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Commentary

Felix Salmon on Madoff – it's the government's loss, too

Felix Salmon – Madoff: The Tax Implications

Let’s say you’re a successful businessman who has managed to earn $10 million this year, but who also had $10 million invested with Bernie Madoff. Obviously, you’re not happy about seeing your savings wiped out — but if I’m reading this WSJ article correctly, since your loss is a “theft loss”, the whole thing is deductible, and you basically get to keep all your income tax-free!

And it gets better: because of Madoff’s high-turnover investment strategy, you probably paid as much as $500,000 in taxes in each of the past three years on fictional trading gains. All those can now be refunded as well.

A week ago, then, you reckoned that you were going to have about $11 million in total earnings (counting $1 million in interest from Bernie), on which you’d pay roughly 40% in taxes, leaving you with $6.6 million after tax.

Today, you have $10 million in tax-free earnings, plus $1.5 million in tax refunds, for a total of $11.5 million in post-tax income: roughly $5 million more than you were expecting.

Which doesn’t completely make up for your $10 million investment loss, of course. But it does soften the blow.

On the other side of the ledger, of course, the IRS was expecting $4.4 million from you this year, but now is going to have to pay out $1.5 million to you instead. Which works out at $6 million less money available for the public fisc. I haven’t seen estimates of the total cost of the Madoff fraud to the US government, but it’s surely in the billions, and quite possibly in tens of billions. Which is real money even by government standards.

Traders rejoice in their own misery, and the government’s going to wonder why there isn’t any money coming in.

Well, such is life – losses involve tax losses as well. Maybe that’s why governments are so afraid of stopping bubbles; their own revenue comes down.

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