Should capital gains be taxed the same as income?

[Benjamin Frank]

1.Capital gains, not capital.  Elizabeth Warren wants a capital/wealth tax.

2.Anybody can and often do make arguments as to why they should/need to be taxed at a lower rate than everybody else/the norm.  Most of these arguments don't hold water.

As Geoffrey Howe argued, it's generally not a good idea to have people favor one type of income over another on the basis of tax incentives as it can distort their behavior and those in employer/management positions can lower their taxes by shifting their earnings to lower taxed forms of income. For instance, most corporate executives don't earn a great deal in regular income, but earn most in stock options, which, after a time, they can then sell and pay lower taxes.

So, yes, all income should be taxed at the 'normal' rate for each person.

Capital gains still receive investment preferences for tax purposes as capital losses can be matched against both capital gains and some regular income.

3.I can see some need to address inflation in reducing the total base of capital gains to be taxed.

[Benjamin Frank]

1.Capital gains, not capital.  Elizabeth Warren wants a capital/wealth tax.

Duly edited.

As Geoffrey Howe argued, it's generally not a good idea to have people favor one type of income over another on the basis of tax incentives as it can distort their behavior and those in employer/management positions can lower their taxes by shifting their earnings to lower taxed forms of income. For instance, most corporate executives don't earn a great deal in regular income, but earn most in stock options, which, after a time, they can then sell and pay lower taxes.

Do you mean me or the politician? It was Nigel Lawson who did this as Chancellor, by the way.

So, yes, all income should be taxed at the 'normal' rate for each person.

Capital gains still receive investment preferences for tax purposes as capital losses can be matched against both capital gains and some regular income.

Yes, and Rishi Sunak has allowed a 130% deduction for investment in equipment and the like.

3.I can see some need to address inflation in reducing the total base of capital gains to be taxed.

The Economist has argued for this in effect - they say 'normal returns' (low-risk bond interest) should be exempted. But as Ernest said to me on another board, this would make accounting rather complicated.

1.Sorry, Nigel Lawson.

3.The hard part I'd think is if an investment is held for more than one year.  If the low risk bond interest was 10% a year (just to make the calculation easier) we have:

One year holding:
Sold: $140
Bought: $100
Gain: $40  - (bought $100 *10%) = $30 to be taxed

Two year holding
Sold $140
Bought $100
Gain $40 - (bought $100 *0.10^2 - that's not the right math, I can't think of how to write it right now) but it's $21 over 2 years = $19 to be taxed.

So, the issue is you'd have to make sure the investment was held as long as the person claimed it was.  I imagine it could be done though with computerized tax filings and documents.  It doesn't seem like a problem that technology can't address.

[Benjamin Frank]

1.Capital gains, not capital.  Elizabeth Warren wants a capital/wealth tax.

2.Anybody can and often do make arguments as to why they should/need to be taxed at a lower rate than everybody else/the norm.  Most of these arguments don't hold water.

As Geoffrey Howe argued, it's generally not a good idea to have people favor one type of income over another on the basis of tax incentives as it can distort their behavior and those in employer/management positions can lower their taxes by shifting their earnings to lower taxed forms of income. For instance, most corporate executives don't earn a great deal in regular income, but earn most in stock options, which, after a time, they can then sell and pay lower taxes.

So, yes, all income should be taxed at the 'normal' rate for each person.

Capital gains still receive investment preferences for tax purposes as capital losses can be matched against both capital gains and some regular income.

3.I can see some need to address inflation in reducing the total base of capital gains to be taxed.

Capital gains are taxed at lower rate specifically to incentivize investing.

The "problem" of executive stock options can be resolved by making such options taxed as ordinary income when exercised, the same as short-term capital gains. Indeed, it's reasonable from a behavioral perspective to treat them as short-term capital gains in the first place when such options are exercised.

If we're going to reform capital gains taxation, I favor the above change in the treatment of executive stock options, the elimination of like-kind exchanges, and possibly the reintroduction of intermediate tax rates for medium-term capital gains (however medium-term gets defined).

Yes, that's the argument, that's what I meant by this: 2.Anybody can and often do make arguments as to why they should/need to be taxed at a lower rate than everybody else/the norm.  Most of these arguments don't hold water.

In regards to encouraging investing, there already is 401Ks. 

[Benjamin Frank]

A capital gains tax could limit investment in the economy, but if it must be taxed, raising the rate for longer-term investments would be the way to go. We also could tax dividends heavily and get rid of these preferential rates too as they exacerbate economic inequality.

It actually can't.  There are only two things to do with money: save it or spend it.  If you spend it, the person who gets that money has the same choices.  At the end of these choices, somebody is going to save the money rather than spend it, and there is no difference between saving and investing.

A lot of people try to make finance seem very complicated in order to justify their high salaries.  Don't overcomplicate it.  Like anything to do with economics, it's just a process of thinking step by step.

Where it is actually beyond complicated to the point of being impossible, is trying to predict the future to know what stocks to invest in, for instance.  It's one thing to analyze existing information to see what people can do with their money (spend or save) and the consequences of that.  It's another thing to try to analyze future information.


This is a much more technical explanation:

Fallacy 2

Urging or providing incentives for individuals to try to save more is said to stimulate investment and economic growth. This seems to derive from an assumption of an unchanged aggregate output so that what is not used for consumption will necessarily and automatically be devoted to capital formation.

Again, actually the exact reverse is true. In a money economy, for most individuals a decision to try to save more means a decision to spend less; less spending by a saver means less income and less saving for the vendors and producers, and aggregate saving is not increased, but diminished as vendors in turn reduce their purchases, national income is reduced and with it national saving. A given individual may indeed succeed in increasing his own saving, but only at the expense of reducing the income and saving of others by even more.

Where the saving consists of reduced spending on nonstorable services, such as a haircut, the effect on the vendor's income and saving is immediate and obvious. Where a storable commodity is involved, there may be an immediate temporary investment in inventory, but this will soon disappear as the vendor cuts back on orders from his suppliers to return the inventory to a normal level, eventually leading to a cutback of production, employment, and income.

Saving does not create "loanable funds" out of thin air. There is no presumption that the additional bank balance of the saver will increase the ability of his bank to extend credit by more than the credit supplying ability of the vendor's bank will be reduced. If anything, the vendor is more likely to be active in equities markets or to use credit enhanced by the sale to invest in his business, than a saver responding to inducements such as IRA's, exemption or deferral of taxes on pension fund accruals, and the like, so that the net effect of the saving inducement is to reduce the overall extension of bank loans. Attempted saving, with corresponding reduction in spending, does nothing to enhance the willingness of banks and other lenders to finance adequately promising investment projects. With unemployed resources available, saving is neither a prerequisite nor a stimulus to, but a consequence of capital formation, as the income generated by capital formation provides a source of additional savings.

Fifteen Fatal Fallacies of Financial Fundamentalism
A Disquisition on Demand Side Economics

William Vickrey

October 5, 1996

http://www.columbia.edu/dlc/wp/econ/vickrey.html

I appreciate there is some technical language used here, but if you make a simple flowchart you can see that this economics explanation is nothing more than 'following the money' step by step.