Thiel's Taxes: Three Things ProPublica Left Out

Some notes on full-picture taxation, and a general plea for saner coverage.

Ok, back to the ProPublica tax series. This time around they targeted billionaire libertarian Peter Thiel for leveraging the Roth IRA structure to grow a traditional retirement account to an astonishing tax-free sum of ~$5bn.

Here’s one of their (non-contributing, but MacArthur Fellow) reporters on Twitter: [1]

Note the “never have to pay a penny of tax” thing. Put a pin in that for a minute.

Now, as a matter of housekeeping, some readers felt my tone was overly fight-y last time around. And it was. While I still think it was warranted, it distracted some from the meat of my arguments. So I’ll restrain myself more this time. This isn’t about dunking on individual journalists or ProPublica. It’s about pointing out how broken journalism’s editorial controls, expertise systems, and publishing incentives are.

Anyway, I’ll give ProPublica that this story was a bit better. While they’re still publishing stolen personal documents to tell us something we already knew almost a decade ago, Thiel is at least a good villain for a tax story. He’s unusually committed to tax avoidance as a general theory of morality, which is at the very least interesting.

Even so, a journalist can imagine that Thiel’s view is wrongheaded in some civic way while still giving him a fair shake. To the degree that his actions are indeed villainous, the journalist’s job is to let the reader gather that from a sober and clear presentation of the full picture. Otherwise what are we doing?

Getting specific here, there are three things that ProPublica left out entirely that I reckon a more serious attempt at balanced reporting would have included:

1. Startup failure rates

2. Induced taxation

3. Estate taxation

Of course, it’s fine for a reader to get their head around all three things and still walk away with an impression that Thiel ought to have not been allowed to use the Roth structure the way he did, else that he should have chosen not to. I don’t mean to tell the reader how to feel. I just think full stories help us judge better.

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I. Startup Failure Rates

The gist of Thiel’s gambit is that he placed 1.7 million PayPal shares into a Roth IRA when those shares were effectively worthless. Then PayPal became a unicorn, and those shares became worth a lot. And the basic structure of a Roth then exempted him from ever having to pay income or capital gains taxes on all said winnings.

As ProPublica frames it:

Thiel also had an advantage over most Americans with IRAs, who typically use them to purchase publicly traded stocks, bonds, mutual funds and certificates of deposit. Since Thiel used his Roth to buy shares of a private company, the value wasn’t set on a public stock exchange. …

… Thiel paid $0.001 per share — yes, just a tenth of a penny — for 1.7 million shares. At that price, he was able to buy a large stake for just $1,700. …

Thiel’s unusual stock purchase risked running afoul of rules designed to prevent IRAs from becoming illegal tax shelters. Investors aren’t allowed to buy assets for less than their true value through an IRA. …

PayPal later disclosed details about the early history of the company in an SEC filing before its initial public offering. The filing reveals that Thiel’s founders’ shares were among those the company sold to employees at “below fair value.”

Victor Fleischer, a tax law professor at the University of California, Irvine who has written about the valuation of founders’ shares, read the PayPal filings at ProPublica’s request. Buying startup shares at a discounted $0.001 price with a Roth, he asserts, would be indefensible.

“That’s a huge scandal,” Fleischer said, adding, “How greedy can you get?”

So, a few things here:

• Why isn’t that SEC filing linked so we can read the disclosure in context? [EDIT: I’ve added a footnote 11 with what I think they’re talking about.]

• All Americans are free to copy Thiel in betting on themselves instead of betting on others. [2] And more should! Entrepreneurs are valuable! The government gives them tax preferences because it rightly wants more of them.

• Our angry professor aside, the law seems to clearly allow founders to use Roths to buy shares prior to outside investment, [3] where the “true” value for a startup that’s just a desk and an idea is going to be pretty close to zero.

• Businesses fail. Only about a third of even venture-backed startups make it to their 10th anniversary. And many of those survivors reach said benchmark on a middling trajectory, never to reach escape velocity. Success is hard!

Taken together, I struggle to grok the fundamental objection here. We’re allowing founders to bet on themselves, where if those bets pay off they’re able to access their winnings between the age of 59.5 and their death without immediate taxation, but where (for billionaires) their total end wealth is very much subject to the estate tax. [4]

If those bets pay off, it means society has been widely and richly rewarded along the way (including several layers of other taxes), and that the pile of money that Uncle Sam has a ~40% ultimate claim has grown handsomely. This seems…fine?

(There are surely some reasonable compromise positions. Maybe there should be a minimum share value, perhaps marked to the valuation of the startup’s first proper venture investment with some sort of sliding discount. The point isn’t that the current system is perfect. It’s that this isn’t some sneaky loophole that we’re just learning about now. The Government Accountability Office wrote a 99-page report about it in 2014, and Thiel’s gambit was reported on back in 2012. [5])

[EDIT: Re-reading ProPublica’s reporting an hour after publishing, I see they even linked the same GAO report! Despite all their “secrets” / “revelations” framing!]

Anyway, moving on.

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II. Induced Taxation

Imagine you’re a founder, and that over the course of a decade or two you transform a vague idea into a company worth $100bn, of which you retain 20% ownership. And imagine that 100% of your shares were shielded in a Roth account all that time.

It’s true that so long as you wait until you’re 59.5 years old to spend any of that wealth (early withdrawals incur both taxes and penalties), you won’t have ever pay any income or capital gains taxes on your ~$20bn in winnings. [6]

Are the various levels of American government sad about this?

Leaving aside estate taxation (our next section), consider what else happens along the way with a $100bn company:

• It will buy a lot of things that it will pay sales and property taxes on

• It will employ a lot of people who will pay income, FICA, and other taxes

• It will induce a lot of capital gains taxation

• It will pay some amount of corporate and headcount taxes

• It will generate a lot of jobs, which is good for GDP growth

• It will advance some industry, inducing even more startups

Put another way, it’s not like federal/state/local coffers are in a drought here as they wait for their eventual payday. They’re still reaping enormous and continuing windfalls from the economic value directly induced by that founder’s labors.

For some reason these reports about how individuals and/or corporations are underpaying in taxes always fail to mention all this. I wonder what that reason is.

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III. Estate Taxation

A general rule of taxation in the US is that, short of breaking the law, Uncle Sam is always going to get his. Taxpayers just get measures of choice in using various IRS-defined structures to transform who pays, and when, and at which rates. For their ultra-rich specifically, their default endgame is the 40% estate tax. If they don’t lawfully disburse their wealth before they croak, the federal government gets to collect a super-tax that makes up for all taxes deferred along the way. [7]

Another thing to understand is that the IRS, though seriously outgunned on a manpower side, generally hires smart people. Their tax lawyers are not a bunch of Owen Wilsons constantly saying “wow” as they review the creative brilliance of the tax lawyers on the other side. The IRS is fairly adept at creating rules to guide the flow of wealth in useful directions, where all paths end with Big Bertha being fed. While some of these flows are quite “leaky” in the advantages they extend to heirs along the way, none really exempt the bulk of very large estates from eventual taxation. [8]

Beginning in 2027 (i.e., when he becomes old enough to begin withdrawing from his Roth penalty-free), Thiel will have four main outflows for his billions:

1. He can invest into new assets or ventures

2. He can spend it all on lattes and pirate island libertarian utopias

3. He can give it away to registered charities

4. He can let the cash sit in an estate that will eventually be taxed at ~40%

Taking those in turn:

• The first is great, as it means new revenue and wealth generation that will ultimately get taxed in various ways

• The second I suppose is mostly bad (if also deeply funny, and maybe kinda ok from a “experimentation is a key part of human progress” angle)

• The third is great, as charities effectively expand the work of government in targeted niches

• The fourth is great, as the very wealthy now get to finish their financial circle of life and repay Uncle Sam’s forbearance

When it comes to billionaires though, it’s worth noting that spending that much money is hard! [9] So the second is a fairly moderate risk. Most of what they buy is real estate and other assets that impose their own subsequent taxation.

The more likely outcome here, as is largely true for most of the ultra-wealthy, is that Thiel will give the bulk of his money away to charity using donor-advised funds, etc. Which also seems fine! Nearly all governments allow citizens to deduct charitable giving, treating it as an alternate form of taxation. Charities meet the public good in orthogonal ways, which society wants a blend of. It’s not a very controversial idea.

I suspect the real objection here is mostly just “well why should the rich get to direct their taxes when I’m not allowed to” — which I suppose is a good argument right until one really thinks about it.

1. Everyone can do this! Just not at the same scale. Because they’re poorer.

2. Deduction limits exist. If someone is giving away more than they can legally deduct, they’re essentially paying an extra voluntary tax. This is good!

3. Who is likely to produce more civic value on a marginal dollar of wealth: the US government, or the guy who ran up a retirement account to five billion dollars? If you can produce even a meaningful fraction of those returns, I’m happy to let you direct 100% of your own taxation. Who wouldn’t be?

Now, I’m for core taxation generally. Some things are only achievable at enormous scale. And I think the US government gets great returns on many investments. But it’s hard to argue that there isn’t a tremendous amount of bloat baked in too. If someone like Thiel wants to avoid that bloat by gifting his riches to public good foundations that he believes will be more efficient, that seems just fine to me.

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In Closing

There was one line of reporting in ProPublica’s piece that I thought was useful, in that the Bush-era conversion scheme was definitely a giveaway. We depend on journalism to notice and write about that sort of thing. Likewise, there are adjacent subjects that would benefit from sane commentary. Perhaps donor-advised funds should have annual disbursement requirements, especially at the donor’s death. And perhaps the estate tax exemption probably should be lower, and so on. Lots of room to discuss.

But think of it like this: if you want tax reform, the only way to get it is to build political consensus. Printing slant pieces about billionaires you dislike is not going to help there! This libel-y approach to tax-policy-by-anecdote isn’t going to cause Thiel and those like him to move towards whatever we imagine the right consensus to be. If anything, we’re just encouraging him to take the other side more aggressively.

I dunno, maybe we should stop doing that? Just a thought.

Anyway, I enjoyed this footer:

I appreciate that ProPublica is trying to recruit tax lawyers to help them. Though maybe the time to do that was before they started writing.

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PS

As an expansion of the above for those interested, I have three related comments on the big Disney heir op-ed from last week, which was written in response to ProPublica’s first story in their current tax series.

(I’ll declare my bias in that I hate this entire genre. There’s a type of heir that talks endlessly about unfair privileges instead of just giving their money away, which I find annoying. They also say things like “acts of turpitude”, which is worse. But YMMV.)

The first excerpt:

The naked fact of the matter is that not a single one of the documented methods and practices that allowed these billionaires to so radically minimize their tax obligations was illegal.

Bearing in mind that most of the report was just “rich founders aren’t selling shares in companies they own/run”, let’s note that this isn’t tax minimization, nor tax avoidance. Those words mean things! And not those things! This is what happens when original reporting makes category errors that are let to stand: most of those downstream will repeat them, eventually making them into a sort of gospel that few readers question.

Then there’s also this (emphasis mine):

What’s worse, these methods and practices—things such as offsetting income with losses in unrelated businesses; structuring assets to grow rather than generate income, then borrowing against those growing assets for cash needs; and deducting interest payments and state taxes from taxable income—are so downright mundane and commonly applied that most rich people don’t see them as unethical.

Well:

• To suggest that anyone ought to see these practices as unethical is wildly subjective, and largely out of step with how even the IRS views it.

• The borrowing part is a red herring, as it’s more related to the delta between interest rates and growth rates than taxation.

• Consider what the bolded part implies. She thinks a company like Amazon should be forced to pay a dividend instead of reinvesting its profits into itself?? That would be a radical reimagination of the tax code. And it’s difficult to see who it would help. Companies like Amazon induce fabulous income for governments, mint loads of millionaires, juice returns for anyone with market-linked pension funds, and accelerate the progress of entire industries. We want them to do…less of this? Just so they can distribute cash to shareholders to invest into companies doing less impressive things??? Did anyone think this through?

And lastly:

Every single method and practice outlined in the ProPublica report has been suggested to me at one time or another by these decent men as a credible, perfectly legal, and not-at-all-questionable way to manage my assets.

Here’s a full list of the methods and practices from that article: [10]

• Put your money into excellent assets that you have operating leverage over and keep it there for as long as you can still drive growth

• Borrow money against your shares to bet on yourself (e.g., wagering that the growth rate of those assets will comfortably exceed the interest rate on your debt, where by doing so you increase your overall very-taxable wealth)

• Bet a lot on high-risk, high-upside startups that sometimes fail but that do great things for the world when they succeed

• Take advantage of vanilla tax cuts expressly made available by Congress

• Give staggering sums to charity

This is why specifics matter. Readers will see this in The Atlantic and say “well if even this billion-heir is talking about how dodgy this all is, it must be bad!” But it isn’t. Not really. The people involved just didn’t read/think carefully, else they hold ethical views so far outside the norm that their opinions borders on the cultishly religious.

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Footnotes:

[1a] As a rule, I try to avoid naming journalists here. First, because it isn’t personal. And second because having these writeups come up whenever someone Googles their name can be an overly strong penalty. I also sometimes strip out Twitter handles to avoid sending trolls in anyone’s direction, especially where they’re not a senior figure. My point in mentioning the MacArthur thing is just illustrating that otherwise bright people are failing to really think through this reporting. But many like him adopted this line of thought / quoted that excerpt, and I just grabbed the first example I saw.

[1b] I suppose it’s true in a purely literal sense that Thiel himself may never pay a penny in taxes on that $5bn. But his estate will, else he’ll have given it all away. That makes the statement more than a little misleading.

[2] You just can’t own more than half the company.

[3a] See commentary in the GAO report, starting at PDF page 32. While they ultimately argue that Congress should consider asset limits and minimum valuations, they acknowledge that the practice of buying at/near par value is happening legally. There’s also nothing especially hard about valuing a day-one startup. They’re worth the sum of assets held and money invested. If that’s like $100, the shares will be cheap! But as I say, I think there’s a plausible compromise here where the IRS indexes shares to the first proper funding round to avoid gamesmanship. Though there should be a discounting mechanism for startups that grow prior to taking in outside money.

[3b] Maybe Thiel’s specific deal was shady? This is why ProPublica should have linked that SEC filing. Without it, it’s impossible to tell how damning that excerpt is. [EDIT: See footnote 11.]

[4] Of course this is no longer true if that wealth is fully disbursed before death. I get into that more in section III of the main text. Commentators also seem to like talking about trusts a lot. While trusts can solve for double-taxation (see 3a here), they all generally still involve someone paying income / gift / capital gains taxes. Or at least this is true for the very rich (i.e., estates above ~$25m).

[5] There may be even older reporting, as it’s based on a public filing from 2001. I didn’t bother to look. Though there is a weird (possible) discrepancy between the two tellings, in that Forbes says Thiel bought 1.7m shares at $0.30 each in 2001, while ProPublica says 1.7m shares at $0.001 in 1999. It could be that this was just the standard size of his vesting allotments? I dunno. My point is just that the basic shape of his gambit is very old news. There was no need to steal/leak his private info. [EDIT: In re-reading ProPublica’s reporting, they acknowledge that Gawker had reported on a similar gambit in 2009. Though that was of Facebook shares when their pre-money valuation was already ~$10m, so a less extreme version of it. Also see note 11.]

[6] Actual winnings might come out higher or lower depending when the founder actually liquidates their shares. Obviously trying to dump 20% of a company over any short period of time will tank the stock. It’s one reason so many founders donate their shares using vehicles where those sales are parcelled out gradually.

[7] A bunch of people tried to dunk on me for this claim last time too. They’re still wrong. See 3a here. It’s as definitive a source for congressional intent as we have.

[8] I suppose there’s an interesting story here about millionaires (i.e., estates worth < $25m for couples, or half that for individuals). They generally get to avoid both capital gains and estate taxation. Seems unideal to me. But billionaires can’t avoid the estate tax in any easy sense, short of just giving all their money away. And the tax code has long recognized that giving money away to registered charities is a civic good roughly on par with paying taxes, as addressed in section III in the main text. The best (worst?) that billionaires can do is use trusts to leak money to their heirs. But per footnote 4, this still mostly induces taxation somewhere along the way. Also see footnote 11.

[9a] I once half-jokingly told Elon Musk that he should do a Brewster’s Billions show where he tries to spend outrageous sums to prove the point. I stand by it.

[9b] I do support luxury taxes though. If someone is going to buy a massive offshore yacht or whatever, that consumption should be taxed. Right now there are various ways of getting around most such taxes (though not many categories that come with price tags that will make a serious dent in > $5bn wallets).

[10] Leaving out corporate taxation, which is a category unto itself. I’d love to write about that more some day, as it’s also very poorly covered. But that day isn’t today.

[11] This is a new footnote, added morning June 28th, then revised shortly after because I missed something the first time. I decided to see if I could find the filing for myself, and I’m reasonably sure I did. Page 96 confirms that Thiel bought ~1.7m common shares of Confinity in Jan 1999, at which point the company’s only funding was a $100k loan from Thiel’s hedge fund (which later converted into equity, per pg. 131). So far as I understand the laws at the time, that par-value of $0.001 per share was thus roughly fair-market value, as a loan wouldn’t have counted as part of the company’s valuation. Though one plausible argument is that it should have counted if it was always intended to convert. The counter-argument is that, if true, and if they knew that would be the IRS’ interpretation, Thiel and co. would have just waited to inject the loan until after issuing the shares, making it moot. So one interpretation here is that the IRS forced them to reclassify later, but allowed them to just pay the difference in cash while keeping the shares in their Roths. Anyway, those 1.7m shares converted into ~850k shares upon Confinity’s merger with X.com a few months later (the combination of which became PayPal). Page F-5 is what I think ProPublica is considering their smoking gun (which I thought/written they’d misread on first reading), in that line three suggests that all ~6m formation shares were purchased below fair-market value. So ProPublica very well might be right on that point, their lack of detail aside. Though we don’t know if the discount there extended beyond just reclassifying that $100k (not obvious what else it could be?), or how the IRS felt about it. It’s impossible to tell from the disclosure itself. We’re also additionally told between pages F-31 and II-3 that Thiel bought 4.5m additional shares in 2001 at $0.30 each, which the filing says directly were below fair-market value. Though those don’t seem to have had anything to do with his Roth. I’ll add a secondary note here if I can confirm more.

(This final footnote doesn’t match anything in the text. It’s an extra PS I guess.)

[12a] Note this gem from Disney’s op-ed: “As long as no one so much as raised an eyebrow about the ethics of the CRAT, the CRUT, and the credit swap, who did I think I was to query the fundamentals?” This is a tactic that lots of journalists use too. Instead of explaining exactly what they imagine is unethical about a given tax structure, they just throw out acronyms and terms that they trust sound sufficiently shady. While some of these trust schemes can be overly generous, most don’t allow the ultra-rich to do much about their overall wealth. While we can/should have informed discussions about 7520 rates and gift-tax exemptions, etc, the way to do that is to be honest about what these vehicles do and don’t allow, and how taxation still flows.

[12b] ProPublica, for example, links this Bloomberg story about a Walmart heir using a trust structure called a CLAT. But ask yourself if you really understand the structure after reading, and if it’s clear to you how Uncle Sam gets paid along the way. Their framing makes it seem like the taxation just disappears. But it very much does not!