Haig-Simons

Income = Consumption + Change in

Wealth
Y = C + W
More important to focus on
Consumption
Wealth

Haig-Simons and Theory of

Income
Focus on wealth and consumption.
Increase in wealth => increase in income.
Consumption provided by third party =>
increase in income
Employer provided car

Decrease in wealth
If used to buy consumption, no effect on income.
If used to buy asset or investment, no effect on
income.
If used to pay for something other than consumption
or investment, then decrease in income.

Examples
Paycheck = increase in wealth / income
Employer provided vacation = increase in
consumption / income
Buy your own vacation
Wealth decreases but
Consumption increases

Buy $10,000 investment

No change in wealth
Only change in form

Pay rent on office building

Wealth goes down
Deduction

What Escapes H-S Income

Unrealized capital gains.
Imputed income.

Average versus Marginal

Rates
Example:
First $100,000 is tax free
Remaining income taxed @ 50%
Arturo has $120,000 of income

Average rate
8.33% of income paid in tax
Justice / distribution

Marginal rate
50 of any extra $1 of income goes to government
Efficiency / incentives

Taxable Units
Touched on this in gifts
Individuals
Married couples
Families

Progressivity
Arturo (prior slide) has child, Betty.
Betty has no income.
What effect if Arturo can assign $20,000
of his income to Betty.

Noncompliance
Innocent mistake
Taxes and interest

Negligence
20% penalty

Substantial underpayment
20% penalty

Civil fraud / criminal

Tax Opinions
Yahoo! wants to distribute its large
stake in Alibaba to Yahoo!
shareholders.
http://nyti.ms/1UFb531

Question: does Yahoo! or its

shareholders have income.
Private Letter Ruling
Opinion from Skadden

Mechanics
Gross income
Above the line deductions

Adjusted gross income

Exemptions
Standard or itemized deductions

Taxable income
Credits

Why AGI Matters

Above the line deductions are
better than itemized.
Itemized can be phased out.
Itemized deductions do no good if you
take standard deduction.

AGI used to determine eligibility for

tax benefits.
Student loan interest deduction

Capital Gains and Dividends

Roughly speaking, taxed at 1/2 of
ordinary rate.
Arguments (more later in course)
Encourage capital formation /
investment / mobility
Blatant giveaway to the rich.

Accounting vs. Realization

Realization
When do we tax changes in property
value.
Generally, sale or exchange.

Accounting
We do we tax compensation, profits, etc.
Cash method: when money hits your
hand or leaves your profits.
Accrual method: more later

Recognition versus
Realization
Realization is an event
Sale
Exchange

Recognition is the tax consequences

from event
Taxable Gain
Deduction Loss

Sometimes, TPs defer tax even if there

is realization (nonrecognition)

Deferral
Money today is better than money
tomorrow.
Payments tomorrow are better than
payments today.
Example
$100 today versus $100 in one year
5% interest rate

Gains and Losses

IRC 61(a)(3): gains from dealing in
property includible
IRC 165(a) (not assigned, but
should have been):
There shall be allowed as a deduction any loss
sustained during the taxable year and not
compensated for by insurance or otherwise.

Mechanics of Gain and Loss

I.R.C. 1001(a)-(c)
(a):Computing Gain or Loss
Gain = AR AB
Loss = AB AR
With gifts, we might have different AB for gain than
for loss.

(b) AR = value of what you received

(c) Generally recognize any realized gain or
loss.

Treas. Reg. 1.61-6(a); -6(b) (skim only);

1.1011-1

Adjusted Basis (AB)

I.R.C. 1011(a), 1012(a), 1016
Generally, we start with cost.
Adjustments, which well cover later.
Additional costs (like improvements).
Recovered costs (like depreciation).

Conceptually important point

Adjusted basis is unrecovered cost.

AB Example
2010: Buy building for $1 million.
2012: Add improvements of $100,000.
New cost

2010-2015: Depreciate $200,000 of value.

Tax deduction

2016: Sell building for $1.5 million.

AR = $1.5 million.
AB is like a deduction against AR.
Start with $1 million
Add new costs of $100,000
Subtract $200,000. Already deducted these amounts.