It is a bit of a puzzle to see the role that depreciation plays here. The idea behind depreciation is that an asset can lose value and this loss gets treated as an expense. If you own a car it...
It is a bit of a puzzle to see the role that depreciation plays here.
The idea behind depreciation is that an asset can lose value and this loss gets treated as an expense. If you own a car it wears out over time and then you might sell it and get another one. If you don’t use depreciation, when you sell it at a low price (because it’s worn out) then it’s a big loss all at once. Depreciation lets you turn that into smaller losses (expenses) that happen ahead of time. These are paper losses only, but they take the place of a bigger loss later and make business expenses seem more predictable. Otherwise you’d appear to be running a profit up to the day you need to buy a new car.
(Some people say that Uber drivers are getting taken in because they don’t understand this. Whether they do or not probably depends on the person.)
Since it’s a paper loss, the effect of depreciation is that cash flow is higher than profits according to your accounting. Money is coming in, less money is going out, but it’s assumed that your assets are losing value, so it doesn’t count as profit.
But this is all based on guesses about the future. You assume the price of the car will be a lot lower and you assume it will wear out in a certain amount of time.
That’s pretty reasonable for a car, but what happens if it’s a rental property, and the guess about it losing value is wrong? This is a way to create a paper loss for a while. Eventually, when you sell a depreciated asset that’s supposedly worn out, suddenly it’s a profit, because it sold for more than it’s worth according to your books.
So this is a way to delay taxes by showing no profits until the very end, when you sell. And it looks like it converts ordinary profits into capital gains, too, by lowering the cost basis of the asset with possibly-nonexistent wear.
Now you know why people love the idea of low capital gains taxes. They can arrange so that they pay capital gains tax instead of income tax, and they pay it when it’s convenient to sell. It only works as long as you sell while the asset is worth more than the book value, though.
How do you prevent this kind of gaming? One way might be to use a VAT instead, which doesn’t allow depreciation to be deducted. (This is why Andrew Yang was advocating for a VAT.)
Isn't this the axiom in that chain of reasoning that's incorrect and pulls the whole chain down? Science generally shows that financial stresses lead to worse decision making, not better.
Once you have less skin in the game, it is easier to make bad decisions. The author argues this is due to a) having a capital buffer to cushion you, and b) having more time to waste.
Isn't this the axiom in that chain of reasoning that's incorrect and pulls the whole chain down? Science generally shows that financial stresses lead to worse decision making, not better.
I don't think it's necessarily incorrect. Having been in both situations wrt a business, it's true that if you have skin in the game, you will care a lot more and make better decisions overall --...
I don't think it's necessarily incorrect. Having been in both situations wrt a business, it's true that if you have skin in the game, you will care a lot more and make better decisions overall -- but having a safety net is very important, so financial stress itself has to be limited in impact.
With that said, the real gem of this article is unrelated to the initial premise imo.
It is a bit of a puzzle to see the role that depreciation plays here.
The idea behind depreciation is that an asset can lose value and this loss gets treated as an expense. If you own a car it wears out over time and then you might sell it and get another one. If you don’t use depreciation, when you sell it at a low price (because it’s worn out) then it’s a big loss all at once. Depreciation lets you turn that into smaller losses (expenses) that happen ahead of time. These are paper losses only, but they take the place of a bigger loss later and make business expenses seem more predictable. Otherwise you’d appear to be running a profit up to the day you need to buy a new car.
(Some people say that Uber drivers are getting taken in because they don’t understand this. Whether they do or not probably depends on the person.)
Since it’s a paper loss, the effect of depreciation is that cash flow is higher than profits according to your accounting. Money is coming in, less money is going out, but it’s assumed that your assets are losing value, so it doesn’t count as profit.
But this is all based on guesses about the future. You assume the price of the car will be a lot lower and you assume it will wear out in a certain amount of time.
That’s pretty reasonable for a car, but what happens if it’s a rental property, and the guess about it losing value is wrong? This is a way to create a paper loss for a while. Eventually, when you sell a depreciated asset that’s supposedly worn out, suddenly it’s a profit, because it sold for more than it’s worth according to your books.
So this is a way to delay taxes by showing no profits until the very end, when you sell. And it looks like it converts ordinary profits into capital gains, too, by lowering the cost basis of the asset with possibly-nonexistent wear.
Now you know why people love the idea of low capital gains taxes. They can arrange so that they pay capital gains tax instead of income tax, and they pay it when it’s convenient to sell. It only works as long as you sell while the asset is worth more than the book value, though.
How do you prevent this kind of gaming? One way might be to use a VAT instead, which doesn’t allow depreciation to be deducted. (This is why Andrew Yang was advocating for a VAT.)
As someone who lives in a country with a 27% VAT rate, I assure you I could write another 5000 world article about the ”Games people play with VAT.”
Isn't this the axiom in that chain of reasoning that's incorrect and pulls the whole chain down? Science generally shows that financial stresses lead to worse decision making, not better.
I don't think it's necessarily incorrect. Having been in both situations wrt a business, it's true that if you have skin in the game, you will care a lot more and make better decisions overall -- but having a safety net is very important, so financial stress itself has to be limited in impact.
With that said, the real gem of this article is unrelated to the initial premise imo.