Applying Sutton’s Law

Sutton’s Law requires that simple plans be implemented before complex ones. The model form is, you rob banks because that is where the money is. The problem is that many stop there and do not pay attention to what happens next.

Eventually banks grow tired of being robbed and create defenses. The slower bank robbers don’t notice and get caught. The smarter ones move on to forms where the risk reward ratio is better.

While Willie Sutton could get a lot of money in the 1930’s, today a robber could not expect to hold up a bank and get enough money to pay for the gun. That is why identity theft and password phishing makes sense today. It won’t forever. Because the offended parties will take action.

In the same context, suppose there is new tax policy that says, “Tax the rich.” From Sutton’s Law standpoint it makes sense because that’s where the money is. Taxing the poor seems like a weak idea.

Will it work? Not likely.

Why? Because no one said, “Okay, what then?”

It won’t work because the tax you pay is calculated based on two variables. First the rate and second the base to which the rate applies. Rate x base = tax payable. Rate alone will not generate cash revenue for the government if the base shrinks.

Rich people can afford to defend themselves.

What do the offended persons do?

First they organize their affairs so that the rate does not matter. That happens when they have no base to pay the rate upon. It is what tax practitioners call “type conversion” If I pay a high rate on investment income like interest, what could I do to turn it into a capital gain or dividend if the rate is lower. As it turns out, maybe I can do that.

Second, in systems that have increasing rates as income rises, what can I do to divide the income.  Again not impossible. Income splitting is a common form of tax management.

Third, maybe I can make myself immune. Is it possible to move to a jurisdiction where the rates are lower, or non-existent. Bad news for the high rate jurisdictions. Movement has two problems for them. They lose cash revenue and some low rate jurisdiction increases their cash revenue. More cash means they can lower the rate even more and thus make it even more attractive for people to change residence. Rate shopping.

Fourth, recognize that you personally spend cash, not income. Is there a way to accumulate income at a low rate in some investment vehicle while spending tax paid capital instead of after tax income. Again not too hard. A dollar deferred is a dollar saved.

So tax policy needs to recognize that the only proper government role in taxation is to find the most efficient way to get the money that the government needs to carry out its mandate. Taxing the rich can never make that work because they can defend themselves more readily than the government can amend the rules.

Where does that lead?

It means you can only get extra money from people who cannot defend themselves. Since it is not the rich, because they will refuse to play the game and it is not the poor because any rate applied to a small number yields little cash, it most be those in the middle. Who knew?

Since the middle group is declining both in numbers and in wealth, how will that work? It won’t. The government will need to find a new paradigm to raise cash or, as a last resort, find a way to spend less.

In Canada, expect an estate tax. In the US, expect a national sales tax.

In both scenarios expect more spending in the short run. New tax revenue creates a “homeless dollar problem” Somebody needs to look after those unfortunate dollars and it won’t be you.

IMHO governments should spend the least they can to get the social results that we have generally agreed upon. They should raise that revenue in the way that least punishes capital formation. They should encourage success rather than denigrate it. They should look to emerging economies and see what their primary problems are. They should avoid creating those problems here.  Things like not enough capital to grow businesses or maybe uneven application of laws.

If governments ignore reality, they get problems. Unfortunately, when governments are incompetent, we the people fail. It is like schools. When teachers do a bad job, the student fails.

In the future we will see vibrant, emerging economies replacing moribund, submerging economies. Merely common sense.

We can help ourselves by keeping it simple and asking “What then?”

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com

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