Category: Taxation

Tax the Gains from AI. Don’t Make Government a Shareholder.

There is a new idea circulating in Washington that cuts across ordinary partisan lines: the federal government should take an equity interest in major artificial intelligence companies so the public can share in the gains from AI.

The Case for Capturing the Gains from AI

The instinct behind the idea is understandable. Artificial intelligence is not being created in a vacuum. AI systems draw from the accumulated knowledge of society: public research, open scientific work, software, writing, images, data, language, law, medicine, engineering, and countless other forms of human knowledge. Much of that knowledge was created by people who will not be directly compensated when AI systems use it. Some of it was supported by government-funded research. Some of it came from public institutions. Much of it came from the creative and intellectual work of millions of people over generations.

So there is a legitimate question: if AI produces enormous private wealth, should the public share in some of that gain?

Yes. But government equity ownership is the wrong way to do it.

The Case Against Government Equity Ownership of AI

The first problem is that it is not obvious where the gains from AI will actually accrue. It is possible that a few AI companies will become immensely profitable and capture a large share of the value they create. But it is also possible that competition will drive the market price of AI assistance very low. If that happens, the companies that spend the most building AI systems may not capture anything close to the full social value of what they produce.

History offers a useful warning. The railroads of the nineteenth century created enormous economic value. They opened markets, reduced transportation costs, changed settlement patterns, and increased productivity across the economy. But that did not mean every railroad investor earned extraordinary returns. In many cases, competition, overbuilding, debt, and financial instability shifted the benefits away from the original investors and toward shippers, consumers, landowners, and the broader economy. Many of these railroads went bankrupt.

AI could follow a similar pattern. The largest gains may not remain with the AI model companies. They may flow to software firms, chip companies, cloud providers, manufacturers, hospitals, banks, law firms, schools, small businesses, workers, consumers, and investors across the economy. If AI becomes a cheap general-purpose tool, much of the value may be captured by those who use AI rather than by those who build the underlying models.

This matters because a government equity stake in selected AI firms is a narrow and speculative instrument. It requires the government to decide which companies are likely to capture the future rents from AI. It also requires the government to value highly uncertain firms, negotiate ownership terms, and then manage the conflict between being a regulator and being a shareholder.

This is not a small problem. The federal government should regulate AI in the public interest. It should be concerned about safety, privacy, national security, labor-market effects, competition, misinformation, energy use, and democratic accountability. If the government also owns shares in the firms it regulates, its incentives become muddier. Will policy be written to protect the public, or to protect the value of the government’s portfolio? Even if the answer is “the public,” the appearance of conflict will be hard to avoid.

There is also a simpler point: we already have mechanisms for capturing broad economic gains.

They are called taxes.

The Case for Capturing Some of the Gains from AI Through the Tax System

If AI produces extraordinary corporate profits, the corporate income tax can capture part of those gains. If AI increases the value of publicly traded companies, capital-gains taxes can capture part of those gains when shares are sold. If AI produces great fortunes, estate and inheritance taxes can capture part of those gains when wealth is transferred across generations. If AI raises productivity and wages, individual income taxes will capture part of those gains. If AI benefits a broad range of firms and industries, the tax system can follow the gains wherever they actually appear.

This is a much better approach than trying to make the federal government a venture capitalist.

The tax system is not perfect. In fact, some of the best arguments for public participation in AI gains are really arguments for repairing the tax system.

One obvious reform is limiting the step-up in basis at death. If AI creates enormous unrealized capital gains, those gains should not simply disappear for tax purposes when an owner dies. A tax system that allows large gains to escape both income taxation during life and capital-gains taxation at death is poorly designed. If this creates a record-keeping burden for small inherited portfolios, the limit on step-up in basis can be tied to estates above some significant threshold.

A second reform is preserving, and possibly modestly increasing, the corporate income tax. The goal should not be to punish business investment. AI will require large investments in computing, energy, chips, software, and talent. But if AI substantially increases corporate profits, it is reasonable for part of those profits to support the public institutions and infrastructure that make economic growth possible.

A third reform is tightening the estate tax. A serious estate tax is one of the few mechanisms we have for limiting the permanent concentration of wealth across generations. This does not mean confiscatory taxation. It does mean that very large fortunes should not be able to avoid taxation through increasingly elaborate planning devices.

One particular issue deserves more attention: the use of charitable structures that allow wealthy individuals and families to receive large tax advantages while retaining substantial influence over the assets. Philanthropy can serve public purposes. But an unlimited charitable deduction for self-governed or family-influenced charitable entities can become a way to avoid tax while preserving social power and control. This is not the same thing as paying taxes to support public purposes through the ordinary budget process.

Conclusion

If the public has a claim to the benefits from AI, the cleanest way to recognize that claim is not for the government to take shares in a handful of companies. It is to make sure the tax system captures AI-generated gains wherever they occur.

This approach has several advantages.

It does not require the government to pick winners.

It does not require the government to decide which AI company will dominate ten years from now.

It does not entangle regulators with ownership interests.

It does not assume that AI developers will capture all of the value they create.

It preserves market competition while allowing the public to share in broad economic gains.

And it fits ordinary public-finance principles. When economic activity creates large gains, the tax system should capture a reasonable share of those gains to support public purposes. When economic activity creates risks or external costs, regulation should address those risks directly.

This distinction is important. AI regulation and AI revenue policy should not be confused.

The government should regulate AI where public risks are real. It should address fraud, discrimination, privacy violations, national-security risks, cyber risks, misuse in elections, labor-market disruption, and the concentration of market power. It should consider whether copyright law, data rules, and competition policy need to be updated for the AI era.

But if the question is how the public should share in the economic upside of AI, the answer should be broad tax policy, not public ownership of selected firms.

CIVPAC’s general view is that public policy should be economically sound, fair, respectful of individual freedom, and politically realistic. A federal equity stake in major AI companies fails too many of those tests. It is economically speculative, administratively messy, politically tempting, and likely to create conflicts between regulation and ownership.

The better answer is less dramatic but more durable: preserve competitive markets, regulate AI directly where public risks are real, and fix the tax system so that AI-generated gains cannot escape taxation simply because they appear as corporate profits, unrealized capital gains, or inherited wealth.

AI may well transform the economy. If it does, the public should benefit. But the way to do this is not to make the federal government a shareholder in a few favored companies. The way to do it is to tax the gains wherever they actually appear.

Centrist View of the Debt Ceiling Debate

The Democrats’ Position

First, let’s admit that Biden’s arguments about the Republicans’ opposition to raising the debt limit without reductions in the deficit have some merit. The Republicans raised the debt limit repeatedly during the Trump administration. The Republicans, also, increased the deficit and the debt level by passing significant tax reductions during the Trump administration.

Biden has indicated that he will not compromise on the issue of the debt cap and expects the House to approve an increase without any conditions.

Some Democrats have suggested a variety of work-arounds that don’t require raising the debt limit, like minting the trillion dollar coin (essentially printing money). Many of these options are legally dubious and/or economically dangerous.

The Real Republican Position

Based on its actions, the Republican Party is not concerned about the debt or the deficit level. What they do want is lower taxes and less government spending, particularly on social welfare programs. They also want the drama of a showdown with the Democrats, to excite their base. They are happy to use the leverage of resisting increasing the debt cap to accomplish these latter two objectives.

A Centrist View

Unlimited government spending and an escalating debt to GDP ratio is a bad thing. Shutting down the U.S. government or putting it into default are bad things.

As President Obama said, “elections have consequences.” The Republicans gained control of the House and governing requires compromising with them. In the past, attempts by the Republican Party to use the debt ceiling as a tool have backfired politically. I am guessing Biden hopes that history will repeat itself. Unfortunately, for the Democrats, taking the position that they will not compromise on the issue, in any way, puts the blame for a government shutdown and possible default at least partly on them.

A Centrist Recommendation

The Democrats need to concede that compromise is appropriate and necessary. They need to offer something to the Republicans in return for an increase in the debt cap.

My recommendation would be to address the problems with Social Security in a bi-partisan manner. Republicans want to raise the age for future eligibility to benefits. Democrats want to raise the income limit on the Social Security tax. Why not do both? Calculate the amount of money it would take to keep the system solvent for the foreseeable future and raise half the money by raising the income limit on the tax and half by extending the age for future eligibility. For more detail on the Centrist Independent Voter’s position on this issue visit the Social Security policy position.

This is not the only compromise that could be offered, but it is a simple, straightforward one that is also good public policy.

For a more detail discussion of the Centrist Independent Voter’s policy position on the questions of the deficit and the national debt visit the policy position on Taxation, Spending, and Debt.

What is in the “Inflation Reduction Act” of 2022? Is it a Good Thing?

Truth in Labeling

First, let’s all admit the “Inflation Reduction Act” of 2022 (IRA) has virtually nothing to do with controlling inflation. Whatever its merits or failures are, they are not about controlling inflation. The name of the act is shameless marketing. The non-partisan Congressional Budget Office estimated the Act’s effect on future prices to be between +0.1% and -0.1%. Some news sources have been referring to the IRA, more accurately, as the climate, health care, and tax act or something similar. Although a number of economists support this legislation, I am unaware of any serious economist who believes that the IRA will have a meaningful impact on inflation. However, for simplicity I will refer to it as the “IRA,” but don’t be fooled.

Climate Legislation

The IRA has a number of subsidies, tax credits, and regulatory incentives to encourage faster adoption of electric and hydrogen cars. It has incentives for rapid development of solar, wind, and nuclear power. It also provides for subsidized loans to encourage consumers to buy various kinds of equipment to reduce their use of energy and/or carbon emissions. Finally, it includes subsidies to make existing energy production, including fossil energy, cleaner.

The Bargain with Manchin

In order to get this package of incentives past Sen. Joe Manchin (D) of West Virginia, Sen. Chuck Schumer (D-NY), the Democratic Majority Leader in the Senate, had to facilitate additional fossil fuel production through promises about federal lease sales and facilitating future build out of energy infrastructure. The fulfillment of these promises is dependent upon separate legislation that could not be passed as part of the reconciliation process. This energy infrastructure legislation faces threats from both the right and the left.

If Sen. Manchin’s quid-pro-quo for supporting the IRA, a separate bill facilitating faster build out of energy infrastructure is passed, that would be a good thing. If it fails because of resistance from progressive environmentalists, we should expect to see a new Republican senator from West Virginia in a few years. If it fails because of mean-spirited resistance from Republican senators, maybe we will end up with two Democratic senators from West Virginia.

Are the Climate Provisions Good Public Policy?

None of the climate change legislation in the IRA is especially bad and some of it may be good, but all of it is suboptimal when compared to a carbon tax and tariff system. Such a system would not only be more efficient in reducing green house gas emissions, it would also have provided a new source of government revenue. If the government did not turn around and spend those additional funds on new programs but simply used them to reduce the deficit, this approach might actually reduce inflation. (But that is a more complicated issue best addressed elsewhere.)

Are the IRA’s climate provisions better than nothing? The climate change provisions, while suboptimal, will encourage the deployment of electric vehicles and electric vehicle infrastructure. These climate change provisions will also encourage the development of solar, wind, and nuclear energy production which will all certainly play a part in addressing climate change in the long run.

We can only hope that, in the not too far distant future, these kinds of credit and subsidy approaches will be replaced by a broad based carbon tax and tariff approach. If this happens, the capital investments encouraged by the IRA will not have been wasted. Unfortunately, the costs of these investments will be born disproportionately by the general taxpayer rather than carbon consumers. In addition, uncountable other activities that would have contributed to reducing carbon emissions under a broad based tax and tariff plan will have been passed over by focusing on a few governmentally favored solutions.

Health Care Legislation

Extending Subsidies Under the Affordable Care Act

The IRA would extend, for three years, the Affordable Care Act subsidies that were included in the 2021 American Rescue Plan. Subsidies are wealth transfers. They are not anti-inflationary. The right level of subsidy for health care insurance is a legitimate area for debate. I would be more inclined to support larger subsidies for ACA premiums, if they were matched with higher deductibles and co-pays. For more on this question visit the Centrist Independent Voter’s policy position on Health Care.

Allowing Medicare to “Negotiate” Drug Prices

For those of you who think that the IRA fights inflation by controlling health care costs, please remember subsidies and price controls do not lower prices. Subsidies and price controls simply hide costs or shift them to other consumers or to the taxpayer.

Giving the government the ability to “negotiate” prices with drug companies is really just a kind of price control. In this case, the government’s ability to “negotiate” arises because it can forbid drug companies from charging more than the government’s offered price for the drugs. Without that, the government’s offer to pay, say $100/dose, might be met with “fine pay what you want, but we (the drug companies) are going to charge the patient $500.” The government “negotiation” only works because it can prevent the drug company from charging the patient any more than the government offer.

This is not to say that giving Medicare the ability to negotiate prices with pharmaceutical companies is a bad thing. Within limits, it might be a good thing. But follow the process through. (I am ignoring co-pays here for simplicity.) Let’s assume that Medicare says that it will only pay $100 for a given drug and the drug company is forbidden from selling the drug to Medicare patients for any more than $100. The drug company has a number of choices, it can: 1) accept that price and produce as much as is demanded at that price; or 2) it can accept that price, but limit the amount of the drug that it produces, creating shortages and possibly black markets; or 3) it can simply refuse to sell the drug to Medicare patients at all.

The challenge for the government is to figure out the price that will induce the drug company to provide the amount demanded at that price. This is not always an easy thing to do, but it can be done. The challenge for the drug company in these negotiations will be to persuade the government that, absent a higher price, the company will choose option 2 or 3 above.

The drug company also has a choice to make about investments in research on future drugs. Drugs that are likely to face enormous demand, if successful, may well be developed normally even in the face of possible limits on prices imposed by Medicare. But research on drugs with more limited potential demand may simply not receive funding. This has been the case pushed by the pharmaceutical industry, and it has at least a little bit of merit. If the government uses its power under the IRA aggressively, it may lower the price on drugs in the short run, but choke off the supply of many new drugs in the future.

International Equity in Funding Drug Research

For a long time, U.S. consumers have been providing benefits to drug consumers in other countries. The highly profitable market in the U.S. encouraged the development of new drugs and Canadian, European and other consumers benefited by being able to buy those drugs at substantially lower prices. The best policy for Medicare, in the long run, might be to demand “most favored nation status.” That would mean that drug companies could not charge Medicare patients any more than the lowest price that they charge in any other developed country. This will discourage U.S. drug companies from offering drugs at heavily discounted prices outside of the U.S. Most favored nation treatments will, therefore, not result in U.S. consumers paying the current heavily discounted prices that many non-U.S. customers now get. It will result in higher prices outside of the U.S. and lower, but equivalent, prices in the U.S. In this way, the burden of supporting the development of future drugs will be more equitably shared across the developed world.

Capping Out-of-Pocket Drug Costs for Medicare Recipients

Similarly, capping out-of-pocket costs for those on Part D of Medicare does not curb inflation. It simply shifts the costs of these drugs to others. How does that happen? Drug companies confronted with the out-of-pocket cap will simply raise the premium for all those insured under their plans. This is not collusion. It will be driven by the underlying economics in the presence of the cap. The losers will be those people who opted for low cost “catastrophic coverage” plans and were never confronted with the need for expensive drugs. In the face of higher premiums, some people may forego Part D drug plans altogether. Is this good public policy? I don’t know; I much prefer the current situation in which individuals can choose the amount of risk they are willing to take.

The provisions for capping out-of-pocket costs are a wealth transfer plan between various low and middle income people. The only unambiguously bad thing about this plan is that it will probably discourage some people from carrying any Part D drug coverage.

Tax Law Changes

Without the changes in the tax law incorporated in the IRA, it could have been called the Inflation, Climate, and Health Care Act. If the spending on climate and health care incorporated in the IRA had not been accompanied by higher tax revenues, it would have constituted stimulative fiscal policy. Stimulative fiscal policy, in the face of a fixed monetary policy, is inflationary. If one accepts the wisdom of the climate and health care aspects of IRA, one has to conclude that increasing tax revenues was a good idea. But what about the way in which tax revenues were increased? Did those make sense, relative to other alternatives?

The Carried Interest Provision

One thing that was stripped from the bill at the insistence of Sen. Kyrsten Sinema (D-AZ), was the taxation of capital gains as ordinary income in the case of private equity managers. Taxing capital gains at a lower rate than ordinary income makes sense on a number of grounds that I won’t go into here. However, the carried interest compensation that private equity managers receive is much more analogous to ordinary income than it is to a capital gain on an investment. I think leaving the carried interest provision in the act would have improved the IRA.

Minimum Corporate Income Tax

Progressive Democrats love to rail against large corporations that pay no or little taxes in some years. They rarely mention the reasons why these corporations pay low taxes. The reasons for low or no taxes can include massive losses accumulated over years. These corporations may also have lowered their taxes by taking advantage of tax credits and accelerated depreciation supported by the very same progressive Democrats. To fix the offensive optics of large corporations paying low taxes in some years, the IRA provides a “book” based minimum tax system.

To understand this, one must realize that Generally Accepted Accounting Principles (GAAP) differ from the accounting rules used to calculate corporate income taxes. Reported corporate income is calculated using GAAP. Taxes are based using a different set of rules that generally result in lower taxable income because of things like accelerated depreciation and tax credits. I have not read the details of the bill, at this time, but I am guessing that, like the Alternative Minimum Tax for individuals, the Corporate Minimum Tax allows firms to roll forward their Alternative Minimum Tax payments as credits for future years. In large part, this results in front loading tax revenue, increasing it in the near term but lowering it in the future. If one focuses on the first ten years following adoption (as many analysts do), this aspect of the act will overstate the amount of revenues raised.

In response to complaints that the alternative minimum tax would hurt manufacturing, the Democrats allowed “manufacturers” to retain accelerated depreciation. This of course means that corporations must maintain essentially three sets of books. One set based on GAAP for SEC reporting purposes, one based on the regular tax code, and one based on a complicated hybrid of GAAP and tax accounting rules.

This is all incredibly complicated and largely pointless. In fact, the minimum corporate tax undermines the effectiveness of many of the tax credits included in the IRA to help on climate change.

Taxation of Stock Buybacks

The IRA includes a 1% excise tax on stock buybacks. Stock buybacks used to be considered a tax efficient way for corporations to return money to shareholders. It was tax efficient because it returned money to shareholders in the form of capital gains rather than as dividends which were taxed as ordinary income. Now that corporate dividends are typically treated as Qualified Dividends for tax purposes and receive the same treatment as capital gains, this is a moot point. Progressives, like Sen. Elizabeth Warren (D-MA), continue to complain about stock buybacks for reasons that elude me. All this accomplishes is to push corporations to return money to shareholders in the form of dividends. I expect that the Democrats are counting the revenue from this tax as part of their fiscal restraint. In all likelihood, there will be little to no revenue raised by this tax.

Fossil Fuel Taxes

The IRA imposes a number of taxes on fossil fuels. Some of these may make sense, but they are definitely suboptimal when compared to a broad based carbon tax. Some of these taxes are reasonable apart from their climate effects, such as making permanent an excise tax on coal mining that is the chief source of funding for the Black Lung Disability Trust Fund.

Additional Funding for the IRS

The IRA provides some funding to improve the audit capabilities of the IRS. I think this is a good thing, although some of the money will be wasted on ensuring compliance with the new Corporate Alternative Minimum Tax.

Obviously, we need to carefully monitor the IRS to ensure that it does not use its considerable powers to target political enemies. Nevertheless, our tax system is dependent on voluntary compliance and a robust audit capability helps to encourage that voluntary compliance.

Are the Tax Law Changes Good Public Policy?

In terms of taxation, I would have preferred a broad based carbon tax and tariff approach. Absent that, I would have preferred they leave in the carried interest provisions and accomplished the rest of the revenue gain with an across the board increase in all marginal tax rates both personal and corporate.

The best that can be said for the tax policies in the IRA is that these taxes finance the subsidies and tax credits in the act with some kind of tax revenue. That is at least better than the half hearted attempts to claim fiscal neutrality in the original Build Back Better plan.

The Bottom Line

If I had been presented with the IRA and told that I had a choice between it and nothing, I would have supported it. It is sad that it is our only choice.

Invitation for Comments

Finally, I have not had time to read the entire act and this analysis was prepared based on a number of summaries of the act. If the reader is aware of any inaccuracies, please let me know by commenting below. If there are any aspects of the IRA not mentioned here that you would like to address, please do so in the comment area below.