Seeing through Sovereign Wealth Funds?

In the first country, the government imposes a 50% flat tax on each individual's income, and uses the proceeds from that tax to finance an annual $10,000 transfer payment to each individual. The government has zero debt.

In an otherwise identical second country, the government has a sovereign wealth fund that owns a 50% non-voting equity share of each individual's personal business, and each individual owns a government bond that pays an annual $10,000 dividend. The government has zero net debt.

In an otherwise identical third country, the government imposes a 50% flat tax on each individual's income, and each individual owns a government bond that pays an annual $10,000 dividend. The government has positive net debt.

In an otherwise identical fourth country, the government has a sovereign wealth fund that owns a 50% non-voting equity share of each individual's personal business, and uses the proceeds to finance an annual $10,000 transfer payment to each individual. The government has negative net debt.

What is the difference between the four countries?

Remember that each individual can borrow or lend to other individuals. An individual in the second or third country can sell his government bonds, but an individual in the first or fourth country can borrow against his future transfer payments.

And each individual can buy or sell shares to other individuals. But there might be a non-negativity constraint here, that I can't quite get my head around. An individual can always issue more than 50% shares in his own business. But I can't figure out how an individual can issue negative shares to bring the total down to 40% if the government insists on owning a 50% share in his business.

Liquidity and risk of default might make a difference. And I haven't said what happens when individuals die or emigrate and new individuals are born or immigrate (things that might make Ricardian Equivalence false). But distorting "taxes" are already in the "model".

Comments

[Majromax]

> What is the difference between the four countries?

For the difference between (1,3) and (2,4), how do the latter governments obtain this sovereign wealth fund? If I want to use some of my after-tax personal income to buy new equipment for my business, can my business issue new shares to me and dilute the government's ownership below 50%? If I have to issue equivalent shares to the government gratis, then the sovereign wealth fund is really funded by a 100% surtax on personal investments.

Additionally, I think you're supposing that each individual is self-employed and receives all income as dividends from their company. Otherwise, the revenues aren't equivalent between these scenarios, as equity usually only has claims on capital income.

For the difference between (1+4) and (2+3), the difference is that the bond is a property right and transfer payments are not. Conventionally, governments may alter transfer payments at any time by ordinary policy, whereas mucking about with bond payments is unthinkable even if technically permissible. It's much more difficult to borrow against future transfer payments than against a bond.

Also, this idealized scenario misses one feature of sovereign wealth funds, which is risk-neutrality. The government as a whole is fairly risk-neutral, whereas individuals are risk-adverse; government (and pension funds) can invest in equities and pay out to people who need the risk profile of fixed income instruments.

[Nick Rowe]

Majro: "For the difference between (1,3) and (2,4), how do the latter governments obtain this sovereign wealth fund?"

By announcing that it now owns 50% of everyone's wealth, and calling the taxes "dividends".

" If I want to use some of my after-tax personal income to buy new equipment for my business, can my business issue new shares to me and dilute the government's ownership below 50%?"

Good point. I think so yes. That might be one way to think about reducing the government's share below 50%.

"Additionally, I think you're supposing that each individual is self-employed and receives all income as dividends from their company. Otherwise, the revenues aren't equivalent between these scenarios, as equity usually only has claims on capital income."

Think of each individual owning human plus non-human capital. And we are all self-employed; we need to "see through" corporations too.

"For the difference between (1+4) and (2+3), the difference is that the bond is a property right and transfer payments are not."

Yes. But property rights, and individuals, can be taxed.

[Market Fiscalist]

Assuming that in all 4 cases net income is $20,000 and what changes is how this sum is made up then outcomes are similar. Are we talking Ricardian equivalence here ?

If people need to spread the distribution of income through time by buying/selling of assets or lending/borrowing against them then option 3 (where net private wealth is highest) appears to be the best and option 4 the worse.

I bet people would likely have the following preferences

3) they own a bond that at least make them feel richer (and can be sold or borrowed against to shift spending forward.).
1) they pay a meaningless tax that has no net effect on anything real
2) They lose control of real assets but at least have a bond to maintain their net worth
4) They have lower net worth and are in effect dependent upon state charity to maintain their income.

[Market Fiscalist]

If distribution of spending can be moved purely by lending/borrowing against future income streams then all 4 models are identical

[Nick Rowe]

MF: " Are we talking Ricardian equivalence here ?"

Good question. I think the answer is "no", though I do see the parallels, and to Modigliani-Miller. Ricardian Equivalence is about the equivalence between bonds and future taxes. It's a time-series question. This post is about the equivalence between bonds and current lump-sum transfers (the government gives you money, regardless of how much you earn), and shares and proportional taxes (the government owns a share of your earnings). It's a cross-section question.

"1) they pay a meaningless tax that has no net effect on anything real"

That tax has a disincentive effect. The manager (you) has less incentive to work hard to earn money to pay someone else.

[Market Fiscalist]

'That tax has a disincentive effect. The manager (you) has less incentive to work hard to earn money to pay someone else.'

Well, If I handed over $10,000 in tax and was immediately given back a transfer payment of $10,000 then I don't see that this would have any affect. If the people paying $10,000 and the people receiving the $10,000 are different groups then there will be incentive and distribution affects that will make the differences between the 4 scenarios much greater.

[Nick Rowe]

MF: the average person has tax = transfer. But if any individual earns more income, his tax goes up, but his transfer only goes up by 1/population, which is approx zero. Nash equilibrium/like prisoner's dilemma.

[Market Fiscalist]

ah, got it ! thanks.

[Matthew Young]

No difference.
In all cases, assets equal liabilities, and both equal to the net present value of a 10k/yr/capita stream. It is a wealth fund, wealth assumed constant.