Wednesday , August 15 2018
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Convexification and complication

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From Richard Rubin at WSJ:The new tax law’s treatment of deductions gives people more reasons to concentrate giving in certain years, both inside and outside donor-advised funds. A donor-advised fund is an investment account held for charitable purposes. Donors take tax deductions when they put money in, then recommend grants to charities over time. Mr. Young,...added ,000 ...

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From Richard Rubin at WSJ:
The new tax law’s treatment of deductions gives people more reasons to concentrate giving in certain years, both inside and outside donor-advised funds. 
A donor-advised fund is an investment account held for charitable purposes. Donors take tax deductions when they put money in, then recommend grants to charities over time. 
Mr. Young,...added $30,000 to a donor-advised fund run by the Los Altos Community Foundation. His plan: alternate years between taking the standard deduction and donating to his fund and claiming itemized deductions.
How very clever. The tax law allows a $24,000 per year standard deduction. Arrange things so that in some years you have zero actual deductions, and get $24,000 free deduction. Pile all the real deductions into other years.

In economics we call this "convexification". There are lots of clever ways to draw lines through a stair step.

Of course, you can also just give $50,000 to charity in alternate years, and let the charity put it in the bank. Donor-advised funds are useful if you think your local charity's endowment investment policy isn't that smart. If they invest in obscure high-fee hedge funds and private equity deals and you'd rather they invested your money in transparent low-fee assets, then set up a donor-advised fund.

In a rare moment of sanity and good government from my ex-home state, Marc Levine, chairman of the Illinois state board of investment, pulled all of Illinois' pension assets out of high-fee obscure hedge funds.

Industry “experts” suggested we keep these investments to diversify our holdings and reduce overall risk. Yet we already owned bonds for that purpose. Our Procter & Gamble bonds made sense to us. I’m pretty sure my children will brush their teeth tonight. But I don’t have a clue about that long-lumber, short-sugar trade. 
Did anyone at the table really understand what these hedge funds were doing? Should we be putting the retirement funds of Illinois state employees into investments that not a single trustee, consultant or staffer could explain?

Donor-advised funds are also a great way to give money to your favorite charity if you think their own investment

The article includes more clever advice:
... Donors who give appreciated assets get an added benefit: They avoid paying capital-gains taxes when they make the donation, and they get a deduction against their income taxes for the full value of the asset.
If you paid $50 for stock, now worth $100, give the stock to your favorite charity (Hoover!). The charity gets $100, you take $100 off your taxes, but you don't pay capital gains taxes on the $50. Essentially you get to take $100 plus the capital gains tax as a deduction.

It gets better though. Give a non-market asset to your favorite charity. You can see both you and the charity have every incentive to report fanciful values for the asset. If it's really worth $100, well, call it $200 for the IRS. The charity still gets $100 for free.

Now you can actually make money out of donations. Conservation easement syndications (here, here and most fun here are even better. Buy land cheap, declare a huge value, put the land in a conservation trust, promising not to build houses on it -- actual operating golf courses are ok, and too bad if sometime in 2050 building some houses is a good idea -- and deduct the high value against other income.
the former Millstone golf course outside Greenville, S.C. Closed back in 2006, it sat vacant for a decade...In 2015, the owner put the property up for sale, asking $5.8 million. When there were no takers, he cut the price to $5.4 million in 2016.
Later in 2016, however, a pair of promoters appeared. They gathered investors who purchased the same parcel at the market price and, with the help of a private appraiser, declared it to be worth $41 million, nearly eight times its purchase price. Why? Because with that new valuation and a bit of paperwork, the investors were suddenly able to claim a tax deduction of $4 for each $1 they invested. ..
...A preliminary IRS analysis of syndicated partnerships this summer showed investors claimed an average of $9 in tax deductions for every dollar they invest.
There are lots of ways to interpret all this. One can celebrate the creativity of the American tax lawyer and wealthy investor. Who said innovation has fled the US?

Obviously, I'm not such a fan. Even if you take a benign view -- the US likes to pass very high taxes for symbolic purposes, and then allows all sorts of shenanigans on the side so people don't actually have to pay the taxes -- much of the economic damage is done. Aside from the fact that marginal disincentives are high, the cost of all this stuff is not trivial either. From the first article
The funds linked to investment firms such as Fidelity and Vanguard typically charge administrative fees... The funds are often invested in vehicles managed by those firms and generate fees for the for-profit business.
And the lawyers who set up conservation trusts, and the lobbyists who keep them in the tax code, are all taking their cut too.

But even that is not the most annoying part. Now, on top of everything else, a wise taxpayer needs to set up a donor advised fund, sign a bunch of papers, and manage it each year. Already, perfectly normal citizens have to have trusts to manage estates, and hundreds of pages of tax forms each year. The needless complexity of life in the Republic of Paperwork is, to me, the most annoying part. We need a grand simplification of our public life. If this is what it leads to, the whole charitable deduction thing should get tossed overboard.

John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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