your profit, 00:06:02.829 --> 00:06:05.649 your capital gain. Cost basis. So that's just 00:06:05.649 --> 00:06:08.029 fancy accounting talk for what I paid for it. 00:06:08.089 --> 00:06:10.939 Usually, yes. Although, as we will find out in 00:06:10.939 --> 00:06:13.000 the avoidance section later, that cost basis 00:06:13.000 --> 00:06:15.959 can, well, it... It can change in some pretty 00:06:15.959 --> 00:06:18.699 magical ways if you inherit property or use certain 00:06:18.699 --> 00:06:20.899 loopholes. It's not always a fixed number. Ooh, 00:06:21.019 --> 00:06:23.420 I love a good loophole. Now, another thing I 00:06:23.420 --> 00:06:25.360 noticed in the research is that individuals and 00:06:25.360 --> 00:06:27.720 corporations don't always play by the same rules. 00:06:28.079 --> 00:06:30.259 That is right. Most countries have different 00:06:30.259 --> 00:06:33.620 rates for individuals versus corporations. Corporations 00:06:33.620 --> 00:06:36.579 often treat capital gains more like regular business 00:06:36.579 --> 00:06:39.620 income because, well, they are businesses. Buying 00:06:39.620 --> 00:06:41.779 and selling assets is part of their operation. 00:06:41.959 --> 00:06:45.079 But individuals often get... preferential rates. 00:06:45.699 --> 00:06:47.839 The thinking is that governments generally want 00:06:47.839 --> 00:06:51.199 to encourage individuals to invest, to save for 00:06:51.199 --> 00:06:54.300 retirement, to buy homes. So they often tax capital 00:06:54.300 --> 00:06:56.819 gains at a lower rate than your salary. It's 00:06:56.819 --> 00:06:59.759 an incentive. And what happens if I'm a terrible 00:06:59.759 --> 00:07:02.040 investor? What if I lose money? Let's say I sell 00:07:02.040 --> 00:07:04.019 that comic book for a huge profit, but I also 00:07:04.019 --> 00:07:06.879 sold some stocks that absolutely tanked. Do I 00:07:06.879 --> 00:07:09.720 still pay full tax on the comic book? Usually, 00:07:09.860 --> 00:07:13.459 no. This is the concept of the offset. It's the 00:07:13.459 --> 00:07:16.459 one mercy the system offers, really. The consolation 00:07:16.459 --> 00:07:20.180 prize for bad investing. Exactly. Most systems 00:07:20.180 --> 00:07:22.740 allow you to take your capital losses and subtract 00:07:22.740 --> 00:07:25.240 them from your capital gains. So if you made 00:07:25.240 --> 00:07:28.600 $10 ,000 on the comic but lost $10 ,000 on the 00:07:28.600 --> 00:07:31.680 stock, your net capital gain is zero. You pay 00:07:31.680 --> 00:07:34.639 nothing. And if I lost more than I gained, then 00:07:34.639 --> 00:07:37.259 you usually have a net capital loss. And in many 00:07:37.259 --> 00:07:39.680 places, you can carry that loss forward to future 00:07:39.680 --> 00:07:42.899 years to offset future gains. It's the government 00:07:42.899 --> 00:07:45.800 effectively sharing in your risk, but only to 00:07:45.800 --> 00:07:47.980 the extent that it lowers your tax bill on other 00:07:47.980 --> 00:07:50.370 winners. OK, so that's the machinery. You buy 00:07:50.370 --> 00:07:53.389 low, sell high, and pay a percentage of the difference 00:07:53.389 --> 00:07:55.310 when you sell after accounting for your losses. 00:07:55.529 --> 00:07:57.589 But you mentioned earlier that this tax changes 00:07:57.589 --> 00:07:59.170 human behavior. This is where it gets really 00:07:59.170 --> 00:08:00.850 interesting. This is the behavioral economics 00:08:00.850 --> 00:08:03.250 of capital gains tax. And this brings us back 00:08:03.250 --> 00:08:05.069 to that locked -in effect you mentioned. Break 00:08:05.069 --> 00:08:07.589 that down for us. Why does realization make me 00:08:07.589 --> 00:08:10.990 freeze? So imagine you own a stock. You bought 00:08:10.990 --> 00:08:13.550 it for, let's say, $10, and now it is trading 00:08:13.550 --> 00:08:17.149 at $100. You have a massive $90 gain per share. 00:08:17.329 --> 00:08:19.949 I'm feeling good. I want to sell and go buy a 00:08:19.949 --> 00:08:23.829 boat. But wait. The moment you click sell, you 00:08:23.829 --> 00:08:27.029 trigger a tax event. If you sell now, you have 00:08:27.029 --> 00:08:29.490 to cut a check to the government for, let's say, 00:08:29.610 --> 00:08:33.169 20 % of that $90 profit. That's $18 per share. 00:08:33.330 --> 00:08:36.730 That is immediate pain. The money is gone. However, 00:08:37.210 --> 00:08:40.309 if you don't sell, what happens? You keep that 00:08:40.309 --> 00:08:42.929 money working for you. The tax liability is there. 00:08:42.990 --> 00:08:44.789 It's hovering over you. But you don't have to 00:08:44.789 --> 00:08:47.500 pay it yet. So I get to keep investing the full 00:08:47.500 --> 00:08:51.120 $100, not just the $82 I'd have left after tax. 00:08:51.299 --> 00:08:53.960 Precisely. You are effectively getting an interest 00:08:53.960 --> 00:08:56.580 -free loan from the government equal to the amount 00:08:56.580 --> 00:08:58.620 of tax you would have paid. You get to keep earning 00:08:58.620 --> 00:09:00.519 returns on the government's money. Oh, I see. 00:09:00.600 --> 00:09:03.960 By postponing the tax, I am keeping more capital 00:09:03.960 --> 00:09:06.120 in the market to grow. It's a deferral strategy. 00:09:06.440 --> 00:09:09.559 It's a powerful deferral strategy. And even if 00:09:09.559 --> 00:09:12.600 the tax rate goes up later, the present discounted 00:09:12.600 --> 00:09:16.379 value of that tax is reduced by weighting. It 00:09:16.379 --> 00:09:19.360 creates a very strong incentive to hold on to 00:09:19.360 --> 00:09:21.899 assets way longer than you naturally would. You 00:09:21.899 --> 00:09:24.879 become locked in. So I might have a stock that 00:09:24.879 --> 00:09:27.299 I think has peaked. My brain is telling me I 00:09:27.299 --> 00:09:30.080 should sell it, but I don't because I hate the 00:09:30.080 --> 00:09:32.860 idea of paying that tax bill today. Precisely. 00:09:32.980 --> 00:09:36.169 You are making an investment decision. based 00:09:36.169 --> 00:09:38.909 on tax policy, not on the fundamental quality 00:09:38.909 --> 00:09:41.149 of the asset. And that's a huge market distortion. 00:09:41.409 --> 00:09:43.210 Is there, I mean, is there evidence that this 00:09:43.210 --> 00:09:45.570 actually happens on a large scale? Or is this 00:09:45.570 --> 00:09:48.070 just economists theorizing in a classroom? Oh, 00:09:48.110 --> 00:09:50.350 it's a huge debate with a lot of data behind 00:09:50.350 --> 00:09:52.909 it. The source material points to Martin Feldstein. 00:09:53.370 --> 00:09:55.149 He was a big deal, the chair of the Council of 00:09:55.149 --> 00:09:56.929 Economic Advisors under President Reagan. He 00:09:56.929 --> 00:09:58.649 was a massive proponent of this theory. What 00:09:58.649 --> 00:10:00.950 was his specific argument? He claimed the effect 00:10:00.950 --> 00:10:03.009 was so massive that if the government reduced 00:10:03.009 --> 00:10:05.429 the capital gains tax rate, they would actually 00:10:05.429 --> 00:10:07.809 make more money in tax revenue. Wait, lower the 00:10:07.809 --> 00:10:10.009 tax to make more money? That sounds completely 00:10:10.009 --> 00:10:12.970 counterintuitive. His logic was that the lower 00:10:12.970 --> 00:10:16.740 rate would unloss the floodgates. All these investors 00:10:16.740 --> 00:10:19.080 sitting on decades of unrealized gains would 00:10:19.080 --> 00:10:21.960 finally say, OK, the penalty for selling is low 00:10:21.960 --> 00:10:24.659 enough now. I'll cash out. So the sheer volume 00:10:24.659 --> 00:10:27.500 of new sales would be so high that it would more 00:10:27.500 --> 00:10:29.720 than make up for the lower rate on each sale. 00:10:30.059 --> 00:10:32.600 That was the theory. A gusher of revenue from 00:10:32.600 --> 00:10:35.299 all this pent up locked in capital being released. 00:10:35.480 --> 00:10:37.139 And did it work out that way? Is that what the 00:10:37.139 --> 00:10:40.710 evidence shows? Well, it's. It's complicated. 00:10:40.909 --> 00:10:43.509 The sources we have cite 1994 estimates that 00:10:43.509 --> 00:10:45.490 suggest a permanent reduction in the tax rate 00:10:45.490 --> 00:10:47.669 would actually have very little effect on revenue 00:10:47.669 --> 00:10:50.129 in that way. Maybe a short -term bump, but not 00:10:50.129 --> 00:10:52.350 a long -term one. So the theory is a bit controversial. 00:10:52.690 --> 00:10:55.600 It's very contentious. So while the locked -in 00:10:55.600 --> 00:10:57.740 effect is real people absolutely do hesitate 00:10:57.740 --> 00:11:01.000 to sell because of tax years, the idea that cutting 00:11:01.000 --> 00:11:03.820 taxes magically pays for itself is still very 00:11:03.820 --> 00:11:05.919 much up for debate. It seems like capital gains 00:11:05.919 --> 00:11:08.220 tax acts as a kind of friction. It's like sand 00:11:08.220 --> 00:11:10.100 in the gears of the market. It is a transaction 00:11:10.100 --> 00:11:13.679 cost. A big one. And there is a fascinating study 00:11:13.679 --> 00:11:16.919 cited in our notes by Li Jian from 2006 that 00:11:16.919 --> 00:11:19.240 looks at this very friction. This was the one 00:11:19.240 --> 00:11:23.889 about great versus small gains, right? Yes. Jin 00:11:23.889 --> 00:11:26.190 found exactly what you would expect for large 00:11:26.190 --> 00:11:31.070 gains. Great capital gains, big profits. Strongly 00:11:31.070 --> 00:11:33.250 discouraged selling. If you are sitting on a 00:11:33.250 --> 00:11:36.149 mountain of profit, you don't move. You are locked 00:11:36.149 --> 00:11:39.000 in. Which confirms the Feldstein theory, at least 00:11:39.000 --> 00:11:41.580 in principle. It does. But there was a twist. 00:11:41.840 --> 00:11:43.659 What was the twist? The study found that small 00:11:43.659 --> 00:11:46.759 capital gains actually stimulate trade. Investors 00:11:46.759 --> 00:11:48.279 are more likely to sell if they have a small 00:11:48.279 --> 00:11:51.059 win. That's weird. Why would that be? It's likely 00:11:51.059 --> 00:11:53.860 psychology. Small win feels like free money. 00:11:54.000 --> 00:11:56.639 You know, the tax bill is negligible, so it doesn't 00:11:56.639 --> 00:11:59.340 trigger the same fear. It validates the investor's 00:11:59.340 --> 00:12:02.299 ego. Hey, I made a profit without the paralysis 00:12:02.299 --> 00:12:04.919 of a massive tax bill. So it's a confidence booster. 00:12:05.200 --> 00:12:08.110 It could be. But once that number gets big, the 00:12:08.110 --> 00:12:10.710 tax paralysis sets in. The pain of the tax bill 00:12:10.710 --> 00:12:12.990 starts to outweigh the joy of the profit. That 00:12:12.990 --> 00:12:15.350 is fascinating. So to be willing to sell a big 00:12:15.350 --> 00:12:18.169 winner, I have to really, truly believe the price 00:12:18.169 --> 00:12:21.070 is going to tank. Exactly. You have to believe 00:12:21.070 --> 00:12:23.710 the asset price will drop by more than the tax 00:12:23.710 --> 00:12:25.929 percentage for it to make mathematical sense 00:12:25.929 --> 00:12:28.149 to sell. Otherwise, the tax barrier keeps you 00:12:28.149 --> 00:12:30.570 holding on, even if you're nervous. Or I suppose 00:12:30.570 --> 00:12:33.149 you play the timing game. The timing game? What 00:12:33.149 --> 00:12:35.490 do you mean? Yeah, you know, waiting for... a 00:12:35.490 --> 00:12:37.889 new president or prime minister to get elected. 00:12:38.269 --> 00:12:41.629 Political speculation. Yes, that is a huge part 00:12:41.629 --> 00:12:43.850 of the behavior. If you think a new administration 00:12:43.850 --> 00:12:46.690 will come in and lower the capital gains rate 00:12:46.690 --> 00:12:49.750 from, say, 20 percent to 15 percent, you just 00:12:49.750 --> 00:12:52.690 sit on your hands. You wait. Which means money 00:12:52.690 --> 00:12:55.509 isn't moving. It causes capital to freeze up 00:12:55.509 --> 00:12:58.289 across the economy. People with massive gains 00:12:58.289 --> 00:13:01.700 are just waiting for a legislative change. It's 00:13:01.700 --> 00:13:03.940 wild to think that factories aren't being built 00:13:03.940 --> 00:13:05.779 or businesses aren't being bought just because 00:13:05.779 --> 00:13:07.639 investors are waiting for an election result 00:13:07.639 --> 00:13:10.220 to save a few percentage points. That is the 00:13:10.220 --> 00:13:12.019 reality of the tax code, though. It shapes the 00:13:12.019 --> 00:13:14.580 flow of capital in very direct ways. It absolutely 00:13:14.580 --> 00:13:17.700 does. Now, speaking of the tax code, we have 00:13:17.700 --> 00:13:20.299 to talk about the sheer annoyance of it all. 00:13:20.519 --> 00:13:24.200 We have a section here on the cost of doing business. 00:13:24.259 --> 00:13:26.960 And it's not just the tax itself. It's the cost 00:13:26.960 --> 00:13:29.970 of figuring out what you owe. The headache. Right. 00:13:30.110 --> 00:13:31.929 And economists divide this into two buckets. 00:13:33.009 --> 00:13:35.590 Administrative costs and compliance costs. Okay. 00:13:35.629 --> 00:13:39.029 So administrative costs. That's what the government 00:13:39.029 --> 00:13:41.049 spends, right? The cost of collecting the tax. 00:13:41.350 --> 00:13:42.909 Correct. The government has to hire auditors, 00:13:43.029 --> 00:13:45.830 build computer systems, process the forms, chase 00:13:45.830 --> 00:13:48.750 down cheats. We have data from a Canadian researcher. 00:13:49.240 --> 00:13:52.799 François Valencourt from way back in 1989. 1989, 00:13:53.100 --> 00:13:56.100 a classic vintage. What did he find? He looked 00:13:56.100 --> 00:13:58.519 at income and payroll taxes and found that the 00:13:58.519 --> 00:14:01.019 administrative costs were roughly 1 % of the 00:14:01.019 --> 00:14:03.779 gross revenues collected. So for every $100 the 00:14:03.779 --> 00:14:05.779 government collects, they spend about $1 to run 00:14:05.779 --> 00:14:07.559 the system. You know, that seems surprisingly 00:14:07.559 --> 00:14:09.840 efficient. I would have guessed it was way higher. 00:14:10.120 --> 00:14:11.840 It is pretty efficient on the government side. 00:14:12.039 --> 00:14:16.259 But the real burden, the hidden cost, isn't on 00:14:16.259 --> 00:14:19.220 the government. It's on you, the taxpayer. And 00:14:19.220 --> 00:14:21.700 that is the compliance cost. The headache factor. 00:14:22.080 --> 00:14:25.179 The hours spent digging through old emails for 00:14:25.179 --> 00:14:28.179 a stock confirmation from 2004. The headache 00:14:28.179 --> 00:14:30.600 factor. Exactly. There was a great study from 00:14:30.600 --> 00:14:33.460 Minnesota in 1992 that tried to quantify this 00:14:33.460 --> 00:14:36.100 headache. They looked at households with capital 00:14:36.100 --> 00:14:38.639 gains versus those without. And what was the 00:14:38.639 --> 00:14:40.700 damage? How much time are we talking? Taxpayers 00:14:40.700 --> 00:14:45.289 with capital gains spent. On average, 7 .9 hours 00:14:45.289 --> 00:14:47.470 more on their taxes than people without them. 00:14:47.549 --> 00:14:50.429 Wow. Nearly a full workday. Just gone. Just trying 00:14:50.429 --> 00:14:52.830 to figure out the basis, the dates, the rates. 00:14:53.149 --> 00:14:55.610 And that's not all. They also spend about $21 00:14:55.610 --> 00:14:57.590 more on professional help. And remember, this 00:14:57.590 --> 00:14:59.929 is in 1992 dollars, so you have to adjust for 00:14:59.929 --> 00:15:02.230 inflation. So it's real money, too. The total 00:15:02.230 --> 00:15:04.789 extra compliance cost per taxpayer was estimated 00:15:04.789 --> 00:15:09.389 at $143. Again, 1992 dollars. That's money that 00:15:09.389 --> 00:15:12.019 just... It didn't go to the government. It didn't 00:15:12.019 --> 00:15:14.179 stay in your pocket. It was just lost to the 00:15:14.179 --> 00:15:16.460 ether of paperwork and complexity. And that's 00:15:16.460 --> 00:15:19.419 a cost to the economy. It is. When we debate 00:15:19.419 --> 00:15:22.039 the efficiency of a tax, we often forget these 00:15:22.039 --> 00:15:25.860 hidden costs. If a tax raises $1 ,000 but costs 00:15:25.860 --> 00:15:28.500 the economy $200 and lost time and accountant 00:15:28.500 --> 00:15:32.259 fees to calculate, is it a good tax? The Vower 00:15:32.259 --> 00:15:34.360 question. And I bet people would work a lot harder 00:15:34.360 --> 00:15:36.919 than 7 .9 hours to avoid paying the tax altogether. 00:15:37.419 --> 00:15:40.100 Oh, absolutely. which leads us perfectly into 00:15:40.100 --> 00:15:43.059 the gray areas, the world of avoidance, deference, 00:15:43.299 --> 00:15:45.360 and outright evasion. I always get these mixed 00:15:45.360 --> 00:15:47.659 up. Avoidance is the legal stuff. Evasion is 00:15:47.659 --> 00:15:50.559 illegal. Correct. Avoidance is smart tax planning. 00:15:51.080 --> 00:15:53.059 Evasion is a crime that can land you in jail. 00:15:54.019 --> 00:15:56.539 Let's start with the loophole tour, the legal 00:15:56.539 --> 00:15:58.899 ways people dodge or delay capital gains tax. 00:15:59.139 --> 00:16:00.879 Okay, I'm taking notes. What's the first stop 00:16:00.879 --> 00:16:03.580 on our tour? The family transfer. In the U .S. 00:16:03.580 --> 00:16:05.820 specifically, tax brackets matter a great deal. 00:16:06.220 --> 00:16:08.340 If you're a high earner, you pay a higher rate. 00:16:08.620 --> 00:16:11.019 But maybe your college -age kid or a retired 00:16:11.019 --> 00:16:13.399 parent has very little income. Right. They're 00:16:13.399 --> 00:16:15.840 in a low tax bracket. Or even a 0 % bracket. 00:16:16.059 --> 00:16:19.080 So if you transfer the asset to them, you gift 00:16:19.080 --> 00:16:21.240 it to them, and they sell it, they might pay 00:16:21.240 --> 00:16:23.759 a much lower rate or even no tax at all. So the 00:16:23.759 --> 00:16:26.000 profit stays in the family, but the government's 00:16:26.000 --> 00:16:28.740 cut shrinks or disappears entirely. Precisely. 00:16:29.019 --> 00:16:30.940 Then there's the charity angle. This is a big 00:16:30.940 --> 00:16:33.220 one. If you have a highly appreciated stock, 00:16:33.480 --> 00:16:35.679 you could sell it, pay the tax, and donate the 00:16:35.679 --> 00:16:39.389 cash. Or you could donate the stock itself directly 00:16:39.389 --> 00:16:41.389 to the charity. What's the difference? If you 00:16:41.389 --> 00:16:43.870 donate the stock, you often get to deduct the 00:16:43.870 --> 00:16:46.870 full market value from your taxes, and the charity, 00:16:46.909 --> 00:16:50.570 being tax -exempt, can sell it and pay zero capital 00:16:50.570 --> 00:16:53.509 gains tax. That's a win -win, I suppose. The 00:16:53.509 --> 00:16:55.529 charity gets more money, you get a bigger deduction, 00:16:55.690 --> 00:16:57.649 and the government gets nothing. It's a very 00:16:57.649 --> 00:17:00.049 popular strategy. Then you have something called 00:17:00.049 --> 00:17:02.529 installment sales. This is where you sell an 00:17:02.529 --> 00:17:04.730 asset, but you agree to get paid over several 00:17:04.730 --> 00:17:07.349 years, not all at once. How does that help with 00:17:07.349 --> 00:17:09.829 tax? It spreads the capital gain out over multiple 00:17:09.829 --> 00:17:12.490 tax years. This can keep you in a lower tax bracket 00:17:12.490 --> 00:17:14.990 each year. And of course, it defers the tax bill. 00:17:15.089 --> 00:17:17.789 You pay as you get paid. But there has to be 00:17:17.789 --> 00:17:20.250 a risk there, right? A huge risk. If the buyer 00:17:20.250 --> 00:17:22.589 goes bust in year three, you might never see 00:17:22.589 --> 00:17:24.910 the rest of your money. You are effectively becoming 00:17:24.910 --> 00:17:27.480 the lender in the deal. Okay, what about the 00:17:27.480 --> 00:17:29.799 grim one? I see it in the notes here. Death and 00:17:29.799 --> 00:17:33.859 taxes. Ah, yes, the ultimate loophole. In the 00:17:33.859 --> 00:17:36.220 U .S., this is known as the step -up in basis. 00:17:36.559 --> 00:17:38.720 Okay, explain that. How does that work? Remember 00:17:38.720 --> 00:17:42.660 cost basis, what you paid for the asset. Let's 00:17:42.660 --> 00:17:44.980 say your grandfather bought Apple stock in 1980 00:17:44.980 --> 00:17:49.980 for $10. Today, it's worth, say, $200. If he 00:17:49.980 --> 00:17:53.440 sells it, he pays tax on a $190 gain. Right. 00:17:53.789 --> 00:17:56.430 Makes sense. But if he passes away and you as 00:17:56.430 --> 00:18:00.089 his heir inherit the stock, the cost basis steps 00:18:00.089 --> 00:18:02.869 up to the market value at the time of his death. 00:18:03.109 --> 00:18:06.650 So for you, the new cost basis is now $200. So 00:18:06.650 --> 00:18:08.210 if I turn around and sell it immediately for 00:18:08.210 --> 00:18:10.910 $200. Your profit is zero. Your capital gain 00:18:10.910 --> 00:18:14.349 is zero. The tax on 40 plus years of growth just 00:18:14.349 --> 00:18:18.000 vanishes. Wow. That effectively wipes out the 00:18:18.000 --> 00:18:19.680 tax liability completely. It's like it never 00:18:19.680 --> 00:18:22.019 happened. It does. It is one of the biggest drivers 00:18:22.019 --> 00:18:24.480 of intergenerational wealth transfer and, as 00:18:24.480 --> 00:18:27.099 you can imagine, a huge point of contention in 00:18:27.099 --> 00:18:29.660 tax policy debates. I can see why. There are 00:18:29.660 --> 00:18:32.019 a couple of other U .S.-specific ones here, too. 00:18:32.079 --> 00:18:34.859 The 1031 exchange, what's that? That is for real 00:18:34.859 --> 00:18:37.759 estate, specifically business or investment property. 00:18:38.440 --> 00:18:40.480 If you sell an apartment building, for instance, 00:18:40.740 --> 00:18:43.259 and you use the money to buy a like -kind... 00:18:43.519 --> 00:18:45.420 property like another apartment building or an 00:18:45.420 --> 00:18:48.619 office block you can defer the tax so you can 00:18:48.619 --> 00:18:51.740 just keep swapping properties forever you can 00:18:51.740 --> 00:18:54.400 basically keep rolling the gains over and over 00:18:54.400 --> 00:18:57.019 from property to property and never pay the tax 00:18:57.019 --> 00:18:59.759 until you finally cash out and don't buy a replacement 00:18:59.759 --> 00:19:02.740 and opportunity zones that sounds newer it is 00:19:02.740 --> 00:19:05.740 a newer program the idea is if you take your 00:19:05.740 --> 00:19:09.039 capital gains from selling say a stock and you 00:19:09.039 --> 00:19:11.319 reinvest that money into specifically designated 00:19:11.319 --> 00:19:14.799 low -income areas, you can defer the tax. If 00:19:14.799 --> 00:19:16.740 you hold that new investment long enough, you 00:19:16.740 --> 00:19:19.259 can potentially eliminate taxes on the new investment's 00:19:19.259 --> 00:19:21.759 growth. So it's a way to recycle frozen capital 00:19:21.759 --> 00:19:24.079 into struggling economies. That's the goal, yes. 00:19:24.279 --> 00:19:26.319 Okay, those are the legal ways to play the game. 00:19:26.380 --> 00:19:29.150 But what about when people just decide? Not to 00:19:29.150 --> 00:19:31.690 pay. What about evasion? Evasion. This is where 00:19:31.690 --> 00:19:34.309 the data gets really shocking. We have a study 00:19:34.309 --> 00:19:37.529 here by James Putterbaugh from 1987. What did 00:19:37.529 --> 00:19:39.950 he find about the relationship between tax rates 00:19:39.950 --> 00:19:43.329 and, well, cheating? He found a direct inverse 00:19:43.329 --> 00:19:47.670 correlation. A 1 % decrease in the tax rate increased 00:19:47.670 --> 00:19:52.190 the reported tax base by 0 .4%. Meaning if you 00:19:52.190 --> 00:19:55.230 lower the tax, people lie less. Exactly. When 00:19:55.230 --> 00:19:57.369 the rate is high, the incentive to cheat is high. 00:19:57.829 --> 00:20:00.109 The risk seems worth it. When the rate is low, 00:20:00.269 --> 00:20:02.430 people figure it's not worth the stress. I'll 00:20:02.430 --> 00:20:05.150 just pay it and sleep soundly. But the real bombshell 00:20:05.150 --> 00:20:08.150 here seems to be the RJR Nabisco study. Yes. 00:20:08.450 --> 00:20:10.910 This was an incredible piece of research. It 00:20:10.910 --> 00:20:13.049 looked at the shareholder data from the massive 00:20:13.049 --> 00:20:16.970 1989 leveraged buyout of RJR Nabisco. It was 00:20:16.970 --> 00:20:19.069 a rare opportunity for researchers because they 00:20:19.069 --> 00:20:21.730 could see the actual transaction data and compare 00:20:21.730 --> 00:20:23.509 it to what people reported on their tax returns. 00:20:23.730 --> 00:20:26.329 A perfect natural experiment. And what was the 00:20:26.329 --> 00:20:28.569 number? How much were they hiding? They found 00:20:28.569 --> 00:20:31.190 that the average level of evasion was 11 % of 00:20:31.190 --> 00:20:33.950 total capital gains. 11%. That's more than one 00:20:33.950 --> 00:20:36.670 in every $10 of profit just being hidden from 00:20:36.670 --> 00:20:39.609 the government. Yes. Just vanished into the shadows. 00:20:39.710 --> 00:20:41.950 And they confirmed the Poterba findings as well. 00:20:42.089 --> 00:20:44.509 They found that a one percentage point increase 00:20:44.509 --> 00:20:49.230 in the marginal tax rate led to a 0 .42 % increase 00:20:49.230 --> 00:20:52.299 in evasion. So the higher the tax, the more people 00:20:52.299 --> 00:20:54.640 cheat. It's a predictable human behavior. It 00:20:54.640 --> 00:20:57.220 is. And that is a staggering amount of money 00:20:57.220 --> 00:20:59.619 leaving the system. It really highlights the 00:20:59.619 --> 00:21:02.220 balancing act governments have to play. Raise 00:21:02.220 --> 00:21:04.440 the rate too high to get more revenue, and you 00:21:04.440 --> 00:21:06.519 might just drive everyone underground. Or into 00:21:06.519 --> 00:21:08.559 different countries, which I think brings us 00:21:08.559 --> 00:21:12.740 to our global tour. Yes. Let's fire up the jet. 00:21:13.019 --> 00:21:15.059 We're going to take a look at how the rest of 00:21:15.059 --> 00:21:17.480 the world handles this puzzle. And it is not 00:21:17.480 --> 00:21:20.490 a one -size -fits -all situation. Not by a long 00:21:20.490 --> 00:21:22.269 shot. It seems like we can group these countries 00:21:22.269 --> 00:21:25.049 by their general philosophy. I think so. Let's 00:21:25.049 --> 00:21:27.329 start with the most popular philosophy, the no 00:21:27.329 --> 00:21:29.809 -tax havens. My kind of places. Where are we 00:21:29.809 --> 00:21:32.529 landing first? Well, you have your classic Caribbean 00:21:32.529 --> 00:21:35.190 spots that everyone knows. Barbados, Belize, 00:21:35.390 --> 00:21:38.950 the Cayman Islands, Jamaica, also Bahrain in 00:21:38.950 --> 00:21:42.250 the Middle East, Isle of Man. In these places, 00:21:42.450 --> 00:21:45.269 generally speaking, there is no capital gains 00:21:45.269 --> 00:21:48.190 tax. What you make is what you keep. But there 00:21:48.190 --> 00:21:50.089 are some major economies on this list, too. I'm 00:21:50.089 --> 00:21:52.450 seeing New Zealand and Singapore here. How do 00:21:52.450 --> 00:21:54.789 they manage that? Yes, and this is where it gets 00:21:54.789 --> 00:21:57.170 nuanced. New Zealand, Singapore, and Hong Kong 00:21:57.170 --> 00:22:00.190 generally do not have a separate tax called a 00:22:00.190 --> 00:22:02.549 capital gains tax. So if I sell a house in Auckland 00:22:02.549 --> 00:22:05.250 or shares in the Singapore exchange, I keep everything? 00:22:05.549 --> 00:22:08.950 Generally. But there is a massive catch. If you 00:22:08.950 --> 00:22:11.190 are deemed to be a professional trader, or if 00:22:11.190 --> 00:22:12.970 you are trading frequently with the intention 00:22:12.970 --> 00:22:15.329 of making a living, they don't see it as a capital 00:22:15.329 --> 00:22:17.680 gain. They see it as? Business income. And your 00:22:17.680 --> 00:22:19.559 regular income tax rates apply, which can be 00:22:19.559 --> 00:22:21.779 quite high. So the line between investor and 00:22:21.779 --> 00:22:24.720 trader becomes really, really important. Crucially 00:22:24.720 --> 00:22:27.059 important. It creates a gray area. Let's look 00:22:27.059 --> 00:22:29.799 at Switzerland. For private individuals, there's 00:22:29.799 --> 00:22:32.680 generally no CGT on securities. It's a huge draw. 00:22:33.299 --> 00:22:36.440 But the local tax authorities have to decide 00:22:36.440 --> 00:22:38.279 if you cross the line into being a professional 00:22:38.279 --> 00:22:40.579 trader. That sounds incredibly subjective. Do 00:22:40.579 --> 00:22:42.880 they just vibe check your portfolio? They try 00:22:42.880 --> 00:22:45.200 not to. To avoid that, they have what they call 00:22:45.200 --> 00:22:49.000 safe harbor rules. Basically a checklist. To 00:22:49.000 --> 00:22:51.480 be safe from being labeled a pro, you must hold 00:22:51.480 --> 00:22:53.619 your securities for at least six months. Okay, 00:22:53.700 --> 00:22:56.240 no day trading. No day trading. You also have 00:22:56.240 --> 00:22:59.039 to have a low trading volume. Your total transactions 00:22:59.039 --> 00:23:01.700 can't be more than 500 % of your starting capital 00:23:01.700 --> 00:23:04.299 in a year. And you can't be using a lot of debt 00:23:04.299 --> 00:23:07.369 or foreign capital to finance your trades. So 00:23:07.369 --> 00:23:10.269 if you trade too much or too fast or with borrowed 00:23:10.269 --> 00:23:13.529 money, you lose your tax free status. Exactly. 00:23:13.710 --> 00:23:16.470 The system is designed to reward long term passive 00:23:16.470 --> 00:23:19.490 investors, not active traders. OK, let's leave 00:23:19.490 --> 00:23:22.450 the sunny tax free havens and fly to the other 00:23:22.450 --> 00:23:25.369 end of the spectrum, the high tax regions. I'm 00:23:25.369 --> 00:23:27.150 guessing we are heading to Europe. Straight to 00:23:27.150 --> 00:23:30.309 Scandinavia. Denmark is often cited as having 00:23:30.309 --> 00:23:32.349 some of the highest rates in the world. They 00:23:32.349 --> 00:23:34.890 have a progressive system. for income from shares. 00:23:35.349 --> 00:23:38.609 It starts at 27 % on the first bracket of gains. 00:23:38.809 --> 00:23:41.789 Which is already pretty high. It is. But for 00:23:41.789 --> 00:23:44.809 gains above that threshold, it jumps to a whopping 00:23:44.809 --> 00:23:49.589 42%. 42%. That is nearly half your profit just 00:23:49.589 --> 00:23:53.190 gone. Wow. Finland is also up there in the 30 00:23:53.190 --> 00:23:56.410 to 34 % range. And France has an interesting 00:23:56.410 --> 00:23:59.480 recent history. It used to be very complex, but 00:23:59.480 --> 00:24:01.940 President Macron introduced something called 00:24:01.940 --> 00:24:05.480 the PFU, or Prélèvement Forfaitaire Unique. My 00:24:05.480 --> 00:24:07.339 French is rusty. What does that translate to? 00:24:07.619 --> 00:24:10.740 It's basically a single flat rate levy, a flat 00:24:10.740 --> 00:24:13.619 tax. It's 30%. Before that, it was a complicated 00:24:13.619 --> 00:24:15.720 sliding scale based on how long you held the 00:24:15.720 --> 00:24:18.359 asset, which created a lot of confusion. The 00:24:18.359 --> 00:24:20.220 idea was to simplify the system and make France 00:24:20.220 --> 00:24:23.059 more attractive to investors. 30 % flat. Simple. 00:24:23.160 --> 00:24:24.740 I'll give them that, but it's still a significant 00:24:24.740 --> 00:24:27.440 chunk. Now, we have to talk about the United 00:24:27.440 --> 00:24:29.839 States. It seems to be in a league of its own 00:24:29.839 --> 00:24:32.119 regarding how it treats its citizens, even when 00:24:32.119 --> 00:24:34.460 they're not in the U .S. The U .S. is unique 00:24:34.460 --> 00:24:37.539 and frankly quite notorious among its expats 00:24:37.539 --> 00:24:40.640 because it taxes worldwide income. Meaning what 00:24:40.640 --> 00:24:43.440 exactly? Meaning if you are a U .S. citizen living 00:24:43.440 --> 00:24:45.480 in Switzerland selling a stock on the London 00:24:45.480 --> 00:24:49.180 Stock Exchange, Uncle Sam still wants his cut. 00:24:49.559 --> 00:24:52.500 Almost no other country on Earth does that. If 00:24:52.500 --> 00:24:54.799 you're a citizen, you owe them tax no matter 00:24:54.799 --> 00:24:56.920 where you live or where you make the money. That's 00:24:56.920 --> 00:25:00.099 intense. And the U .S. system splits the tax 00:25:00.099 --> 00:25:03.579 by time, right? Yes. This is a key feature. Short 00:25:03.579 --> 00:25:06.160 -term gains on assets held for less than a year 00:25:06.160 --> 00:25:09.200 are taxed as ordinary income. That could be as 00:25:09.200 --> 00:25:11.539 high as 37 percent, depending on your income. 00:25:11.660 --> 00:25:14.549 Ouch. But long -term gains... For assets held 00:25:14.549 --> 00:25:17.490 more than a year, get preferential rates. It 00:25:17.490 --> 00:25:20.609 can be 0%, 15%, or 20%, again, depending on your 00:25:20.609 --> 00:25:22.849 total income. So the U .S. system is explicitly 00:25:22.849 --> 00:25:25.170 designed to discourage short -term speculation 00:25:25.170 --> 00:25:27.630 and encourage holding for at least a year and 00:25:27.630 --> 00:25:29.849 a day. Precisely. It's another way of trying 00:25:29.849 --> 00:25:32.109 to separate the investor from the trader. Let's 00:25:32.109 --> 00:25:34.089 hit a few more of these unique systems from around 00:25:34.089 --> 00:25:35.710 the world. What's going on down in Australia? 00:25:36.029 --> 00:25:39.650 In Australia, CGT isn't a separate tax. Which 00:25:39.650 --> 00:25:41.230 is interesting. It's just part of your income 00:25:41.230 --> 00:25:43.930 tax. You calculate your gain and you add it to 00:25:43.930 --> 00:25:47.490 your other income for the year. But if you hold 00:25:47.490 --> 00:25:50.369 an asset for more than 12 months, you get a 50 00:25:50.369 --> 00:25:52.730 percent discount. So you only have to include 00:25:52.730 --> 00:25:55.529 half the profit on your tax return. Right. It's 00:25:55.529 --> 00:25:57.789 a much simpler way of achieving the same goal 00:25:57.789 --> 00:26:00.609 as the U .S. system rewarding long term holding 00:26:00.609 --> 00:26:03.029 without having a whole separate schedule of rates. 00:26:03.210 --> 00:26:06.029 And Japan. You mentioned a weird history there 00:26:06.029 --> 00:26:08.349 in the outline. This is fascinating. For a period 00:26:08.349 --> 00:26:13.430 from 1989 to 2003, Japan had an optional withholding 00:26:13.430 --> 00:26:16.490 tax system. You could choose to either calculate 00:26:16.490 --> 00:26:19.650 your actual gain and pay tax on that, or you 00:26:19.650 --> 00:26:22.430 could just pay 1 .05 % on the total proceeds 00:26:22.430 --> 00:26:24.730 of the sale. Wait, 1 % of the total sale price? 00:26:24.990 --> 00:26:28.109 Even if I lost money on the deal? Yes. It was 00:26:28.109 --> 00:26:30.269 an administrative convenience. If you didn't 00:26:30.269 --> 00:26:31.970 want to bother with the paperwork of finding 00:26:31.970 --> 00:26:34.190 your cost basis, you could just tell the government, 00:26:34.329 --> 00:26:36.589 here's 1 % of the sale value and we'll call it 00:26:36.589 --> 00:26:38.309 even. That sounds like an absolutely terrible 00:26:38.309 --> 00:26:40.750 deal if you're selling at a loss or a small gain. 00:26:40.950 --> 00:26:43.869 It was, but it was optional. People with big 00:26:43.869 --> 00:26:47.549 gains and no paperwork might have taken it. Now, 00:26:47.630 --> 00:26:50.150 thankfully, they have moved to a more standard 00:26:50.150 --> 00:26:53.970 flat 20 % tax on actual gains. That makes more 00:26:53.970 --> 00:26:55.890 sense. Now, one issue that keeps popping up in 00:26:55.890 --> 00:26:57.670 my reading, and you see it debated everywhere, 00:26:57.930 --> 00:27:00.990 is inflation. Ah, yes. The problem of the fictional 00:27:00.990 --> 00:27:04.930 game. This is a huge philosophical criticism 00:27:04.930 --> 00:27:07.390 of the tax. Right. So let's walk through the 00:27:07.390 --> 00:27:11.049 math here, slowly. Suppose I buy a stock for 00:27:11.049 --> 00:27:14.710 100 dollars. Ten years go by. Over those ten 00:27:14.710 --> 00:27:16.809 years, general inflation has doubled the price 00:27:16.809 --> 00:27:19.190 of everything in the economy. A loaf of bread 00:27:19.190 --> 00:27:22.529 that was $2 is now $4. Okay. Standard inflation. 00:27:23.019 --> 00:27:25.420 My stock has also kept pace with inflation, and 00:27:25.420 --> 00:27:28.759 it is now worth $200. So I sell it for $200. 00:27:28.819 --> 00:27:31.660 On paper, I have a $100 capital gain. Correct. 00:27:31.779 --> 00:27:34.200 The tax authority sees a $100 profit. But in 00:27:34.200 --> 00:27:37.160 reality, that $200 buys me exactly the same amount 00:27:37.160 --> 00:27:39.839 of bread as my original $100 did 10 years ago. 00:27:40.339 --> 00:27:42.940 I haven't actually increased my real purchasing 00:27:42.940 --> 00:27:45.660 power at all. Your wealth hasn't increased in 00:27:45.660 --> 00:27:48.180 real terms. You've only broken even against inflation. 00:27:48.599 --> 00:27:50.799 But the government comes along and taxes me on 00:27:50.799 --> 00:27:54.140 that $100 gain. They do. And this is the core 00:27:54.140 --> 00:27:57.519 of the critique. Critics argue it is a tax on 00:27:57.519 --> 00:28:01.000 inflation, not on real profit. You're being penalized 00:28:01.000 --> 00:28:04.000 simply because the currency lost value over time. 00:28:04.299 --> 00:28:07.400 Do any countries try to fix this? Do they adjust 00:28:07.400 --> 00:28:10.980 for inflation? Some used to. Ireland, for example, 00:28:11.079 --> 00:28:12.900 used to have something called indexation relief, 00:28:13.119 --> 00:28:15.119 where you could adjust your purchase price upwards 00:28:15.119 --> 00:28:17.420 by the rate of inflation. But they abolished 00:28:17.420 --> 00:28:21.500 it in 2003. Now you pay a 33 % tax even if your 00:28:21.500 --> 00:28:24.700 entire gain was purely inflationary. Ouch. What 00:28:24.700 --> 00:28:27.039 about Canada? Canada has an interesting approach. 00:28:27.240 --> 00:28:29.779 They handle it by only making 50 % of the gain 00:28:29.779 --> 00:28:33.180 taxable. The argument, though not explicit, is 00:28:33.180 --> 00:28:35.759 that by leaving the other 50 % tax -free, they 00:28:35.759 --> 00:28:38.440 are roughly compensating for inflation and encouraging 00:28:38.440 --> 00:28:40.930 investment. It's a kind of rough justice, but 00:28:40.930 --> 00:28:43.089 I guess it's better than nothing. It is. It acknowledges 00:28:43.089 --> 00:28:45.049 the problem, even if it doesn't solve it with 00:28:45.049 --> 00:28:47.470 precision. Okay, let's zoom in on one specific 00:28:47.470 --> 00:28:49.369 asset class that everyone listening probably 00:28:49.369 --> 00:28:52.009 cares about more than any other. Real estate. 00:28:52.329 --> 00:28:55.750 Their homes. The roof over your head. This is 00:28:55.750 --> 00:28:58.670 where CGT becomes a massive political hot potato. 00:28:59.089 --> 00:29:01.970 In most places, selling your own home, your main 00:29:01.970 --> 00:29:05.470 residence, is tax -free, right? Generally, yes. 00:29:05.730 --> 00:29:08.230 It is known as the primary residence exemption. 00:29:08.759 --> 00:29:11.779 or principal private residence relief. You see 00:29:11.779 --> 00:29:15.500 it in Australia, Canada, France, the UK. The 00:29:15.500 --> 00:29:17.640 logic is that governments don't want to penalize 00:29:17.640 --> 00:29:20.420 people for moving house. It would impede labor 00:29:20.420 --> 00:29:22.880 mobility. Right. If I have to pay a huge tax 00:29:22.880 --> 00:29:25.299 to sell my house to move for a new job, I might 00:29:25.299 --> 00:29:27.720 just not take the job. Exactly. It would grind 00:29:27.720 --> 00:29:30.160 the economy to a halt. But there are always restrictions. 00:29:30.500 --> 00:29:33.220 In Australia, for instance, the property can't 00:29:33.220 --> 00:29:35.230 have been used to produce income. like running 00:29:35.230 --> 00:29:37.549 a business out of it or renting out a room. If 00:29:37.549 --> 00:29:39.970 you do, you lose part of the exemption. And what 00:29:39.970 --> 00:29:42.230 about the flipping trap? People who buy a house, 00:29:42.269 --> 00:29:44.289 throw on a coat of white paint, and sell it six 00:29:44.289 --> 00:29:46.789 months later for a profit. Oh, governments generally 00:29:46.789 --> 00:29:49.190 hate that. They see it as pure speculation that 00:29:49.190 --> 00:29:51.690 drives up housing prices for everyone else. So 00:29:51.690 --> 00:29:53.890 they create traps to catch these people. New 00:29:53.890 --> 00:29:55.369 Zealand has a great example called the Bright 00:29:55.369 --> 00:29:57.769 Line Test. The Bright Line Test? What is that? 00:29:58.160 --> 00:30:01.039 It's a time -based rule. Initially, if you sold 00:30:01.039 --> 00:30:02.960 a residential property that wasn't your main 00:30:02.960 --> 00:30:05.880 home within two years, you paid tax on the profit. 00:30:06.339 --> 00:30:08.980 But as the housing market got hotter, they extended 00:30:08.980 --> 00:30:12.000 it to five years, and now it's 10 years. 10 years. 00:30:12.039 --> 00:30:14.019 Wow. So in New Zealand, if you sell an investment 00:30:14.019 --> 00:30:16.059 property within 10 years of buying it, you are 00:30:16.059 --> 00:30:17.900 treated like a professional property trader. 00:30:18.240 --> 00:30:20.500 That's right. You pay tax on the profits at your 00:30:20.500 --> 00:30:23.259 full marginal income rate. It is designed specifically 00:30:23.259 --> 00:30:26.019 to stop short -term speculation and encourage 00:30:26.019 --> 00:30:28.650 long -term landlords. And I saw a note about 00:30:28.650 --> 00:30:30.730 Kenya here, too, which is an interesting case. 00:30:30.890 --> 00:30:33.089 Yes. Kenya actually abolished its capital gains 00:30:33.089 --> 00:30:36.430 tax way back in 1985, hoping it would stimulate 00:30:36.430 --> 00:30:38.609 the real estate and stock markets. But they brought 00:30:38.609 --> 00:30:43.009 it back in 2015, a 5 % tax specifically on land 00:30:43.009 --> 00:30:45.329 and property transactions. Why bring it back 00:30:45.329 --> 00:30:48.150 after all that time? To try to control the spiraling 00:30:48.150 --> 00:30:51.250 cost of land, especially around Nairobi, and 00:30:51.250 --> 00:30:53.009 for the government to get a slice of the revenue 00:30:53.009 --> 00:30:55.940 from a booming real estate market. It shows how 00:30:55.940 --> 00:30:58.579 developing nations often toggle this tax on and 00:30:58.579 --> 00:31:01.500 off as a tool to either heat up or cool down 00:31:01.500 --> 00:31:04.180 their economies. It really is a lever, isn't 00:31:04.180 --> 00:31:06.200 it? It's not just revenue collection. It's a 00:31:06.200 --> 00:31:09.119 throttle for the entire economy. That is the 00:31:09.119 --> 00:31:11.480 perfect way to describe it. So we have covered 00:31:11.480 --> 00:31:13.779 the mechanics, the psychology, the costs, the 00:31:13.779 --> 00:31:16.440 loopholes, and the global map. It feels like 00:31:16.440 --> 00:31:18.500 we have to ask the big question now. So what 00:31:18.500 --> 00:31:21.000 what does this all mean for the future? Where 00:31:21.000 --> 00:31:23.460 is this all hitting? At the end of the day, it 00:31:23.460 --> 00:31:26.599 all comes down to a fundamental debate, a tension 00:31:26.599 --> 00:31:29.799 between fairness and efficiency. OK, unpack that 00:31:29.799 --> 00:31:33.099 for us. Fairness versus efficiency. On one hand, 00:31:33.119 --> 00:31:35.619 you have the fairness argument. Capital gains 00:31:35.619 --> 00:31:37.920 are disproportionately how the wealthy make their 00:31:37.920 --> 00:31:40.940 money. If you work a nine to five job, you pay 00:31:40.940 --> 00:31:43.799 income tax on every single dollar you earn. So 00:31:43.799 --> 00:31:45.740 if you are a billionaire living off stock sales, 00:31:46.000 --> 00:31:48.819 shouldn't you also pay tax on your gains? That 00:31:48.819 --> 00:31:51.099 seems like the standard argument for having a 00:31:51.099 --> 00:31:54.240 high CGT. It's about progressivity. It is. It's 00:31:54.240 --> 00:31:56.720 about taxing wealth, not just labor. But then 00:31:56.720 --> 00:31:59.079 you have the efficiency argument. As we saw with 00:31:59.079 --> 00:32:01.599 the locked -in effect in the Legion study, taxing 00:32:01.599 --> 00:32:04.109 capital gains freezes capital. It stops money 00:32:04.109 --> 00:32:06.609 from moving from old, unproductive investments 00:32:06.609 --> 00:32:09.750 to new, innovative ones. It stops people from 00:32:09.750 --> 00:32:12.309 selling houses. It creates deadweight loss in 00:32:12.309 --> 00:32:15.130 the economy. So if you tax it too much, the gears 00:32:15.130 --> 00:32:18.049 of the economy grind to a halt. But if you tax 00:32:18.049 --> 00:32:20.410 it too little, wealth concentrates at the top 00:32:20.410 --> 00:32:23.430 and the working class feels, rightly, that the 00:32:23.430 --> 00:32:26.210 system is rigged. And that is the pendulum swing 00:32:26.210 --> 00:32:28.930 we see throughout history. A country lowers rates 00:32:28.930 --> 00:32:31.720 to spur investment. Then a few years later, a 00:32:31.720 --> 00:32:33.900 different government raises them to address inequality. 00:32:34.440 --> 00:32:37.779 The U .S. lowers rates in 2003, raises them later. 00:32:37.940 --> 00:32:40.480 Kenya abolishes it, then brings it back. Every 00:32:40.480 --> 00:32:42.859 country is constantly trying to find that Goldilocks 00:32:42.859 --> 00:32:44.839 rate where you get the revenue you need without 00:32:44.839 --> 00:32:47.039 killing the market. And that inflation argument 00:32:47.039 --> 00:32:48.900 really sticks with me. I feel like it's the hidden 00:32:48.900 --> 00:32:51.599 variable here. If we enter a period of high inflation, 00:32:51.960 --> 00:32:54.339 capital gains tax becomes so much more punitive. 00:32:54.579 --> 00:32:58.329 It does. Dramatically so. If inflation is running 00:32:58.329 --> 00:33:01.589 at 10 % and your asset just keeps pace by going 00:33:01.589 --> 00:33:06.029 up 10%, you have made zero real money. But the 00:33:06.029 --> 00:33:08.049 taxman shows up and treats you like you made 00:33:08.049 --> 00:33:10.990 a 10 % profit, that can destroy wealth accumulation 00:33:10.990 --> 00:33:13.630 for the middle class very, very quickly. It feels 00:33:13.630 --> 00:33:16.589 like there is no perfect system. Every single 00:33:16.589 --> 00:33:19.009 option we've looked at has a downside. There 00:33:19.009 --> 00:33:22.289 isn't. It is always, always a tradeoff. Before 00:33:22.289 --> 00:33:24.210 we wrap up, I want to leave the listener with 00:33:24.210 --> 00:33:26.710 something to chew on, a final thought. We talked 00:33:26.710 --> 00:33:29.029 a lot about those professional trader definitions 00:33:29.029 --> 00:33:31.369 in places like Switzerland and New Zealand. Yes, 00:33:31.529 --> 00:33:34.029 that blurry line. In a world where everyone has 00:33:34.029 --> 00:33:36.769 a trading app on their phone and algorithms can 00:33:36.769 --> 00:33:38.809 conduct high -frequency trading for you while 00:33:38.809 --> 00:33:41.990 you sleep, where is that line now? At what point 00:33:41.990 --> 00:33:45.390 does managing your own money become a job? That 00:33:45.390 --> 00:33:49.049 is a great question. If you use an AI bot to 00:33:49.049 --> 00:33:51.950 trade crypto for you 24 -7, are you the professional 00:33:51.950 --> 00:33:55.170 trader or is the bot? The tax codes were written 00:33:55.170 --> 00:33:57.250 for a world of paper stock certificates and phone 00:33:57.250 --> 00:34:00.049 calls to a broker. They are struggling badly 00:34:00.049 --> 00:34:02.230 to keep up with the speed and nature of modern 00:34:02.230 --> 00:34:04.930 finance. And then think about the locked -in 00:34:04.930 --> 00:34:07.750 effect on a global scale. If that theory is even 00:34:07.750 --> 00:34:10.190 partially true, how much capital is currently 00:34:10.190 --> 00:34:13.769 frozen in the world economy? Trillions. Easily 00:34:13.769 --> 00:34:16.670 trillions. Just sitting there stagnant. in an 00:34:16.670 --> 00:34:18.630 asset that might not be the best use of that 00:34:18.630 --> 00:34:23.389 money, all because someone, somewhere, doesn't 00:34:23.389 --> 00:34:26.170 want to write a check for a 20 % tax bill. Imagine 00:34:26.170 --> 00:34:29.250 if that capital was released, if it flowed into 00:34:29.250 --> 00:34:32.130 new businesses, new technologies, new infrastructure. 00:34:32.530 --> 00:34:35.630 It's a staggering thought. The tax code is literally 00:34:35.630 --> 00:34:38.309 shaping the physical world around us by holding 00:34:38.309 --> 00:34:40.849 that money hostage. It is the invisible hand, 00:34:40.969 --> 00:34:43.250 but this time the hand is holding a tax form. 00:34:43.550 --> 00:34:46.280 A perfect summary. Well, on that note, we hope 00:34:46.280 --> 00:34:48.219 this deep dive has helped you understand why 00:34:48.219 --> 00:34:50.539 that silent partner in your transactions is there 00:34:50.539 --> 00:34:53.099 and why they operate the way they do. It's not 00:34:53.099 --> 00:34:55.280 just a number on a form. And please remember, 00:34:55.440 --> 00:34:57.840 check your local laws before you sell that vintage 00:34:57.840 --> 00:35:01.440 Spider -Man comic. This is not tax advice. Absolutely. 00:35:01.739 --> 00:35:04.500 We're not tax advisors, just two curious people 00:35:04.500 --> 00:35:07.159 with a giant stack of research. Thanks for listening 00:35:07.159 --> 00:35:09.320 to the deep dive. We'll see you next time. Goodbye, 00:35:09.400 --> 00:35:09.619 everyone.