-Thomas Jefferson on speculators
Are
Capital Gains Rates Necessary?
There are several valid arguments for limiting tax on capital gains. Likewise, there are good arguments for never imposing any tax on anything. But if we are to have a workable society with a government that can afford to provide the security, infrastructure, and enforceable ground rules needed for a healthy economy and a good life, we need to tax something. The question is which balance of taxes is least harmful overall.
The primary arguments for limiting taxes on capital gains are
1) Capital gains may not be real gains: they may simply be a product of inflation. (Given the overall structure of our tax system, though, this is a bit of a childish whine. If someone makes an investment that pays current interest or dividends, most or all of that income is just making up for inflation, but all of it is taxed nonetheless, and the taxpayer pays the tax currently. If someone instead invests in such a way that the income accumulates as a capital gain, the taxpayer at least gets to defer the tax bite until the capital gain is realized, so the taxpayer has already come out ahead. Proponents of the inflationary gains argument are in effect saying that this deferral advantage is not enough, that they also need to get special protection from tax on the part of the income that corresponds to inflation. Why? They are not contributing any more to the economy than the person who invests and takes interest or dividends. Further, special capital gains rates are a very poor instrument for trying to account for inflation. Most stock investments grow in value at a rate well above inflation. So, Shared Economic Growth has the right solution. Induce corporations to pay out their earnings as dividends currently, and then the type of long term investors who care about inflation will pay tax on their income year by year just like everybody else. They won't have any right to complain.)
2) If capital gains taxes are high, asset owners may be reluctant to sell their assets and trigger the tax. Therefore, they hold onto the investment, resulting in an inefficient allocation of capital that reduces growth.
3) If returns on capital investments are reduced by high taxes, the owners of available capital will be less willing to invest it rather than spend it on consumption, again reducing economic efficiency.
On the other hand, the downsides of low capital gains tax rates are significant, including
1) They cause income from passive investment to be taxed less heavily than income from productive labor, diverting intellectual talent into investing activities that are largely parasitic rather than into activities that create new, real value.
2) Ownership of capital is by definition skewed
towards people who are already wealthy, so low capital gains rates cause the
wealthy to be taxed less heavily than the working middle class, undermining our
progressive tax system.There are several valid arguments for limiting tax on capital gains. Likewise, there are good arguments for never imposing any tax on anything. But if we are to have a workable society with a government that can afford to provide the security, infrastructure, and enforceable ground rules needed for a healthy economy and a good life, we need to tax something. The question is which balance of taxes is least harmful overall.
The primary arguments for limiting taxes on capital gains are
1) Capital gains may not be real gains: they may simply be a product of inflation. (Given the overall structure of our tax system, though, this is a bit of a childish whine. If someone makes an investment that pays current interest or dividends, most or all of that income is just making up for inflation, but all of it is taxed nonetheless, and the taxpayer pays the tax currently. If someone instead invests in such a way that the income accumulates as a capital gain, the taxpayer at least gets to defer the tax bite until the capital gain is realized, so the taxpayer has already come out ahead. Proponents of the inflationary gains argument are in effect saying that this deferral advantage is not enough, that they also need to get special protection from tax on the part of the income that corresponds to inflation. Why? They are not contributing any more to the economy than the person who invests and takes interest or dividends. Further, special capital gains rates are a very poor instrument for trying to account for inflation. Most stock investments grow in value at a rate well above inflation. So, Shared Economic Growth has the right solution. Induce corporations to pay out their earnings as dividends currently, and then the type of long term investors who care about inflation will pay tax on their income year by year just like everybody else. They won't have any right to complain.)
2) If capital gains taxes are high, asset owners may be reluctant to sell their assets and trigger the tax. Therefore, they hold onto the investment, resulting in an inefficient allocation of capital that reduces growth.
3) If returns on capital investments are reduced by high taxes, the owners of available capital will be less willing to invest it rather than spend it on consumption, again reducing economic efficiency.
On the other hand, the downsides of low capital gains tax rates are significant, including
1) They cause income from passive investment to be taxed less heavily than income from productive labor, diverting intellectual talent into investing activities that are largely parasitic rather than into activities that create new, real value.
3) Low capital gains rates can actually lock in inefficient investments and create other inefficiencies by providing incentives to structure income as artificial capital appreciation rather than just taking the income currently.
4) Given a choice between working the family farm or small business and being taxed at ordinary rates on the income or selling it and paying tax at the lower capital gains rates, there is a strong incentive to sell out, undermining the base of small farmers and entrepreneurs that balance our economy and invest for the long term. It is good to encourage the free flow of capital, but there is a difference between that and having a system that puts a premium on getting a short term value spike and turning a quick profit at the expense of long term profitability.
The Shared Economic Growth proposal offers a way to get most of the benefits of low capital gains rates without the burdens:
1) Inflationary gains on stock would become less relevant because earnings would be paid out and taxed on a current basis.
2) Corporations would be pressured to pay out their earnings back into the economy, preventing cash from getting locked into a corporation where it is only available to go to the best investment available to that company rather than the best investment available in the economy, thus increasing efficiency without distorting the tax system or undermining progressivity.
3) By eliminating double taxation of corporate equity (once at the corporate level and then again at the shareholder level), Shared Economic Growth would make capital investments much more attractive and would give corporations many investment opportunities that are not economical for them today.
4) By eliminating the tax penalty for U.S. investments and jobs, Shared Economic Growth would make much more capital available for investments in the United States, greatly stimulating the growth of our economy.
Shared Economic Growth would accomplish all of this while improving the progressivity of our tax system, eliminating incentives to spend effort on siphoning off value rather than creating value, and providing incentives to keep the family farm or business rather than selling out.
Isn't that a better way to do it?
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