Taxing Capital Gains

(Photo: Philip Taylor)

Dividends in the U.S. are taxed at only 15 percent (much lower than wages/salaries).  The argument is that since corporate profits, from which dividends are paid, are already taxed, taxing dividends is double taxation.  But what about capital gains—why are they taxed at 15 percent too?  The standard argument is that we should be taxing real capital gains, not nominal gains.  Okay, but it would be easy to include the Consumer Price Index for each of many years in TurboTax or TaxCut, base taxes on real gains and tax the real gain at the same rate as wages. The administrative cost of calculating real gains has disappeared. Another argument for a lower tax on capital gains might be that investment/risk-taking is more responsive to net returns than is labor supply, justifying a lower tax rate as optimal taxation.  Perhaps, but at best the evidence is scarce.  My guess is that the real justification is the ability of wealthy people, who are the main beneficiaries of this tax giveaway, to get Congress to enhance their net incomes. (HT: PLM).


BradK

Capital gains rate should be commensurate with income tax rate, including marginally progressive.

Mark B

What about the argument that high capital gains rates discourage selling of those assets -- thus less revenue raised?

Ben

(1) Are you aware of the Rothschild/Stiglitz result? Optimal taxation literature says capital taxation should be zero. If you want an easy look-in on the optimal tax literature try http://dash.harvard.edu/bitstream/handle/1/4263739/Mankiw_OptimalTaxationTheory.pdf?sequence=2

(2) Surely CGT is a form of double-taxation as well? The same fairness ideas would apply.

BradK

It says that capital taxation should be zero, but that they recommend "individuals face non-zero capital taxes," and that, "...households with surprisingly low labor income face positive capital taxes and those with surprisingly high labor income receive subsidies to their capital income."

Simply, the wealthiest individuals (those that usually make most of their wealth via capital gains, e.g. Warren Buffett) should pay a high capital gains tax and that proportionally high labor income individuals, e.g. those in poverty, low middle class earners, should actually be subsidized within the capital gains taxation structure.

If you're going to reference something to defend an argument, at least understand the conclusions and prescription.

dan

What about the fact that an individual's income (wages) are taxed once by the federal government, and then that individual uses what is left after taxes to invest? Then said individual pays taxes on that money AGAIN if their invest produces a gain. It's the same aargument that you used for the why dividends aren't taxed at a higher rate.

bewarecoward

No, the individual pays taxes on the *gain*, not the invested money itself.

Bobby G

Increasing taxes on capital gains lowers benefit of investing while having no change on cost (seed money required / risk). As such that will lower investment than at the previous tax rate. The amount of that change depends on the many other variables involved, of course, but there will be a reduction.

Not to mention the seed money for investments has already been taxed. In the case of dividends, there is triple taxation (you have to have bought stock to receive a dividend). The stockholder's seed money was taxed as income tax, the corporation has already been taxed before it can issue dividends, and then the dividends are taxed via capital gains tax.

Personally I think the reason to avoid high capital gains taxes is simply to not dissuade investors from investing, a key component of economic growth. Government should only get involved when there is a market failure (in my opinion), and I don't see the economic need for the government to tax capital gains in the first place.

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Baughman

This post makes no sense at all. You imply that capital gains aren't double taxed. But they are. Corporations earn revenue, pay expenses and taxes. The result is called net income. Net income can either be distributed to shareholders as a dividend or reinvested into the company. The former results in a dividend liability on one's income tax filing. The latter results in a capital gain liability on one's income tax filing, provided (of course) that he realizes his capital gain. This is because a company with more reinvested earnings has more stuff, be it short term assets, factories, etc.

Your ending sentence is left-wing liberal nonsense. Investors are taxed through the roof already once accounting for the double counting of corporate profits, and ignorance like this perpetuates the myth that all taxes are absorbed at the individual level. What happens when investors are subject to higher taxes? Demand for stocks decreases, prices decrease, expected returns increase. Investors aren't idiots. They will demand higher compensation in return for a higher tax burden. http://www2.mccombs.utexas.edu/faculty/Clemens.Sialm/sialm09.pdf. If investing is so lucrative to the rich, as you describe above, surely the poor would jump on this too-good-to-be-true bandwagon and create unimaginable wealth for themselves.

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BradK

You're attacking the wrong side of the equation. Capital gains taxes should be higher for the wealthiest investors as shown by the optimal taxation paper referenced by Ben, as well they should be lower for poorer investors whose income is most labor-generated.

Your problem should be with corporate taxation, not capital taxation. Federal corporate taxes should be eliminated, or at least greatly reduced, but the necessary adjunct to that is the elimination of all federal corporate subsidies/rebates.

Phil

Taxing capital gains is also double taxation, as many have argued. My own take is here:

http://sabermetricresearch.blogspot.ca/2011/10/capital-gains-and-warren-buffett-part.html

m

I believe capital gains are taxed lower to give investors an incentive to invest.

BradK

Capital gains are lower because the wealthiest individuals know it's the quickest way to rapidly increase personal wealth and therefore lobby Congressman to legislate it as such.

Matthew

Aren't capital gains taxed at the lower rate because the value of the investment has already been decreased by the taxation of the entities profits? Since the enterprise already had value taken out when taxes were paid, taxing the gain on sale at full income rates is some proportion of double taxation.

I question your statement that wealthy people are the main beneficiaries of the reduced capital gains tax rate. Don't pension funds and the mutual funds that are the asset vehicles of 401(k) plans also benefit from the reduced rate?

Clancy

The “Double Taxation” argument always seemed a little bogus to me. My wages are taxed, but the money comes from my company’s sales, which are taxed; that money comes from the income of our customers, which is taxed etc. etc.
It’s never the case that you can’t tax money that’s already been taxed. You can certainly make the argument that certain tax rates are too high, or that when aggregated together, taxes are too high. But saying that you can’t tax something more than once makes no sense.

Seminymous Coward

Double taxation is a nonsensical argument. The government takes a slice several times over. They extract their take very nearly every time money changes hands, frequently more than once of a single transaction. A flow like personal income tax --> sales tax -> corporate income tax -> capital gains tax -> sales tax -> corporate income tax -> personal income tax is routine. If you want to reduce double taxation, the personal income and sales tax combination is surely a better target than the corporate income tax and capital gains tax combination. It's truly pointless, though, since every transaction tax is likely and, in fact, meant to recur. Per capita taxation isn't exactly nice, either.

I am sick of hearing how capital gains tax is supposedly so unfair to the rich because of a perfectly normal, necessary situation of the same money being taxed repeatedly.

Joe

Society benefits when invested capital is somewhat mobile. Investors can move resources to new ideas. A tax on each transaction discourages mobility, and higher rates equal more discouragement.

Say I put 10k years ago in something that has matured into 100k in a slow growth business. If I move that to a new enterprise, I have to expect my new investment to out-earn the current slow growth business PLUS to tax penalty I pay to move it.

Raise the tax rate too far and money will stay put. No one will take a chance on new ideas. Those new ideas, if they pay off, would generate far more tax revenue than encouraging me to keep the 100k in a stagnant business.

Joe

My guess is that the real justification is the ability of wealthy people, who are the main beneficiaries of this tax giveaway, to get Congress to enhance their net incomes.

Congress is overwhelmingly made up of wealthy people.

The trade on inside information. The vote to tax themselves less.

There's no need for anyone to get Congress to do enhance anything. They do it by (and for) themselves.

Michael

Why are capital gains taxed at all? Why are they considered income? I'd think that only salaries and wages should be taxed. That's money earned by you, for your labor. Capital gains and dividends are money earned by your money. No justification for government to take a part of it, other than 'because they can'.

Give capital gains as low a rate as possible, but just high enough that people don't try to get around taxes by disguising wages as capital gains.