***The Omnibus Tax Policy Thread*** (1 Viewer)

Over the years we've had a bunch of threads devoted to tax policy discussions. Recently there seems to be an uptick in interest, spurred first by Warren Buffett's statements and then by tax plans offered recently by Republican Presidential hopefuls Herman Cain and Rick Perry. Probably not going to settle anything in here but maybe we can get some good nerd/nutjob talk going. Anybody is welcome to bring up any tax policy issues, but here's something I'm interested in discussing because it never seems like I get a satisfactory answer to this question.

Why shouldn't we just treat capital gains as ordinary income?

Here's a New York Times column that came up when I googled this question

This is largely why legislative efforts to eliminate the carried interest exemption have gone nowhere, not because of any special fondness in Congress for hedge fund managers. Unless Congress is willing to say baldly that hedge fund and private equity managers are a special class who deserve to pay higher taxes — a potentially dangerous effort to use the tax code to punish a group of people who are in disfavor largely because they make a lot of money — policy makers are going to have to confront a much broader and potentially far more explosive question: why are all capital gains, not just carried interest, treated more favorably than ordinary income?

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Whatever benefits lower capital gains rates might generate, they indisputably complicate the tax code and have spawned a multibillion-dollar industry in tax avoidance. “Every imaginable individual income tax shelter is driven by the differential,” Mr. Burman noted. He added that the tax code was needlessly complex. “Have you looked at the alternate rate schedule on the back of Schedule D? It’s so complicated. It’s insane. That alone is a really good argument for change.”

But the biggest reason for equalizing capital gains rates may be that it would generate a vast amount of additional revenue for the Treasury. The Internal Revenue Service reports that for taxpayers with the top 400 adjusted gross incomes, capital gains in 2008 amounted to an eye-popping average of $154 million for each of those taxpayers, or 57 percent of their adjusted gross income, and this in a year when the stock market plunged. In 2007, it was $229 million each, or 66 percent. Much of the windfall from higher capital gains rates could be offset by cutting the rate on ordinary income. For antitax zealots who vow they won’t accept one more penny of federal tax, all of it could be offset by lower rates on ordinary income. And for advocates of reducing the government deficit at least in part through higher taxes, tax reform is an appealing approach.

Though controversial, this isn’t a new idea. The most prominently successful advocate of a drastically simplified tax code that treated ordinary income and capital gains the same was Ronald Reagan, who made it a centerpiece of his successful 1986 tax reform proposal. (The lower rate reappeared as part of the Taxpayer Relief Act of 1997, championed by Newt Gingrich, the former Republican speaker of the House, and signed by Democratic President Bill Clinton.)

In the end, the most compelling argument for equalizing tax rates on capital gains and ordinary income may not be economic efficiency, growth incentives, higher tax revenue or reducing the deficit. It’s simple fairness. It’s hard to quantify or put a dollar value on a just society. “I’ve earned both, and in my experience earning income from capital gains is a lot easier than earning ordinary income,” Mr. Burman said. “Why not tax both at the same rate? It only seems fair.”

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Here are some past threads where we've had some decent tax policy discussion. The list isn't comprehensive.

What Would Rick Perry's Tax Plan Actually Do?

What would Herman Cain's '9-9-9' tax plan really do?

Stop Coddling The Rich, Warren Buffett Speaks Out

That FairTax! thingy is gaining steam

Repeal of Estate Tax costs taxpayers

Isn't the logic (albeit flawed, and not my opinion) that if you treat it like ordinary income in a year of declining stock market someone could basically wash out their portfolio to avoid tax liability of a large income? They could then re-invest this income in other equities and really be no better off, but the govt. has just written them a check for being such a ####ty investor.

At the moment the most you can carry forward is 3k in losses, but how FairTax is it to treat it like ordinary income if you are going to cap losses?

'culdeus said:

Isn't the logic (albeit flawed, and not my opinion) that if you treat it like ordinary income in a year of declining stock market someone could basically wash out their portfolio to avoid tax liability of a large income?

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I'm not sure why this is a bad thing. If somebody earns $200K at their job but loses $200K in the stock market, shouldn't their income for the year be considered $0?

Capital gains taxes impede growth. If you want small businesses to expand and hire more people, you are not helping them to do so. This is not by itself a reason not to do it- our situation is so dire that we may very well need to consider this and all other means of additional taxation. But it's important to recognize the heavy cost.

'fatguyinalittlecoat said:

'culdeus said:

Isn't the logic (albeit flawed, and not my opinion) that if you treat it like ordinary income in a year of declining stock market someone could basically wash out their portfolio to avoid tax liability of a large income?

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I'm not sure why this is a bad thing. If somebody earns $200K at their job but loses $200K in the stock market, shouldn't their income for the year be considered $0?

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I don't think you understand the implications of that. I think if you could uncap losses it could turn into a gigantic revenue shortfall for the federal govt. I don't see them uncapping losses and raising cap gains to ordinary. For one it's going to invite more panic selling and push more people into bonds or convertibles.

'culdeus said:

'fatguyinalittlecoat said:

'culdeus said:

Isn't the logic (albeit flawed, and not my opinion) that if you treat it like ordinary income in a year of declining stock market someone could basically wash out their portfolio to avoid tax liability of a large income?

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I'm not sure why this is a bad thing. If somebody earns $200K at their job but loses $200K in the stock market, shouldn't their income for the year be considered $0?

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I don't think you understand the implications of that. I think if you could uncap losses it could turn into a gigantic revenue shortfall for the federal govt. I don't see them uncapping losses and raising cap gains to ordinary. For one it's going to invite more panic selling and push more people into bonds or convertibles.

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I think you're right I don't understand all the implications. That's why I asked the question. I don't understand the "gigantic revenue shortfall" argument. The New York Times column I quoted above said it would create a huge revenue gain, which seems to make sense to me. What's the opposing argument exactly?Why would it invite more "panic selling?" And what constitutes panic selling anyway?

'timschochet said:

Capital gains taxes impede growth. If you want small businesses to expand and hire more people, you are not helping them to do so. This is not by itself a reason not to do it- our situation is so dire that we may very well need to consider this and all other means of additional taxation. But it's important to recognize the heavy cost.

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Lack of demand and inability to get credit is a far bigger drag on small businesses than capital gains. We never talk about that when we are talking whether to expand or not.

I don't know if I buy into treating capital gains as ordinary income fully, but I'm sure the 20% spread is too much.

'timschochet said:

Capital gains taxes impede growth. If you want small businesses to expand and hire more people, you are not helping them to do so. This is not by itself a reason not to do it- our situation is so dire that we may very well need to consider this and all other means of additional taxation. But it's important to recognize the heavy cost.

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You are, however, lowering the effective cost of hiring people to the business.My worry on raising capital gains run along a different course.* It makes more high-yield investments less attractive (as tax rate approaches 100%, the delta between investments approaches 0). So you're discouraging risk-taking.* It makes tax-free investments more attractive.* It makes tax shelters/tax planning/tax shanigans more attractive.That all said, I don't view these as compelling enough reasons not to do it, just things to bear in mind.

'Matthias said:

'timschochet said:

Capital gains taxes impede growth. If you want small businesses to expand and hire more people, you are not helping them to do so. This is not by itself a reason not to do it- our situation is so dire that we may very well need to consider this and all other means of additional taxation. But it's important to recognize the heavy cost.

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You are, however, lowering the effective cost of hiring people to the business.My worry on raising capital gains run along a different course.* It makes more high-yield investments less attractive (as tax rate approaches 100%, the delta between investments approaches 0). So you're discouraging risk-taking.* It makes tax-free investments more attractive.* It makes tax shelters/tax planning/tax shanigans more attractive.That all said, I don't view these as compelling enough reasons not to do it, just things to bear in mind.

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You know I am good with a little less risk taking in light of the last few years.

'Matthias said:

My worry on raising capital gains run along a different course.* It makes more high-yield investments less attractive (as tax rate approaches 100%, the delta between investments approaches 0). So you're discouraging risk-taking.* It makes tax-free investments more attractive.* It makes tax shelters/tax planning/tax shanigans more attractive.That all said, I don't view these as compelling enough reasons not to do it, just things to bear in mind.

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You might need to spell out some of this stuff for unsophisticated people like me. How exactly would it do these things and why are these things bad?

'fatguyinalittlecoat said:

'culdeus said:

'fatguyinalittlecoat said:

'culdeus said:

Isn't the logic (albeit flawed, and not my opinion) that if you treat it like ordinary income in a year of declining stock market someone could basically wash out their portfolio to avoid tax liability of a large income?

Click to expand...

I'm not sure why this is a bad thing. If somebody earns $200K at their job but loses $200K in the stock market, shouldn't their income for the year be considered $0?

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I don't think you understand the implications of that. I think if you could uncap losses it could turn into a gigantic revenue shortfall for the federal govt. I don't see them uncapping losses and raising cap gains to ordinary. For one it's going to invite more panic selling and push more people into bonds or convertibles.

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I think you're right I don't understand all the implications. That's why I asked the question. I don't understand the "gigantic revenue shortfall" argument. The New York Times column I quoted above said it would create a huge revenue gain, which seems to make sense to me. What's the opposing argument exactly?Why would it invite more "panic selling?" And what constitutes panic selling anyway?

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All these projections are based on stock market going to infinity and beyond. If someone has a 1MM portfolio with basis of 1MM and it goes to 800k they could liquidate and wipe out 200k of income. Today you could only wipe out 3k of income. So in a declining stock market, likely due to a declining economy and income as is you'd have a double whammy.It also creates an incentive to sell into a bear market because you can recapture 35% of your losses courtesy of the federal govt. It also incents you to sell your worst stocks causing even more selling and eventually panic selling to avoid 0-ing out.

'culdeus said:

'fatguyinalittlecoat said:

I think you're right I don't understand all the implications. That's why I asked the question. I don't understand the "gigantic revenue shortfall" argument. The New York Times column I quoted above said it would create a huge revenue gain, which seems to make sense to me. What's the opposing argument exactly?Why would it invite more "panic selling?" And what constitutes panic selling anyway?

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All these projections are based on stock market going to infinity and beyond. If someone has a 1MM portfolio with basis of 1MM and it goes to 800k they could liquidate and wipe out 200k of income. Today you could only wipe out 3k of income. So in a declining stock market, likely due to a declining economy and income as is you'd have a double whammy.It also creates an incentive to sell into a bear market because you can recapture 35% of your losses courtesy of the federal govt. It also incents you to sell your worst stocks causing even more selling and eventually panic selling to avoid 0-ing out.

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I guess I still wonder why it's fair to cap capital losses. And I also wonder why it's bad for people to sell into a bear market. If people are depressing the value of a stock by selling it for tax purposes, won't the people that buy the stock at the discounted price eventually end up paying those taxes if the stock goes back up?

'fatguyinalittlecoat said:

'Matthias said:

My worry on raising capital gains run along a different course.* It makes more high-yield investments less attractive (as tax rate approaches 100%, the delta between investments approaches 0). So you're discouraging risk-taking.* It makes tax-free investments more attractive.* It makes tax shelters/tax planning/tax shanigans more attractive.That all said, I don't view these as compelling enough reasons not to do it, just things to bear in mind.

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You might need to spell out some of this stuff for unsophisticated people like me. How exactly would it do these things and why are these things bad?

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This isn't sophisticated b/c I'm not a sophisticated guy. These are just basic micro ways of looking at the world.But point by point.* When considering where to put their money, investors model the risk-adjusted, post-tax return. If you have a safe investment that will give you 3%, and a risky one which gives you 10%, the risk premium on the second is 7%. But that premium is cut by whatever tax rate you have to pay on the return. So at a 10% rate, the #s are 2.7%, 9%, and 6.3%. At 50%, 1.5%, 4.5%, and 3%. You're driving down the additional benefit of taking on risk. I'm not sure if I'd say that is necessarily good or bad, but it is.* Similarly, consider if you have an investment which is tax-free. I'm not a finance guy but I think municipal bonds might fit the bill here. If not, whatever. Presume investments which are non-taxable. Consider above, but that the 3% rate isn't changing because there's no taxes on the income. Basically you get the same effect except more pronounced as one return is staying constant whereas the other is falling relative to the tax rate.* By making tax shelters/tax evasion/tax whatever more attractive. If you have $1MM in cap gains and the tax rate is 15%, you have $150k of interest in shielding/hiding/whatever that income. If the tax rate increases to 40%, you have $400k worth of interest. It may now be worth your while to seek out a high-priced tax atty to figure out what to do since you have $250k more at play to pay him with.

Good thread. I believe part of the Simpson-Bowles tax plan was to treat capital gains as ordinary income as well.

'Matthias said:

* When considering where to put their money, investors model the risk-adjusted, post-tax return. If you have a safe investment that will give you 3%, and a risky one which gives you 10%, the risk premium on the second is 7%. But that premium is cut by whatever tax rate you have to pay on the return. So at a 10% rate, the #s are 2.7%, 9%, and 6.3%. At 50%, 1.5%, 4.5%, and 3%. You're driving down the additional benefit of taking on risk. I'm not sure if I'd say that is necessarily good or bad, but it is.* Similarly, consider if you have an investment which is tax-free. I'm not a finance guy but I think municipal bonds might fit the bill here. If not, whatever. Presume investments which are non-taxable. Consider above, but that the 3% rate isn't changing because there's no taxes on the income. Basically you get the same effect except more pronounced as one return is staying constant whereas the other is falling relative to the tax rate.* By making tax shelters/tax evasion/tax whatever more attractive. If you have $1MM in cap gains and the tax rate is 15%, you have $150k of interest in shielding/hiding/whatever that income. If the tax rate increases to 40%, you have $400k worth of interest. It may now be worth your while to seek out a high-priced tax atty to figure out what to do since you have $250k more at play to pay him with.

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OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?As for the third bullet point, I guess I have two feelings: 1) To the extent that accountants and tax lawyers reduce tax liability by characterizing income as capital gains, the incentive to hire them is diminished; and 2) Once you get to a certain level of taxation, you already have a big incentive to hire people to reduce your tax liability. I'm not sure this would create much of an increase in incentive.

'fatguyinalittlecoat said:

OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?

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I'm not saying that they are good or bad, just that they are.ETA: Re: the tax advice, I don't think it would be a major effect, but there may be some marginal uptake. Before they got hammered for it, there was a law firm (Vinson & Elkins, I think?) who had developed a tax shelter that they sold to clients for $500k. Straight deal. You gave them the half million and they gave you the powerpoint. Obviously you'd need > $500k of tax liability to make that worth your while. Generally speaking, it's depressing to me that so much of the best brainpower in our country goes to blowing giant holes through the tax code but that's where there's big money to be reaped. So it goes.

Why don't we treat capital gains as income? Because the smartest and most powerful people currently use capital gains to get ahead in life. I suppose you could in theory treat it as ordinary income. But you must understand that the smartest and most powerful people would only allow that to happen if they found a replacement for capital gains as a means to get ahead in life.

This war some people fight to make things fair and equal is akin to Sisyphus pushing that boulder up a hill. Its not gonna happen.

OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?

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Did you see how well that worked out for Japan?

Know this. Other people spent their lives fighting for "fairness" and "equality" and they all failed miserably. This country wasn't founded on fairness and equality. It was founded on freedom, because that's the best you can do.

'culdeus said:

OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?

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Did you see how well that worked out for Japan?

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How well what worked out?

'fatguyinalittlecoat said:

'culdeus said:

OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?

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Did you see how well that worked out for Japan?

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How well what worked out?

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This part. Look at how Japan plowed nearly all their assets into their Post Office (yes, really the post office look it up) now it's not really a post office per se it's more like a insurance agency. They did this in lieu of investing in their own country or making investments in China or other developing economies. This while their post office plowed all that money into real estate and BOOOOOM!!!!

'timschochet said:

Capital gains taxes impede growth. If you want small businesses to expand and hire more people, you are not helping them to do so. This is not by itself a reason not to do it- our situation is so dire that we may very well need to consider this and all other means of additional taxation. But it's important to recognize the heavy cost.

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I don't understand this argument at all. Typically a small business owner only pays capital gains tax when he sells the business, at which point he is no longer going to be hiring anyone. How does a higher capital gain tax rate impede hiring and growth?

'culdeus said:

'fatguyinalittlecoat said:

'culdeus said:

OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?

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Did you see how well that worked out for Japan?

Click to expand...

How well what worked out?

Click to expand...

This part. Look at how Japan plowed nearly all their assets into their Post Office (yes, really the post office look it up) now it's not really a post office per se it's more like a insurance agency. They did this in lieu of investing in their own country or making investments in China or other developing economies. This while their post office plowed all that money into real estate and BOOOOOM!!!!

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I don't get it. Why would this happen if there was a greater tax incentive for municipal bonds?

'fatguyinalittlecoat said:

'culdeus said:

'fatguyinalittlecoat said:

'culdeus said:

OK, I think I understand how some of these incentives might change, but I'm not entirely clear on why the stuff in the first two bullet points are bad. Why should we prefer investors to make riskier investments rather than safer ones? Why do we not want them to be investing in stuff like municipal bonds?

Click to expand...

Did you see how well that worked out for Japan?

Click to expand...

How well what worked out?

Click to expand...

This part. Look at how Japan plowed nearly all their assets into their Post Office (yes, really the post office look it up) now it's not really a post office per se it's more like a insurance agency. They did this in lieu of investing in their own country or making investments in China or other developing economies. This while their post office plowed all that money into real estate and BOOOOOM!!!!

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I don't get it. Why would this happen if there was a greater tax incentive for municipal bonds?

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There is always a cause/effect when changing the tax policy to modify investor behavior. There are examples for every flavor of tax policy out there. What you are discussing looks most like a 90s era Japan. Munis are a nice mix, but you are taking cash out of the hands of institutional investors and startup firms and placing it in the hands of local govt. so they can build convention centers. One can see that eventually that's going to cause a bit of a competition problem when the US is already struggling to make it in a post-manufacturing mindset.

'culdeus said:

'fatguyinalittlecoat said:

I don't get it. Why would this happen if there was a greater tax incentive for municipal bonds?

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There is always a cause/effect when changing the tax policy to modify investor behavior. There are examples for every flavor of tax policy out there. What you are discussing looks most like a 90s era Japan. Munis are a nice mix, but you are taking cash out of the hands of institutional investors and startup firms and placing it in the hands of local govt. so they can build convention centers. One can see that eventually that's going to cause a bit of a competition problem when the US is already struggling to make it in a post-manufacturing mindset.

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Wouldn't municipalities just lower the interest rate they paid on their bonds if the tax code favored them even more? Or if we're really worried about too much investment in municipal bonds, couldn't we monkey with their tax status too?

'fatguyinalittlecoat said:

'culdeus said:

'fatguyinalittlecoat said:

I don't get it. Why would this happen if there was a greater tax incentive for municipal bonds?

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There is always a cause/effect when changing the tax policy to modify investor behavior. There are examples for every flavor of tax policy out there. What you are discussing looks most like a 90s era Japan. Munis are a nice mix, but you are taking cash out of the hands of institutional investors and startup firms and placing it in the hands of local govt. so they can build convention centers. One can see that eventually that's going to cause a bit of a competition problem when the US is already struggling to make it in a post-manufacturing mindset.

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Wouldn't municipalities just lower the interest rate they paid on their bonds if the tax code favored them even more? Or if we're really worried about too much investment in municipal bonds, couldn't we monkey with their tax status too?

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I'd say we've done enough monkeying with the tax code. Maybe government should stop picking winners and losers, and instead go to a system like the FairTax.

'Rich Conway said:

I'd say we've done enough monkeying with the tax code. Maybe government should stop picking winners and losers, and instead go to a system like the FairTax.

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There would still be winners and losers if we switched to the FairTax.

'fatguyinalittlecoat said:

'culdeus said:

'fatguyinalittlecoat said:

I don't get it. Why would this happen if there was a greater tax incentive for municipal bonds?

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There is always a cause/effect when changing the tax policy to modify investor behavior. There are examples for every flavor of tax policy out there. What you are discussing looks most like a 90s era Japan. Munis are a nice mix, but you are taking cash out of the hands of institutional investors and startup firms and placing it in the hands of local govt. so they can build convention centers. One can see that eventually that's going to cause a bit of a competition problem when the US is already struggling to make it in a post-manufacturing mindset.

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Wouldn't municipalities just lower the interest rate they paid on their bonds if the tax code favored them even more? Or if we're really worried about too much investment in municipal bonds, couldn't we monkey with their tax status too?

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Well, in the current environment you can't lower munis much more. But yeah, there would be some adjustments.

'fatguyinalittlecoat said:

'Rich Conway said:

I'd say we've done enough monkeying with the tax code. Maybe government should stop picking winners and losers, and instead go to a system like the FairTax.

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There would still be winners and losers if we switched to the FairTax.

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If we switch to any system, there will be winners and losers, because the groups that government has currently picked to be winners would lose that status and vice versa. However, a system could be implemented in which government no longer gets to pick winners and losers.

Investors look at after-tax returns. Lower capital gains tax rates mean that investors would require lower returns to own a stock. Lower required returns means that the valuation of the stock/company would be higher--making it easier and cheaper for them to raise capital (to invest, grow and hire people).

Let's say you have two investment options: you could earn 5% (after-tax) on a bond investment or 5% (after-tax) on a stock investment (let's ignore risk premiums). If you raised capital gains tax rates, the value of the stock would have to decline to the point where the after-tax return would be 5% again. A lower stock price would mean it's harder and more expensive to raise equity capital--so there would be less capital to invest, grow and hire.

'guderian said:

Investors look at after-tax returns. Lower capital gains tax rates mean that investors would require lower returns to own a stock. Lower required returns means that the valuation of the stock/company would be higher--making it easier and cheaper for them to raise capital (to invest, grow and hire people). Let's say you have two investment options: you could earn 5% (after-tax) on a bond investment or 5% (after-tax) on a stock investment (let's ignore risk premiums). If you raised capital gains tax rates, the value of the stock would have to decline to the point where the after-tax return would be 5% again. A lower stock price would mean it's harder and more expensive to raise equity capital--so there would be less capital to invest, grow and hire.

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Two serious questions:1. Under the current rules how do investors calculate after-tax returns without knowing whether the gain will be short or long-term. It would seem the valuation would be different to an active trader than a buy and hold investor.2. Was it more difficult for companies to raise capital during the dot-com bubble of the 90's when capital gains rates were higher than it is since the rates were lowered in 2001?

'Rich Conway said:

'fatguyinalittlecoat said:

'Rich Conway said:

I'd say we've done enough monkeying with the tax code. Maybe government should stop picking winners and losers, and instead go to a system like the FairTax.

Click to expand...

There would still be winners and losers if we switched to the FairTax.

Click to expand...

If we switch to any system, there will be winners and losers, because the groups that government has currently picked to be winners would lose that status and vice versa. However, a system could be implemented in which government no longer gets to pick winners and losers.

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Even the FairTax has stuff the government can tinker with. The rate, the amount of the prebate, whether any types of goods can be excluded from sales taxes.

'fatguyinalittlecoat said:

'Rich Conway said:

'fatguyinalittlecoat said:

'Rich Conway said:

I'd say we've done enough monkeying with the tax code. Maybe government should stop picking winners and losers, and instead go to a system like the FairTax.

Click to expand...

There would still be winners and losers if we switched to the FairTax.

Click to expand...

If we switch to any system, there will be winners and losers, because the groups that government has currently picked to be winners would lose that status and vice versa. However, a system could be implemented in which government no longer gets to pick winners and losers.

Click to expand...

Even the FairTax has stuff the government can tinker with. The rate, the amount of the prebate, whether any types of goods can be excluded from sales taxes.

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It does, true. But it's far less, and the items you mention are far more out in the open than the tinkering the government does now.

'Tom Hagen said:

'guderian said:

Investors look at after-tax returns. Lower capital gains tax rates mean that investors would require lower returns to own a stock. Lower required returns means that the valuation of the stock/company would be higher--making it easier and cheaper for them to raise capital (to invest, grow and hire people). Let's say you have two investment options: you could earn 5% (after-tax) on a bond investment or 5% (after-tax) on a stock investment (let's ignore risk premiums). If you raised capital gains tax rates, the value of the stock would have to decline to the point where the after-tax return would be 5% again. A lower stock price would mean it's harder and more expensive to raise equity capital--so there would be less capital to invest, grow and hire.

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Two serious questions:1. Under the current rules how do investors calculate after-tax returns without knowing whether the gain will be short or long-term. It would seem the valuation would be different to an active trader than a buy and hold investor.2. Was it more difficult for companies to raise capital during the dot-com bubble of the 90's when capital gains rates were higher than it is since the rates were lowered in 2001?

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1. Tough question to answer because there are so many directions to go in, but I'll speak to the big institutional investors (endowments, pension funds, etc.) since they put the most $$$ to work. For them these decisions are all long-term, so that's the rate they'd use in figuring out where to allocate money. 2. It probably was easier for most companies to raise money during the bubble because valuations were sky high for other reasons.

Few disagree with the desire to curtail government corruption and favoritism. Overreaching powers of taxation expand the kind of corruption everyone claims to stand against.

The Founders thought an income tax was immoral. They curtailed the federal government's power to tax to minimize the special interest lobby and corruption we see expanding today. Only in the wisdom of the early 1900's did the nation decide to totally buck their wisdom, and establish an income tax, which then was only intended for the "1%". Its been a slow road, but look at the fruit born by that decision. We are now left debating winners and losers as decided by the "government", which is us; how unifying as a nation.

i've wondered the same thing, fgialc, and from what i've read, it seems the difference is along two lines

1) Inflation - note that short-term capgains are already taxed as ordinary income. Long-term capgains, unlike ordinary income, have been earned over a period of years, and thus have already been degraded by inflation.

2) Double Taxation - Capgains come from investments. Investments are made with dollars that have already been taxed (at least) once.

I still think Carried Interest should be at a higher tax rate than it is today.

'oso diablo said:

i've wondered the same thing, fgialc, and from what i've read, it seems the difference is along two lines1) Inflation - note that short-term capgains are already taxed as ordinary income. Long-term capgains, unlike ordinary income, have been earned over a period of years, and thus have already been degraded by inflation.2) Double Taxation - Capgains come from investments. Investments are made with dollars that have already been taxed (at least) once.I still think Carried Interest should be at a higher tax rate than it is today.

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I've always found the whole "double taxation" thing to be a load of crap when talking about other taxes, and that's no less true here. And I'm not sure there actually is double taxation here. The capital gains taxes are on the increase in value. So even if taxed money paid for the original investment, the increase hasn't been taxed yet.The inflation thing is a new argument for me I need to think about. It does seem to make sense. Maybe capital gains need to be first discounted by inflation, then taxed as income.

Why can't they pay just like a professional poker player pays. They pay a heavy percent on the wins but can only claim loses to offset the wins?

Anyone have any thoughts on A Progressive Consumption Tax?

The simplest step would be to scrap the current progressive income tax in favor of a much more steeply progressive tax on each household’s consumption. Families would report their taxable income to the IRS (ideally under a tax code that greatly simplifies the calculation of taxable income), and also their annual savings, as many now do for IRAs and other tax-exempt retirement accounts. The difference between those two numbers—income minus savings—is the family’s annual consumption expenditure. That amount, less a large standard deduction—say, $30,000 for a family of four—is the family’s taxable consumption. Rates would start low and would then rise much more steeply than those under the current income tax.

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Families in the bottom half of the spending distribution would pay lower or no higher taxes than under the current system. But high marginal rates on top spenders would not only generate more revenue than the current system, but would also reshape spending patterns in ways that would benefit people up and down the income ladder.

Click to expand...

My primary objection to the "FairTax" folks has always been that sales taxes tend to be regressive (I know the FairTax prebate would make it slightly progressive, but not much). I'm not sure whether I'm a fan of progressive consumption taxes. The way the author describes it working wouldn't really simplify anything v. an income tax. But it would get tax revenue from wealthy people with low incomes.

'Wrighteous Ray said:

Anyone have any thoughts on A Progressive Consumption Tax?

The simplest step would be to scrap the current progressive income tax in favor of a much more steeply progressive tax on each household’s consumption. Families would report their taxable income to the IRS (ideally under a tax code that greatly simplifies the calculation of taxable income), and also their annual savings, as many now do for IRAs and other tax-exempt retirement accounts. The difference between those two numbers—income minus savings—is the family’s annual consumption expenditure. That amount, less a large standard deduction—say, $30,000 for a family of four—is the family’s taxable consumption. Rates would start low and would then rise much more steeply than those under the current income tax.

Advertisement

Families in the bottom half of the spending distribution would pay lower or no higher taxes than under the current system. But high marginal rates on top spenders would not only generate more revenue than the current system, but would also reshape spending patterns in ways that would benefit people up and down the income ladder.

Click to expand...

My primary objection to the "FairTax" folks has always been that sales taxes tend to be regressive (I know the FairTax prebate would make it slightly progressive, but not much). I'm not sure whether I'm a fan of progressive consumption taxes. The way the author describes it working wouldn't really simplify anything v. an income tax. But it would get tax revenue from wealthy people with low incomes.

Click to expand...

Interesting idea.

When does fatguy come off suspension? He's a good man to have on these boards.

'Matthias said:

'Wrighteous Ray said:

Anyone have any thoughts on A Progressive Consumption Tax?

The simplest step would be to scrap the current progressive income tax in favor of a much more steeply progressive tax on each household’s consumption. Families would report their taxable income to the IRS (ideally under a tax code that greatly simplifies the calculation of taxable income), and also their annual savings, as many now do for IRAs and other tax-exempt retirement accounts. The difference between those two numbers—income minus savings—is the family’s annual consumption expenditure. That amount, less a large standard deduction—say, $30,000 for a family of four—is the family’s taxable consumption. Rates would start low and would then rise much more steeply than those under the current income tax.

Families in the bottom half of the spending distribution would pay lower or no higher taxes than under the current system. But high marginal rates on top spenders would not only generate more revenue than the current system, but would also reshape spending patterns in ways that would benefit people up and down the income ladder.

Click to expand...

My primary objection to the "FairTax" folks has always been that sales taxes tend to be regressive (I know the FairTax prebate would make it slightly progressive, but not much). I'm not sure whether I'm a fan of progressive consumption taxes. The way the author describes it working wouldn't really simplify anything v. an income tax. But it would get tax revenue from wealthy people with low incomes.

Click to expand...

How so?He's deducting savings off of income, not adding to it. So someone who who was wealthy with a low income still wouldn't see much tax.

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I guess I was assuming that if you spent some of your savings in a year, that would constitute a negative savings, which would therefore be taxed. The article doesn't really spell it out though.

'roadkill1292 said:

When does fatguy come off suspension? He's a good man to have on these boards.

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Pretty sure he has been here the whole time

'roadkill1292 said:

When does fatguy come off suspension? He's a good man to have on these boards.

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Overrated if you ask me.

'Wrighteous Ray said:

'roadkill1292 said:

When does fatguy come off suspension? He's a good man to have on these boards.

Click to expand...

Overrated if you ask me.

Click to expand...

'Wrighteous Ray said:

'roadkill1292 said:

When does fatguy come off suspension? He's a good man to have on these boards.

Click to expand...

Overrated if you ask me.

Click to expand...

Well, dang. I need to borrow somebody's notebook from time to time. Howdy.

'Wrighteous Ray said:

Anyone have any thoughts on A Progressive Consumption Tax?

The simplest step would be to scrap the current progressive income tax in favor of a much more steeply progressive tax on each household’s consumption. Families would report their taxable income to the IRS (ideally under a tax code that greatly simplifies the calculation of taxable income), and also their annual savings, as many now do for IRAs and other tax-exempt retirement accounts. The difference between those two numbers—income minus savings—is the family’s annual consumption expenditure. That amount, less a large standard deduction—say, $30,000 for a family of four—is the family’s taxable consumption. Rates would start low and would then rise much more steeply than those under the current income tax.

Advertisement

Families in the bottom half of the spending distribution would pay lower or no higher taxes than under the current system. But high marginal rates on top spenders would not only generate more revenue than the current system, but would also reshape spending patterns in ways that would benefit people up and down the income ladder.

Click to expand...

My primary objection to the "FairTax" folks has always been that sales taxes tend to be regressive (I know the FairTax prebate would make it slightly progressive, but not much). I'm not sure whether I'm a fan of progressive consumption taxes. The way the author describes it working wouldn't really simplify anything v. an income tax. But it would get tax revenue from wealthy people with low incomes.

Click to expand...

I think there are a lot of details that would have to be worked out. For example, if you received a gift or inheritance and put it in savings would that reduce your tax or would we have to consider those items income under this system?Also, the only thing I like about the Fairtax is that (in theory) it makes tax evasion more difficult because it's not tied to income. This plan would still allow cash businesses, drug dealers, etc. to underreport income and therefore tax.

Some reasons why capital gains should be taxed at a lower rate than ordinary income:

1. On average, about half of capital gains are only nominal, not real. If I buy a house for $100,000 and sell it twenty years later for $200,000, there's a good chance that my real income on that set of transactions is zero. The purchasing power of $100,000 in 1980 is roughly equal to the purchasing power of $200,000 in 2000 because of inflation. (I'm making that up, but if it's inaccurate, feel free to substitute numbers that are accurate.) People should arguably pay tax only on real income, not on strictly nominal income. On average, inflation is about 3% annually, and returns on capital investments are about 6% annually. (Some people make a lot more than 6% on their capital investments, which is part of why Warren Buffet's true tax rate may really be lower than his secretary's. But he's the exception rather than the rule.) Therefore, on average, about half of all capital gains are strictly nominal; and the true tax rate on capital gains is about double the nominal rate. It would make a lot of sense for taxes on capital gains to be indexed to inflation. Barring that, just figure that a nominal 15% tax rate on capital gains generally equates to a real rate of about 30 percent. (I think this is a very strong argument.)

2. "It's already been taxed." As silly as it can be in certain other contexts, I think this argument has some merit when talking about earnings on capital that was taxed when it was acquired. If you want to know what Mitt Romney's effective tax rate is, I don't think you should just look at the amount he pays in taxes in a given year as a percentage of his income that year. I think you should compare his earnings in the real world to his would-be earnings in a fictional world without taxes. If Romney makes $100 in 1980, pays $25 in taxes, uses $50 to live on, and invests the remaining $25 . . . his original $25 investment will eventually be worth $250 when he cashes out a few decades later. If he pays 15% on his $225 gain, he'll be left with after-tax income of about $191. In a world with no taxes, he'd have been able to invest $50 instead of $25, and his investment would have eventually been worth $500 instead of $250. Comparing his after-tax income in a tax-free world with his after-tax income in the real world, it appears that Romney's effective tax rate is way higher than 15 percent even in years when his income is limited to capital gains. (I don't think this is a strong argument, but some economists smarter than me do. And even though I don't think it's a strong argument in itself, I do think it helps counteract certain objections to point #3.)

3. Why favor consumption over savings? Arnold Kling puts it simply: "If A and B earn the same income, but A saves and B spends more, then A should not have to pay higher lifetime taxes." If we want to distort behavior less, we should tax alternative activities at similar rates. Sales tax is usually around 7% or so. If we want our tax policy to be neutral with regard to spending versus saving, the tax on capital gains should be no higher than the tax on sales. (Arguably it should be zero, but we don't have to go that far here.) After all, when people resent the rich, it's usually for their lavish spending rather than for their lavish saving. Or at least it should be. (I think this is a fairly strong argument, but it's at least partially offset by the fact that capital gains taxes don't have to be paid on assets donated to charity. So Bill Gates can donate shares of MSFT to the Bill & Melinda Gates Foundation without either Bill or the Foundation having to pay taxes on the gains. At least I think that's how it works.)