Rogue AI Agents, Off-Balance-Sheet AI Financing & Xerocon 2026

0:04David Leary: Is this even constitutional? Because this is the tax that targets basically 200 people in a state of millions and millions and millions of people. And I always had this impression that like taxes are supposed to be, you know, generally like equitable or like you can't just can you even could you do that? Could you just pass a lot of tax one person?

0:28Blake Oliver: Coming to you weekly from the OnPay Recording Studio.

0:58David Leary: That hurts. Hope it was fun. Everyone who was there.

1:02Blake Oliver: I got a little FOMO. I was looking at pictures. I got a little FOMO.

1:06David Leary: We've also got an interview with Ben Jaros from the Hoover Institution about the California billionaire tax. David, you've got a story here about all the accounts receivable on Microsoft's books that are, that's due to AI. That ties into this whole story about this off balance sheet financing of all this CapEx investment that's happening in like AI data centers that's not showing up on the books of all these big tech companies. We'll dig into the nerdy accounting around that. And we'll see what else we get to. But first, David, let's thank our sponsors.

1:41Blake Oliver: Our sponsors this episode are Canopy, Thomson Reuters, OnPay, and Cloud Account and Staffing. Let me ask you something. how much of your day is actually spent doing accounting? If you're like most firm owners, 30 to 40 % of your time is eaten alive by the work around the work. We're talking, chasing client documents, drafting the exact same emails over and over again, manual filing, and trying to remember what that client said on the last call on last Tuesday. It's an administrative task and it's killing your profitability. That's where Canopy comes in. Canopy actually delivers the all-in-one practice management promise.

2:17Blake Oliver: It handles everything from proposal to payment and the steps in between. Smart client intake, tax workflows, month-end close automation, and billing all are in one unified platform. No more duct taping 10 different apps together. Plus, they have Canopy Coworker. It's a secure AI assistant that lives right inside the platform and actually does real work. It drafts context-aware emails, summarize clients' histories, takes meeting notes, and turns them into tasks automatically. Early access firms are already seeing what's possible when AI works inside your workflow instead of alongside it. To see what a truly modern automated practice looks like, head over to accountingpodcast.promo.com.

2:55Blake Oliver: That is accountingpodcast.promo.com.

3:01David Leary: So if you follow what's going on in the AI world, the big news in the last few weeks was all of those hacks by AI agents coming out of OpenAI. and I think it's happened to Anthropic as well. They've been testing these frontier models and asking them to like figure things out, find vulnerabilities in systems. I think Facebook's had a story where rogue agents would like,

3:27Blake Oliver: they're creating secret message boards and communicating with each other. Then they didn't like one of the messages. So they deleted that person on the board and changed their code. Like they're acting like humans, like asshole humans, what they're acting like.

3:39David Leary: Well, they're really intelligent models and they're given a task and sometimes they decide to break the rules to accomplish that task. Yes. Just like people. And this isn't just happening inside of these labs where they're developing these frontier models. It's actually happening to regular people and to small businesses. And the stories are actually pretty funny. And one I saw that's not accounting related that led me into this was about a guy in Australia who asked a Claude-powered AI agent to book him a spot in a gym class. It's a very popular gym class, not a lot of spots. And this was on Instagram.

4:19David Leary: And the agent found a hole in the booking system that let it book weeks earlier than the gym allowed. cloud. And so the user, this Australian guy asked if it could figure out how to move him up the waitlist. And the agent figured out the system. It had no authorization checks. So it deleted another person's reservation. And when the guy realized what his agent had done, he asked it to undo that, but it couldn't because the booking was gone. So that's an example, right? Regular cloud user asked to automate a task and the agent goes and delete somebody else's booking because the website is insecure.

5:00David Leary: And this kind of stuff is starting to happen in accounting. And Accounting Today did a great write-up of rogue AI agents in accounting. And Sage's CTO, who has been a guest on this show, Aaron Harris, he wrote about how he He was testing an agent that he named Arthur, using a spreadsheet for a fictional company to see whether it could supply the reasoning normally structured accounting software provides. And what happened is that when two invoices arrived from the same vendor for the same amount on the same day, Arthur assumed they were duplicates and deleted one without permission. and because Arthur had access to Aaron Harris's email inbox, it inferred that Harris would miss a delivery and emailed the vendor to reschedule it without telling him.

5:55David Leary: But when confronted, it denied acting and asked Harris to prove it. So when you give autonomy to AI agents, this is the risk. And actually something like this happened to me last night, David. I was using a Claude in voice mode on my iPhone. And I have some rules in the desktop app where if I ask it to like send an email, it won't. It will draft the email and stage it for me, but it won't actually send it. That's on my work account. And that's part of like our organization settings that I configured when I set it up, but I was using Claude on a personal account and I hadn't configured that. And so it didn't have any of those restrictions and it just sent the email.

6:42David Leary: It drafted an email as me, didn't run it by me, and then sent it. Thankfully, the email didn't have anything bad in it, right? It didn't quite sound like me, but I mean, these are the risks you take. some other stories here in this article Ellen Choi founder of Edgefield Group she has an AI chief of staff she calls TARS I think that's from that what's that movie Interstellar the robot that walks around that looks like a brick

7:22Blake Oliver: the blue phone book, a phone booth right? No, no.

7:26David Leary: It's like silver. It's like metallic. Anyway, it doesn't matter. She calls it TARS. TARS mistook an unusual but legitimate purchasing pattern for duplicate payments and recommended auto-refunding thousands of dollars in real revenue. But thankfully, it lacked the authority to execute it. She hadn't given it permission to actually do refunds. But if she had, then it would have done it. so her recommendation for anyone listening who wants to control these agents is to not allow right access or automatic execution so like if you're using the cloud desktop app or whatever you when you connect an integration you can specify which tools it needs to ask for permission to use and which it can just use automatically and i go in there and i always like make sure that the right tools the ones where it can actually change things or delete things those I lock down pretty tight.

8:23David Leary: I'm not going to let it like send an email without me. But you have to actually like set that.

8:29Blake Oliver: But yeah, you have to know where these settings are. I just got the new Google Pixel 11 phone yesterday. And it's very AI heavy. And it's every time I turn around, it's doing something automatically on my phone. Like you called me earlier and it immediately wanted to start transcribing and recording our phone call. Like, I don't know where all these settings are. Like we're entering this new world where like, it's crossed the line of like me asking you to do something to quickly like I'm going to start saying stop doing stuff because I don't even know what it's doing at this point. I might have to turn all these features off on my phone because I don't know what it's doing.

9:04Blake Oliver: It's just like it changes words on my home screen. It suggests this. It seems like it's convenient. Like here's your next appointment. But when it tries to record a phone call, I never set a setting for that. Where did this come from? So we're in a whole new world.

9:16David Leary: So Byron Patrick also shared his experience with a rogue AI agent. You know, Byron, David, he's now a senior product manager at Carbon. And he asked an assistant to summarize his thinking after a customer conversation. But instead, it created a shared document and drafted a Slack message to the team. Fortunately, no data left the company. Nothing was deleted. but what if it had shared like the document with somebody outside? What if it had emailed the information to somebody that wasn't on the team? His standing rule is quote, give me a plan before acting unquote. So the agent has to explain what it intends to do and in what order before execution.

10:02Yeah.

10:03Blake Oliver: And we've implemented that for AI and developer tools. All the coding tools have that, that ask and build, ask and build, but I'm not seeing it in accounting tools. It's just, there's a lot of just doing, or maybe posting, like it needs a draft and then a post. Yes, go post these transactions now.

10:24David Leary: All right, David, let's talk about all this off-balance sheet AI financing.

10:28Blake Oliver: Or on-balance sheet, I guess, right? If you want to call it that for Microsoft's case.

10:32David Leary: And I'm going to let you kick that off with this story about Microsoft and their accounts receivable growing by tens of billions of dollars. But before that, let me thank our next sponsor. And that is Thomson Reuters. If your tax workflow still feels like a grind every busy season, you're not alone. We hear from firm owners every week who are buried under disconnected systems, manual data entry, and staff stretched way beyond their limits. But it doesn't have to be that way. Thomson Reuters built the Tax Automation Suite to solve exactly this headache. It connects SafeSend, SurePrep, and UltraTax CS into a single ecosystem that covers every step with true end-to-end automation, from gathering a client's documents to final delivery.

11:19David Leary: We're talking up to 65 % fewer clicks per return, AI-powered data extraction that saves 90 minutes per return, a 58 % increase in capacity with current headcount, and a 55 % improvement in profitability because those time savings go straight to your bottom line. This isn't some patchwork of tools bolted together. It's a purpose-built suite where data flows automatically between every stage. That means no rekeying, no bottlenecks, and no back and forth with clients. Firms using it aren't having to bring on additional staff during peak season while still growing revenue. That's the power of real automation to see why tax professionals across the country are making the switch to thompson reuters head over to accountingpodcast.promo slash tax automation that's accountingpodcast.promo forward slash tax automation let's talk microsoft so microsoft's an article that microsoft

12:14Blake Oliver: is owed billions that it hasn't collected and so specifically they have 80 billion owed to them 81 $21 billion is on their balance sheet. And so first I was like, what's that? Versus like other corporations, like paint a picture. So Apple, or I'm sorry, Alphabet, Google is about 55 billion. Nvidia is about 47 billion of accounts receivable. Apple is about 73 billion. Walmart's 10 billion. Caterpillar, who in theory is selling everything financed, right, big, huge tractors and machinery, Caterpillar, right? big diggers for, they only have$10 billion on their accounts receivable. And so then I was like, all right, well, like, what about the history?

12:56So if you go back to 2015, the end of the year there with about 17.9 billion,

13:04Blake Oliver: right? So this was, as a percent of revenue, it was 19%. And the implied days to collect was about 70 days. But then it really, and then they had a couple of years where it jumped a good $4 billion a couple of times, but then you get to 2022, 2023, 2022 to 2023 is about a 4 billion jump. So it goes from 44 billion to 48, but then it goes to 56 billion, 23 to 24, then 24 to 25, from 56 to 69 billion. And now in 26, it's up to 80 billion. So what happened the last three years? AI companies, right? So, so you start doing, and so they've disclosed that of the 80 billion, get the exact number here,$6 billion is definitely from OpenAI, but they don't disclose all the rest of who owes them the money.

13:50David Leary: And so this is wild because Microsoft invested money in OpenAI. Yes. OpenAI then buys compute from Microsoft, but doesn't actually pay them cash. It's in AR. I mean, we don't know how much, I guess, they've paid, but it's funny, right? So Microsoft gets to book the revenue even though it hasn't collected the cash. And this brings up an interesting question, which is like if there is an AI bubble that pops and these AI companies can't pay their bills.

14:27Blake Oliver: All the legit companies are going to suffer, which is going to crash the stock market, and then it just dominoes from there. We have a real bubble happening that's a dangerous bubble.

14:35David Leary: Well, let's talk about that off-balance sheet financing, because that was all on balance sheet. But there is, and that's only, you know, whatever. One company. $6 billion owed to Microsoft. Not a big deal. Wall Street Journal, they did an analysis of securities filing footnotes. and they found roughly$3 trillion in off-balance sheet commitments across nine companies, Alphabet, Meta, Amazon, Microsoft, Oracle, NVIDIA, Broadcom, SpaceX, and AMD, all companies that are big in the AI bubble, the AI boom. The article, if you want to go look it up, is called Why Big Tech's AI Spending is$3 Trillion Higher Than It Seems.

15:22David Leary: These obligations are tied to AI data centers, chips, hardware, energy, and future investments. Basically, all the capital expenditures related to the AI boom. So it's$3 trillion off balance sheet commitments. How much of it is on balance sheet? $600 billion over the last 12 months. and it equals about three times their outstanding leases and long-term borrowings. So there's 1.2 trillion of leases that have not commenced and 1.9 trillion of purchase obligations. That's how you get to that 3 trillion number. Uncommenced lease obligations, so leases that have been committed to but haven't started, four times higher than just one year earlier.

16:18David Leary: Here's the accounting tie-in. Under the current rules, purchase commitments get to remain off balance sheet until delivery. Future leases remain there until the lease commences off balance sheet. So signed contracts, these commitments for $3 trillion do not appear as recognized liabilities yet. So this is going to make all these commitments that are not on the balance sheet make the leverage of these companies. In other words, the debt versus their income and their other assets harder for the investors to assess because it's in the footnotes. It's not on the balance sheet. So here's an example to illustrate this.

17:09David Leary: Meta's Hyperion data center campus. It's enormous. It covers the equivalent of 1 ,700 football fields.

17:18Blake Oliver: That is insane.

17:20David Leary: Can you imagine? 1 ,700 football fields all stuck together. Meta is building this project, but neither the campus nor its$27 billion of construction debt appears on Meta's balance sheet. A company called Blue Owl Capital, this private equity fund, is funding most of the joint venture that owns Hyperion. It has a holding company. The holding company is Beignet Investor. It raised the construction financing through bonds. So it issued debt in the form of bonds to fund the construction. And Meta, even though it's Meta's campus, is the minority owner and tenant. And it makes the lease payments that support the payments to the bondholders.

18:08David Leary: It has a four-year lease that begins in 2029 with renewal options extending 20 years. Meta has guaranteed bondholders against losses if it leaves before the full period, but hasn't recognize the liability because it considers payment under the guarantee improbable. So it's saying that it itself doesn't think that it's not going to be able to pay the lease payments. So therefore, it doesn't have to recognize the liability because it probably won't happen. So you see the risk there that is no longer represented in numbers on the balance sheet because a potential future liability should be calculated.

18:59David Leary: I mean, investors would think about that, right? But under the accounting rules, if it's improbable enough, you don't have to recognize it at all.

19:09Blake Oliver: The accounting rules are there, but from the public opinion, when this all explodes, who do you think is going to get blamed? accounting firms accountants and accounting firms the auditors blame for the auditors but why didn't you tell us this was going to happen why didn't you tell us these numbers were not kosher right like they're just gonna like accountants are going to be the ones that get blamed for the ai bubble pop when it's all said and done should have been the episode title name well accountants will be

19:37David Leary: blamed for the ai bubble collapse so that hyperion lease commitment it's uh meta has reported an initial Hyperion lease commitment of about$12.3 billion and$347 billion of total uncommenced lease obligations as of June. So only$12.3 billion is on the balance sheet. $347 billion is not yet. That's a big difference. $12 billion,$347 billion, like it shows you the scale of all these off-balance sheet liabilities.

20:19Blake Oliver: It's going to have to show up somewhere eventually, right? Or as soon as somebody doesn't pay, it's going to be like that collapse.

20:27David Leary: Right, because let's say Meta doesn't make good on its lease payments. What is going to happen to that holding company, to those bondholders? They're not getting their bond payments, right? They're not getting their money. So then the bonds plummet in value because the rating goes down. It goes to junk because Meta is not going to pay it if that happens. If Meta gets in trouble, it won't make the payments, and nobody else is going to do it because who else is going to be able to take over that campus that was basically designed for Meta? Is it easy just to take over someone else's data center?

21:10David Leary: and these chips, we've been talking about how the chips are theoretically only useful for like two to three years because things are changing so fast. So why would anyone want to do that?

21:22Blake Oliver: Nobody's going to buy the old chips.

21:24David Leary: Yeah. And Meta is saying that, oh, it's really five or six years, but even that's not very long. They depreciate in value very quickly.

21:33Blake Oliver: It's starting to feel a lot more like 2008 and not the 1999 dot-com bubble. 2008 was all the packaging of bad loans inside of bigger packages of bad loans and a lot of circular arguably circular financing right and there's other derivatives all the derivatives around those mortgage-backed securities yeah and it was rolled up rolled up rolled up and as soon as one of it collapsed like they they the demonstration was a jenga tower in that movie right it's one collapsed and then everybody collapsed and it took out a whole bank like this is this is it feels like dot com 1.0 was just a lot of speculative bubble and investing yeah they weren't all tied to each other it was just people oh yeah sure pets.com they're just investing these companies right but it wasn't like this is the companies investing in each other which is a whole different

22:19David Leary: game the circular money thing yeah it's it's there's there's it feels similar but it's also different i mean we don't have the derivatives the derivatives are when you get into real trouble because then it's really hidden yeah when you have derivative financial products on top of of securities that have been packaged together and repackaged together a bunch of different times and nobody knows what's in there anymore. That's when you start to get into like layers and layers is when you start to get in trouble.

22:44Blake Oliver: But isn't that kind of what the SpaceX IPO was? Well, I mean, it was a roll up of all these other things rolled up into the SpaceX IPO. It's confusing. Now you're investing in things you didn't know you're investing in.

22:57David Leary: I mean, yeah, it's similar, right? It's like by packaging together all these smaller things, you obfuscate - Because you're investing in Twitter that you didn't want to invest in,

23:06Blake Oliver: but now you have an investment in Twitter.

23:08David Leary: And really you just want to invest in rocket technology or what the real winner, which is what the satellites, the Starlink. And then people also just betting on Elon must have figured out AI better than anyone else and just win the race, right? But yeah, you're right. It's like if you actually took all the pieces and considered them separately and IPO'd them separately, they would not get the price that you get if you bundle them all together. Because when you hide all that stuff, you get more interest because people want to buy one thing, but they have to buy the package. It's like cable.

23:48Blake Oliver: And that's what they did with the loans, right? They bundled them all up and they stuffed a bunch of bad crap in there like Twitter into a different investment. It feels more similar to that than it does the dot-com 1.0 boom.

24:00David Leary: A few other companies I just want to highlight. Alphabet. Alphabet has lots of purchase commitments and contractual obligations. It was$811 billion as of June 30th. $811 billion. It went up that much to that number from$332 billion only three months earlier. year. So it went up by like 400, 500 billion, right? NVIDIA committed to 27 billion of equity investments between April 26 and the end of its fiscal year in January, 2027. Like less than nine months, I think, 27 billion of equity investments. And here's the problem, right? We talked about those lease payments. Alphabet and Amazon recently reported negative free cash flow.

24:56David Leary: So that means CapEx is exceeding operating cash generation. They're spending more to invest in capital assets, these data centers, than they're getting in cash from customers. and free cash flow when that goes negative that's like the first indicator that there could be a potential issue because they have to for this to be sustainable they have to have free cash flow you can't run a business on negative cash flow indefinitely so something has to turn around these assets have to start generating enough revenue to cover the lease payments or it's not going to work. And then they're going to default.

25:43Blake Oliver: If there's no revenue coming in, because that's the one thing with Microsoft, right, part of the article is that all these receivables is generating $183 billion in revenue or cash flow for them coming in. And you're right. If you owe all this money, if you don't have the money coming in, which is obviously happening at different parts of this chain. Yeah.

26:03David Leary: And this is the thing that like the average person, the non-accountant, just struggles to understand is the difference between revenue and cash. Yeah. Because it's all about timing. And when you have a period of heavy capital investment and circular financing, you've got all these companies reporting revenue, but they're not getting cash in the bank. And eventually the cash has to come in or the whole thing collapses. So there you go. David, should we talk about Xerocon a little bit since we teased it?

26:41Blake Oliver: Yeah, you're going to jump in.

26:42David Leary: We don't have very much time at all because we got to play this Ben Jaros interview about the billionaire tax.

26:46Blake Oliver: Yes. So let's jump into the next ad for OnPay. I'll do that while you prepare your story.

26:51David Leary: Sounds great.

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27:31Blake Oliver: Their seamless QuickBooks and Xero integrations eliminate manual journal entries, and they support any type of business you serve. Farms, restaurants, CAI. I had it on mute, sorry. This is the problem. I have it on do not disturb. I shouldn't have a ring like that. What is going on?

27:46David Leary: You got to ask CAI to fix your settings, right? Can it do that now? Because I can't do that with my iPhone.

27:52Blake Oliver: Yeah, I have, like literally it's on do not disturb. I apologize for that. So we'll rewind for a second. They're seamless QuickBooks and zero integrations eliminate manual journal entries and they support any type of business you serve. Farms, restaurants, nonprofits, you name it. on pay can handle unique requirements without adding complexity and on pay keeps pricing simple too everything your clients expect from multi-state filing to off-cycle pay runs it's included no hidden fees no surprises to book a demo head over to accountingpodcast.promo slash onpay that is accountingpodcast.promo forward slash o-n-p-a-y all right we got to talk about zero

28:25David Leary: con real quick we've got like five minutes and then i have to go and then we'll we'll play this interview for everyone. That'll be like the rest of the episode. Okay. So, Zerocon, neither of us were there. We got the press releases. What stood out to you, David? I see a bunch of AI stuff.

28:43Blake Oliver: I think the new things that stood out to me were stuff Melio's pumping out. So, they bought Melio in theory to get new customers in the States, but it's looking like Melio is becoming like a innovation development center. So Melio launched an expense management tool, which is weird because didn't Xero buy Hubdoc for that? Right?

29:06David Leary: Yeah.

29:06Blake Oliver: What happened to that? Melio announced that they have an API, but then the other thing that caught my eye was Melio announced the launch of Casper and it's an AI powered client manager for accounting firms. So Casper will proactively identify missing information, go contact clients, retrieve information for the close. So they built like a close agent called Casper that will work with Jax, the agent in Xero. But it's interesting that, you know, this acquisition now is leading to these other new product integrations for, or I wouldn't say integrations, but product offerings for Xero.

29:43David Leary: It sounds exciting, but the issue with this kind of thing, getting into practice management, is that it never quite works the way you want it to as an accountant. Like I've never heard any accountant say, oh, I love the QuickBooks online accountant practice management tool or whatever Xero has built in previous years. Like it's never right. And you always end up using something like our sponsor this week, Canopy. Yes. Because they are specifically building practice management, not just bolting on something to a GL. And it doesn't get like the feature prioritization.

30:19Blake Oliver: It doesn't get the attention it needs, right? So it's one product manager, one developer, and then it never gets the support. And then that person leaves and then the whole project falls apart. Yeah.

30:30David Leary: So I've always said they should just partner with these practice management solutions to like integrate better. And that's what Xero did when it comes to payroll, because they struggled to build payroll in the US for years. They partnered with Gusto eventually and built an integration to do that. And now they announced at XeroCon that Xero Payroll is powered by Gusto. Basically, they brought Gusto directly inside of Xero. And why not do that with the practice management apps? Let them create a tab that you can open up in Xero and have your practice management stuff there. Why not do that? And you could just choose which one you want to use, Carbon or Canopy or what have you, right?

31:16Blake Oliver: Well, I think the difference is Xero tried to do that with Gusto in the past, these failed rollouts of Xero payroll with Gusto. But Gusto as a platform has changed to where they are basically payroll APIs that you could build a payroll app on top of. And that's basically what Xero is doing. They're building a payroll app on top of – it's powered by Gusto under the covers, but it's really not – it's not going to taste and feel like Gusto.

31:43David Leary: Zero's UI, but then connects to Gusto. I don't think it's Zero's UI.

31:47Blake Oliver: It's Zero's calculations, calculators. It might be. Well, no. Sorry, you said Zero's UI. Yes, Zero's UI, Gusto's calculators.

31:54David Leary: Then Gusto is powering all the actual payroll calculations and everything. And so, okay.

31:59Blake Oliver: So going back to your argument about practice management, one of the practice management platforms like a canopy or something would have to have like an API where Zero could build a front end that's powered by the practice management APIs. or the engine.

32:15David Leary: Let's see, any other updates from Xerocon that are worth highlighting here? Oh, they've updated auto bank reconciliation. I griped about that on the show previously. My problem with it, I turned it on. And my problem with it was that it was reconciling stuff, but it wouldn't tell me why. I could view a report of what it had auto reconciled and what it had done, but I couldn't see the logic and I couldn't teach it. So now the auto bank rec tool will explain why it matched high-confidence transactions and send exceptions to the humans. The tool has auto-reconciled more than 100 million transactions since launch, probably incorrectly.

32:56David Leary: So maybe they should also build a tool to go back and audit what it did. They've got this new smart document capture feature that will read source documents and enter data directly into Xero. Easy win to do with AI. In the future months, their bank rec, their auto bank rec tool is going to address more complex cases, including splitting one payment across sales and fees. They've got this feature called document requests coming soon. That's going to let the zero AI, which is called JAX, contact clients, send reminders, answer clarifications, and match documents to transactions while requiring the accountants to approve every step.

33:37David Leary: I wonder if that's the same thing as what Melio announced. That might be the Casper tool. That's the Casper thing?

33:41Blake Oliver: Yeah, I think that's the Casper.

33:43David Leary: Cashflow actions identifies potential cash shortfalls, payment follow-ups, and bill protection aim to accelerate collections and improve control over outgoing cash. Oh, those are feature names. I was so confused. So they're going to be building these features. I hate covering future product roadmap stuff that gets announced at conferences. I'm going to skip past that. No more coming soon stuff. Sorry, guys. You can't fill up your conference with promises. just show us what you've built, announce it there. Like you get into that habit. And the problem is you're always going to be doing future stuff until you get to the point where like some of these apps, like there's nothing new at the conference is all just, here's what we're going to do.

34:24David Leary: And then it's always, here's what we're going to do forever. And they never actually do it.

34:28Blake Oliver: Like, well, Microsoft was the king at that to intimidate others from getting into the market.

34:34David Leary: All right, David, I have to run, But first, I want to introduce our guest this week. David and I sat down with an economist, a research fellow from the Hoover Institution, who has run the numbers on the California billionaire tax measure. And it's a lot messier than either side is letting on. There's a lot of complexity in this, especially because it's a wealth tax. And taxes on wealth are really hard to calculate. And there's a lot of unintended consequences. And this California one, which is on the ballot, is going to be a doozy if it passes. It's looking like it might. Because as you say, David, in the interview, it's like 48 % approve it.

35:18Blake Oliver: Yeah, they need 50 % to pass it. And it's like 48 % are supporting it already, which is amazing to me, the numbers. Before you hit player where you're queuing that up, I'm going to do our last ad for cloud accountant staffing.

35:28David Leary: All right, let's do it.

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36:34David Leary: So David, we've been talking about this California billionaire tax on the show a lot recently. This one-time 5 % tax net worth, California residents worth$1 billion or more. So it's a wealth tax on billionaires in California. and there's a lot of opinions about this well because it's going to go to the ballot right it's going to be on the ballot yeah proposition 40 november 3rd on the ballot in california and there's a ton of opposition to it a lot of money flowing in uh from obviously billionaires i think it was uh one of the google founders has put in over a hundred million dollars to fight this proposition.

37:21David Leary: And then there's a lot of money and activity coming in from the left. We've got unions supporting it and the governor caught in between. So we wanted to get a different take on what's going on with this. And so we've got Ben Jaros here from the Hoover Institution. He's a research fellow there. Ben, welcome to the program. Hi, Blake. Hi, David. Thank you for having me on. Great to have you here. So Ben, let's talk about this tax. Is it good? Is it bad? What's it going to do to California's economy? Is it going to push out the billionaires? Is it going to raise the money it's supposed to raise? Give us your take.

38:06Yeah. I guess I'll stay away from good and bad. That's more of an opinion position.

38:12David Leary: You leave that to us. That's all right. Yeah, I'll leave it to you guys, leave it to your listeners, and I'll just present what we've worked on at the Hoover Institution and how I see the measures. So Prop 40, as you said, is on the ballot November 3rd. It is a one-time 5 % tax on net assets of people who have over a billion dollars in assets, excluding residential real estate. It's an important exclusion. Good or bad for the state? The proponents, when they filed it, wrote an expert report claiming that the measure would raise about$100 billion for the state and that the revenue would go to backfill funding reductions from one big, beautiful bill.

38:57That's their claim. When we went through a residency or audit, so to speak, our team at Hoover, what billionaires had actually left? when you exclude the billionaires who actually left to file, either move their businesses, most notably, Larry Page, move 15 of his different businesses before the filing date. And Sergey Brin as well, move some of his you lose about 50$500 billion of the taxable base. If you just use their December 31st, functionally, it's January 1st, 2026 cutoff. So When you actually start removing individuals who may have left in time, you get a max revenue of$67 billion. That's your top end.

39:47If you start removing people who you're going to have, and a lot of this is in accounting, and I guess probably some tax law lawyers are on listening to this as well. If you moved a lot of stuff before the first, you're going to have a residency fight, no matter how you square that peg around that square peg. So you have the ceiling there. And then our team tried to estimate, okay, what about silent departures, people who don't make the news. And we from that for that estimate, we looked at the European wealth taxes, and what behavior response, how many people moved when by people I mean, net assets, what fraction of the assets moved.

40:28And our team estimated a lower bound of 35 billion with a central revenue estimate of around 40 billion, 35 to 46 billion. So we estimate about 40 billion when you go through who left. And we also excluded residential real estate. So we went through, these are billionaires. So you can find a lot of the residences on Redfin or Zillow realtor.com. We found about 130 something of their residential real estate assets and we exclude them from the base. The proponents didn't do that. And yeah, when you do that, that's how you get to that 67 billion round number. So.

41:03Blake Oliver: So when they introduced the bill, the thought was, hey, there's 536 billion we're going to be able to possibly tax. And then as people flee the state, now it's down to you're saying around 40 billion left? Well, so there's about, when they put it on the ballot, there was about 2.3 some odd trillion dollars in net assets, billionaire net assets. They say in October, when this measure was filed with the attorney general's office, there was about 2.3-ish, you give or take, right? There's a lot of publicly traded companies that surround where it is. Between the filing date in late October and December 31st, about 500 billion of that 2.2, 2.3 left the state.

41:51Wow. Right. That's a lot. So that's, well, there's a residency dispute there, but as accounting, this accounting podcast, tax law podcast, it's not revenue the state should bank on getting if you're conservative about it. And they publicly, I mean, it's not my job to relitigate whether the New York Times is tracking where Sergey Brin or Larry Page is. If they said they moved and they incorporated 15 of their businesses in a different state, I guess good luck to the state of California trying to get them. Or anyways, yeah, so that's that's what I'm saying. So they if they're taking the the 5 % of the two trillion, then you get the hundred billion and they have a behavioral response estimate.

42:36They estimate about 10 % would move or leave and then a greater fraction than that moved before the 31st cutoff date. And then in late February, Mark Zuckerberg left as well. Him leaving alone would decrease that$67 billion, another$12 billion. But he left after their cutoff date. So that's an interesting thing to talk about on the podcast is the way the framers, the proponents wrote the measure is the measure is voted on in November, but the residency for whether you pay the tax, Your residency is determined on one day, January 1st, 2026, retroactive, which is going to create, many people in your mind probably thought, a clear, probably due process and commerce clause issues.

43:23David Leary: Right. Because I've left the state. Let's say I'm one of those 200 billionaires who decided I'm leaving, but I didn't get out before January 1st. Now I'm somewhere else. I'm not in California anymore. do they even have jurisdiction or whatever you want to call it? That's right. To tax me. That's right. Is that revenue going to be disallowed? Right? Not in dispute. Dispute would mean California has a claim on it. Will those net assets be disallowed by a court? And I'm certain whoever's advising Mark Zuckerberg has made that point that his$12 billion could very plausibly be disallowed by the courts because he's left.

44:03So it sounds like the argument that, well, what you're implying here is that you do a tax like this, you decide you're going to tax 200 billionaires on their net assets, and a

44:19David Leary: bunch of them are just going to get up and leave the state, reduce that taxable base there, and thus weaken the tax. I want to dig into this more because we've seen other states do this. Massachusetts, they passed a millionaire's tax back in 2022. And in Washington, there was a capital gains tax in 2021. And as far as I know, we didn't see a bunch of millionaires leaving those states. So why is –

44:51Blake Oliver: Jeff Bezos. Didn't Jeff Bezos leave Washington and move into his parents' house in Florida? or aircraft? That's true.

44:58David Leary: It wasn't his yacht. I don't remember. I mean, my pushback on that is those taxes were not wealth taxes. They were increased rates on income taxes, higher rates on earned income. Wealth tax is different. The effect, the comparable capital income tax rate on a 1 % wealth tax, if you assume historic risk-free rates to capital is about 17.5%. So take a 5%, 5 % would be 52.5%. We have a calculator on our website and a paper to back up that. So you're saying like a 5 % wealth tax, one-time wealth tax would be like equivalent to a what? Income tax? Well, so remove the word one time, a 5 % wealth tax would be equal to a 52.5 % income tax.

45:45David Leary: It was 5 % year after year. Yeah. Got it. This is going to be a one-time wealth tax, right? Allegedly. Well, an important, let's talk about that. There is a clause within the act where the legislature with two-thirds majority can amend any part of the act if it furthers the purpose of the act. So they can get rid of the one time. They can get rid of the rate. They can change the rate, and they can change the threshold with two-thirds vote in the state legislature. So to maintain its one time means you're entrusting that what California wants to use these funds for. The state legislature is also just going to say, yeah, this is one time cost.

46:26So we could, you know, first digest that point. Let's dig into that if you want. Yeah, let's do it. OK, so the the proponents say that the revenue when we can say, OK, there's dispute between one hundred and forty billion dollars. The revenue is going to fund. healthcare reductions, one big, beautiful bill. Okay. What were the reductions from one big, beautiful bill that impact the state of California? There's two main components. First are the eligibility requirements. What are those? If you do not work, go to school or volunteer 80 hours a month, and you are on Medi-Cal, which Medi-Cal is the state's version Medicaid, then you, within a six month period, the state of California is supposed to audit it, would lose your coverage to Medi-Cal.

47:14Now there's about 15 different exemptions. You're not able bodied, you're exempt, dependents exempt, SNAP exempt. There's 15 different exemptions to that. It's a pretty kind of a Clinton era-esque work requirement would be the way to put it from the nineties. And about 90 billion of the 156 billion over the next 10 years. So about two thirds of the reductions come from that. The last 60 billion or so, it's about 156 billion over the 10 years. The last third comes from provider tax limitations, which most people's eyes glaze over when I say that, but provider tax limitations are where the provider taxes, when the state of California levies a tax on healthcare providers, the healthcare providers that pay the tax, the state of California then uses that tax revenue to fund healthcare in the state and it draws down federal matching funds.

48:08So that's search. So state state of California is better off. State health care facilities are better off. In fact, in the last 10 years, the state health care facility has lobbied to increase this tax. We'll leave that there. And the only one worse off is the federal government, which is through increased matching funding. A lot of that change. State of Connecticut last 10 years famously balanced their state budget through increasing provider taxes. The Biden administration flagged the provider tax limitations of California specifically as a gross use of the, because that quote is wrong, but he flagged it as a non-equitable misalignment of the way the federal drawdown was supposed to be.

48:51The increased matching was so if a state wanted to fund more healthcare, the federal government's going to help them do that, not use a circular finance mechanism to increase it. Okay, so there you go. So that's what One Big Beautiful Bill does to the state. Let's talk about Billionaire Tax Act. The language of the act itself does not commit the state of California to taking on the individuals who do not meet that work requirement. The proponents have said it does, but in the actual act language, it does not. It just designates a new health care spending account for the legislature to draw down 22.5 billion a year and some fraction a year for education, 10 % for education.

49:29It doesn't require that it's actually going to backfill. So maintaining that it's actually doing a backfill from one beautiful bill is not accurate. You're relying you're relying on the legislature. Then once that money exists, spending it on that ineligible population. And they could choose not to. They they have to spend it on health care education, but they don't have to pick up the people who lost coverage from one beautiful bill. Right. And the state of California is projected to run a$93 billion deficit over the next four years. So the idea that they won't find uses for that money is potentially stretches credibility.

50:10Right. So then you're. They run out of if you if you use our revenue estimate and you include the lost income tax revenue so we can chat about that. and you include lost income tax revenue, the state of California would run out of this one-time revenue by 2029. And two-thirds of the reductions from one big, beautiful bill are going to take place after 2030 because that's when the provider tax limitations start coming into effect. So what that means is the state's going to run out of the money right when they need it most. And the idea that if they, with two-thirds vote, can just change one word in it and make it permanent and aren't going to do that.

50:52I would say an expectation that's unlikely, and the billionaires are pricing that to be unlikely by the way they're moving. They're not reacting like this is a one-time tax. And I think that they have real reasons, other than academic reasons, to conjecture about whether they trust the California legislature. I'm just conjecturing on what's going on in Sacramento.

51:14Blake Oliver: I think their suspicion is probably somewhat valid because anytime somebody has an increased budget, you change your behaviors to spend all the money. And then now the budget went away, but your behaviors don't change. So you're going to have to go get more money. Like it's, yeah, I probably could agree with the billionaires. It's probably highly likely this is going to get extended. It's just, it's the nature of government, right? And spending your money, those departments. Once they get that money, they don't want to, they want it again and again and again they're hooked on it Ben let's set California aside well I guess we can include them but

51:49David Leary: let's just uh think about this in in principle in general right if a state wants to raise more revenue from wealthy residents and they don't want the impact that a wealth tax is going to have which it seems to be having which is these billionaires now leaving the state which means a bunch of money is leaving the state, right? Assets are leaving the state. Is there a right way to do this? Is there a different way? Is there a better way? One that's been talked about in a lot of circles for years on the federal level is it's called closing the tax gap between what people are projected that they owe versus what they actually end up paying in taxes.

52:31And it's a good accounting podcast. It's great to chat about this. Oh, we love the tax gap. We've done entire episodes on it. The question, you could argue a lot of what has been done on a policy lever to fix that in the last 20, 30 years has been grab a hammer and more enforcement on the IRS side or enforcement side. But that's not true because they've been cutting the IRS for 30 years, the budget.

52:57Blake Oliver: There's not more enforcement. Well, with the exception of the IRA. But the idea within the policy space as a response to the tax gap has been, well, we need more enforcement. And I would contend that the last 30 years undermine, I think, to your point, David, undermine that point. Parts of these are structural, right? The way we have separate accounting on a territorial basis versus we have apportionment on a statewide basis. It's a way of determining what fraction of business activity is taking place in a jurisdiction and whatnot. I don't work in the Office of Tax Analysis in the U.S. Treasury, but you could argue if they were really serious about working on that, they would look at what structural issues in the IRC should we do research on that are going to reduce the cost we literally have to pay for enforcement but make it structurally a way where the tax gets closed.

53:56How can we close it through changing either the incorporation or the way we realize income? Plenty of people talk about the stepped up basis of death. I mean, I think that the borrow by die narrative is overstated. If you look at actuarial tables of what billionaires are actually going to benefit from that, at least in theory, I think it's overstated. It's a great talking point. Right. And for those who don't know, borrow by die is I'm going to I got to borrow against my assets. Elon, you know, say Elon Musk could borrow against his assets, spend that money, but then the return of his assets is going to exceed what he has to pay on interest for the debt.

54:39So you can just use infinite money glitch. Right. So does. Yeah. And then he dies and his heirs. Heirs and they get his numerous heirs. never yeah exactly and and i if you really look at the act if if that was actually true you'd see more people doing it uh the only the most billionaires want to live forever they don't want to die there's that right so the only the only i think and some people probably could do much more serious work than my back the envelope work with an actuarial table but unless you're within five years of death it doesn't seem like it makes a lot of sense to me but and if you know you're within five years of death, that's another interesting, you know, look through the through

55:21David Leary: the looking glass moment, I guess. I got one more question before we go, Ben, and that is, is this even constitutional? Because this is the tax that targets basically 200 people in a state of millions and millions and millions of people. And I always had this impression that like, Like taxes are supposed to be, you know, generally like equitable or like you can't just can you even could you do that? Could you just pass a lot of tax one person?

55:52Blake Oliver: Only tax blakes. Yeah. You cannot. Right. Bill of attainder would be the legal phrase for this. Right. The majority cannot vote. We're going to tax. The federal Congress could not tomorrow say we're going to pass a trillionaire tax. Couldn't do it. All right. There's only one person that hits. That would be unconstitutional. The bill of attainder sits somewhere between commerce and due process, and there's some tax attorney who can explain this much better than me. Whether the 200 individuals hits that threshold, I don't know. There's certainly legal arguments for why it does. The other parts where it's going to face a lot of constitutional challenge are, first and foremost, that retroactive residency clause.

56:33Can we pass a tax in November that's effective back to January? that is a new tax, right? That's a key point within law. There have been non, there have been priorly existing taxes that have been changed retroactively, but not new ones. The second is whether that one day of residence gets the application of a full, you know, you guys might know this better, 183 days of residency for income tax purposes gets squeezed into one day. That's going to be a fight. And then they want worldwide assets, right? So they're trying to tax worldwide assets. Suriana, who is a foreign national, I think Barbados, one of those, right?

57:15If she has assets there, those we have tax treaties and then the supremacy clause, the constitution that says taxing authority of states stops with a federal at water's edge where the federal taxing authority stops. So whether California can lay claim to assets that are literally outside the jurisdiction of even the nation as well. Good luck. So yeah, so those are all clear legal problems, whether it's patently unconstitutional is for a tax attorney or a judge to decide. But I as an economist reading it with some tax attorneys on our team, there are clearly constitutional issues with it. The state of California, if it passes, we'll have to fight it.

57:55Yeah, there's my this my final answer on that. David, I'm gonna let you have the last question. Yeah.

58:01Blake Oliver: So I saw some poll results and you have 48 % of the people are for it, 41 % oppose it, and 11 % are undecided. What is the argument that the billionaires are making that they have in common with the common voter to convince 41 % to oppose this? I'm surprised there's not a higher amount of people opposing this. There's no interest. I share no interest with a billionaire. And then the second follow-up question -

58:26David Leary: Are you surprised that it's higher, not higher, or that not lower?

58:29Blake Oliver: I'm surprised 48 % of the people are supporting, or 40 % support the tax, but an amazing 41 % are against it. Considering it's 200 people, it's an amazing percentage. It tells me that when, I think, Sergey Brin just spent$100 ,000 on advertising campaigns against it.

58:48David Leary: I think it was$100 million.

58:49Blake Oliver: $100 million, yeah, against this. Obviously, what's the argument? What's making people believe, oh, this is bad for the state of California or bad for the country? You know, I actually, I think it comes back to not just the right phrase and word ideas, a social compact. We pay taxes and we get a certain level of public services for them. There's something broken in the state of California right now. And it became really visible in 2020, but it's been going on for the last 26 years. Since 2000,$50 billion in taxable income has left California for other states. That's equivalent of$5 billion plus in income taxes.

59:30So some people are saying I pay X amount of taxes and the public services I receive are not commensurate to it. And eventually the level gets out of whack and I move. It's not a question of who, it's not a question of if, it's a question of who someone knows who lives in California, who left in the last 10 years for some other state, whether it's Nevada, whether it's Texas, with Colorado, Nevada, wherever. And that is starting to ring true. So the proponents are saying people don't actually move because of tax increases. And to that, I would say, wherever I sit as a lay person or expert, Elon Musk was in California six years ago.

1:00:10Larry Ellison was in California six years ago. Peter Thiel was in California in the last five years. That's all true. We know they were here and they left because at some point, Tesla should still be building cars in California. They're not. Or at least it's reduced. Their operations are reduced. That is tangible. I can see it. It doesn't matter what an economist says at Berkeley. I see people moving. I know people in the upper middle strata who moved because, and you can look at this. If you had dependence during COVID in California, it was one of the most likely predictive impacts. Okay, you were getting out.

1:00:46Schools closed. I pay a high tax bill and schools are online. I'm out of here. Right. So something's broken. And whether that gets communicated to Sacramento, whether that gets communicated to the proponents, I don't know. But that's this is an opportunity for that 41 percent and potentially higher. I think that's what they see, that this is not an academic exercise, that when these founders leave, that there's costs that aren't being talked about by the experts, so to speak, that they they own. I mean, since 2015, about a quarter million jobs by anchor firms, Google, Meta, et cetera, have gone to other states.

1:01:25That's a real, for them, a plausible issue. That's a tangible issue in their neighborhood. That's what I think it is. I think it does come down to that. They recognize that something's out of balance. They may not be the one paying, but they implicitly know. What does California need revenue for? Since 2019, state tax revenues are up 55%. That's greater than 45, 46 of other states, entire state budgets. And, but somehow they found a way to spend 60 % more on what? Did your services in California go up by 60 %? I haven't heard any, I mean, if I, I'm not meeting people who validate that view. So there you go.

1:02:03That's, that's the summary on it, David. And, and I, you know, that there it is.

1:02:09Blake Oliver: And is this a trial balloon? if this passes in California, are there states gonna be like, hey, we just got like five new billionaires here. We should just do the same tax. In 2023 or 24, state of Texas made an unconstitutional tax. Well, just as a sidebar, I'm not a billionaire, very clearly. Interesting. Right, so maybe some states recognize we're gonna benefit from some capital flow if we make our business environment more supportive and friendly to that. Yeah. That's I don't. Does it scale? Great question. I don't know. I I'm not an armchair political economist. Some people are making the case that it will.

1:02:53I don't know. Well, I guess if it passes, see how it goes. I'm certain that's what the proponents want. But as you pointed out, David, enough of the California electorate is saying we pay Cal we pay Sacramento enough.

1:03:06David Leary: If it passes, it's going to be an incredible case study for what happens when you do a meaningful wealth tax. Ben, thank you so much for joining us and sharing your knowledge with our listeners and with me and David. Very informative. I've been speaking with Ben Jaros of the Hoover Institution. Ben, thanks a lot. Mike and David, thank you for having me on.

1:03:30Blake Oliver: Thanks for joining us this week, everybody. Don't forget, you can get CPE for listening to this show. You just want to head over to earmark.app. You can register really easily. If you already registered, just go to the latest episode, take the quiz, get your CPE certificate for this episode, and check out all the other shows and courses and channels that we have in the earmark app. It's just earmark.app. See you next week, everybody.

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