Global tax codes can be idiosyncratic and complex, but general taxation structures can be grouped into broad categories and assembled into global taxation models that can be applied across jurisdictions, thus improving the service and after-tax results wealth managers provide to clients.
The authors focus on the economic implications of managing assets in a taxable setting. Until recently, tax-efficient investing was largely ignored in the mainstream literature, and when considered, it was generally examined from a local perspective despite the reality that global wealth management is becoming more geographically integrated and less independent. The authors believe that taxation should be considered in a global context with a keen focus on the influence of taxation on investment performance, terminal wealth, and consumption. Their conclusions provide perspective on the significance of an economically based, jurisdictionally neutral understanding of taxation for wealth managers.
How Is This Research Useful to Practitioners?
Most wealth management professionals have been educated on nontaxable models developed for tax-exempt investors. Although the application of these models in wealth management is appropriate in many circumstances, they fail to consider taxes. Without understanding how traditional investment theory intersects with taxation, wealth managers often make ad hoc decisions that may be economically suboptimal, such as minimizing taxes in a given year rather than taking into account how taxation influences risk, return, and investment strategy.
Global tax codes can be idiosyncratic and complex, but the authors show that general taxation structures can be grouped into broad categories based on income, capital appreciation, and wealth. They believe that understanding the economics of taxation in these broad categories will allow wealth managers to make informed decisions irrespective of the jurisdiction. The authors review the economics of these categories and bring them together into a global taxation model that can be applied across jurisdictions.
They demonstrate that wealth managers can make decisions in an after-tax context without being experts in the particular tax rules of a specific jurisdiction. Managers can also extract economic insights from global taxation models and improve the service and after-tax results that they provide to clients.
How Did the Authors Conduct This Research?
The authors’ approach is illustrative rather than exhaustive and is intended to provide perspective on the significance of an economically based, globally neutral understanding of taxation.
They first establish that general taxation structures can be grouped into broad categories even though specific tax codes around the globe can be quite different. The categories are taxes on income; taxes on capital appreciation; taxes on wealth, assets, or property; and taxes on wealth transfers. They also review the economics of each category. For example, the authors demonstrate the economics of taxes on interest and dividends for any tax regime that taxes investment returns annually by using an equation that is simply a future value interest factor based on an after-tax return. The model shows the significant effect of the tax drag on capital accumulation and that the tax drag compounds over time as taxes are paid annually.
After examining the general taxation structures and the models that apply to them, the authors combine the simple forms they develop into a single globally relevant model for after-tax returns and wealth accumulation. The general model can accommodate virtually any local tax code and any type of investment vehicle simply by specifying the proper distribution rates for interest income, dividends, and capital gains.
The authors also examine how investment style affects the tax-related parameters by considering four types of hypothetical equity investors (traders, active investors, passive investors, and tax-exempt investors). They find that trading behavior and investment style influence tax burden and future accumulation.
They conclude by offering a similar perspective in the context of estate planning. They develop a framework for understanding generic tax and nontax estate planning issues in both a domestic and cross-border context. Both tax-free and taxable gifts and the location of the gift-tax liability are examined.
Any investment manager operating in a taxable environment should consider the pervasive influence taxes can have on investment performance, wealth accumulation, and consumption. Applying a model of taxation, as suggested by the authors, can add value and distinguish a wealth manager relative to peers who fail to consider the economic implications associated with managing money in a taxable setting. I agree with the authors that failing to consider the influence of taxation is a missed opportunity because, unlike market direction and volatility, taxes are one of the factors that wealth managers can effectively influence to the benefit of clients.