Why not tax capital gains as ordinary income?
That's an old chestnut among those of us who believe that the differential between tax rates on different types of income causes more harm than good.
James Stewart has a great piece in today's NYT asking this question. The usual objection to increasing the rate on capital gains -- that's the money you get when you sell an asset for more than you paid for it -- is that it will discourage investment.
And once again, we have a great quote from Warren Buffett:
I have worked with investors for 60 years and I have yet to see anyone -- not even when capital gains rates were 39.9 percent in 1976-77 -- shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off.
[Side note: I'm serious about this: Warren Buffett should be the next Treasury Secretary. No rush re: Tim, but when he steps down, I have a feeling Buffett would be a great Treas Sec'y. He knows business and markets, he's affable and could presumably work well with folks on all sides. And he's got great progressive instincts on taxes and fiscal sanity. Sure, the ruling classes would oppose him based on his recent calls to "stop coddling the rich" but that's a fight I'd very much welcome.]
What about evidence? Plotting the top cap gains rate against real business investment doesn't show much (see first figure -- biz investment is in natural logs to show proportional growth over this long time series). Cap gains bounce around based more on politics than policy, while investment pretty much grows with the cycle. Hard to see anything in the picture supporting the view that either the level or changes in cap gains taxes play a determinant role in investment decisions, just like Warren said.
There's been considerable academic work on this question, but tax expert Len Burman, quoted in the NYT piece, called the academic evidence "murky, at best." A few correlations support this view.
The table shows correlations between (the log change in) real private investment and both levels (KGAINS) and changes (DKG) in capital gains tax rates, from 1929-2010. The correlations have the "wrong" sign and are statistically significant, meaning increases in the level or positive changes in the capital gains tax rate are associated with an increase in the growth rate of real private investment.
That probably just reflects the fact that both real investment and tax changes can be cyclical, so I did a second correlation exercise that controls for the cycle (I ran a VAR with 2 lags on cap gains, the log change in real business investment, and unemployment rates). The graph shows the impact on real private investment growth over a number of years if you raise the capital gains rate. The result is... nothing. The investment line barely budges and is statistically insignificant.
These are quick correlations -- not causal models. But they are consistent with both the literature and the insights of practitioners like Buffett.
There are a few economic principles that we consistently get wrong in ways that do lasting damage to our economy and diminish our future. At the top of this list are arguments about large behavioral responses to changes in tax rates. I don't think it's zero, but I've simply never seen compelling evidence that tax increases significantly hurt growth, labor supply, jobs, wages, or that rate decreases provide much of a boost the other way. And when you factor in the benefits of the investment and services government provides -- something the literature tends to ignore -- the hyper-responsiveness arguments are even less compelling.
(That reminds me -- the one place Stewart slips up in the piece is buying into the argument that if you raise the cap gains rate, you should be open to arguments to return some of the revenue you gain back to taxpayers in the form of lower rates -- "Much of the [revenue] windfall from higher capital gains rates could be offset by cutting the rate on ordinary income." That doesn't make sense -- if you don't believe that taxing cap gains as ordinary income is a problem in terms of investment and growth, then why tweak other rates?)
So, in the interest of better, simple tax policy that diminishes a distortion in the system while raising some much needed revenue, we should seriously consider taxing capital gains as normal income. I know -- not exactly consistent with our current politics, but perhaps Sec'y Buffett can take a run at this someday.
This post originally appeared at Jared Bernstein's On The Economy blog.
The Great Capital Gains Charade
Herman Cain: Mr. President, you're fired
Right now you just offset gains with losses and the net of which, if positive, is taxed at the lower capital gains rate.
What should the level be? Maybe when the income rises above two thirds the median?
I am all for making the tax structure a little more progressive, but we need to encourage people to save and invest.
First, get rid special-interest tax breaks and deductions. This change will help the government reduce its costs since deductions are considered to be the equivalent of government spending. (http://eng.am/pxo5XL)
Second, reduce the number of tax brackets and lower the tax rate. These changes will increase tax compliance which leads to greater tax revenue and helps spur economic growth. (http://eng.am/nz0KaJ)
By instituting low rates without deductions, similar to low price supermarkets like Walmart, the government has the ability to generate more revenue while also saving people money, two things this country desperately needs. http://eng.am/rcsgra
"The correlations have the "wrong" sign and are statistically significant, meaning increases in the level or positive changes in the capital gains tax rate are associated with an increase in the growth rate of real private investment."
Just think about that for a moment. Raising the capital gains tax rate INCREASES the growth rate of private investment.
Higher taxes means more investment.
amount earned by people making over $200K/yr = $1.53B
taxed at 100% it would lower deficit by?...
If every cut, no matter how small is needed to balance the budget and pay the debt, then by the same logic, every small increase is needed.
If you feel that there is an unfair tax advantage going to the rich, wouldn’t it be easier to just convert labor to equity, subject them to the same economics as capital investors, and then subject them to the lower dividend tax.
For (simplistic) example , let’s say you want to you want to start an auto manufacturing company (on a small scale) that requires only one worker. Instead of paying his salary, insurance, welfare benefits, you just lump it all together and consider it the workers equity in the venture, say it equates $100K. Now let’s assume the capital needed to start the business is $8MM, the total capital for the company would be $8.1MM, of which the worker owns 1.235%. The ROE is 15%, equating to a Net Income, after tax, of say $1.215MM, of which the one laborer would get $15K (1.235% of $1,215MM), which would then be taxed at 15%, resulting in a net take home dividend of $12,750. He forgoes salary up front, takes the same risk, but each year he works his share of the business increases as do his dividends & upon sale he gets a pro rata share of sale proceeds.
All he has to do is decide to not take a salary of $100K up front. And when the business loses money, so does labor. Salaries are obliterated & labor gets fair reward (or loss) for fair investment and fair risk.
Fair?
Kai
The have's are not making investments in this country. They have no interest in creating jobs for us.
They invest the money overseas not for lower taxes but for cheap labor and government paid healthcare. The unfair trade agreements have not produced wonderful jobs we were promised. Our taxes,(government spending) has to pay for food stamps, unemployment, medicaid etc for the have nots. Where will they go, otherwise for help???
What he said. Not sure where you are getting this idea that capital pays less in taxes than labor. If I use my capital to start an S Corp, my profits are taxed as ordinary income--same as all of the employees. If I start a C-Corp, my capital has to pay corporate taxes, and then profits are taxed again when profits are distributed as dividends. If I sell the business for more than it cost me to start it, I receive the gain--but I'm also the one who took all of the risk and in most cases (including my own), I'm the one who put sweat equity into the business. You can't compare capital gains to labor's tax rate because labor doesn't have any cost or any gain--it only has income.
Regarding the comments about taxes and hiring, think of the law of supply and demand. The demand curve slopes downward because as cost increases, demand decreases. It's the same way with hiring. Payroll taxes, health insurance, etc all add cost. The more cost you add, the less demand there is. Now let's consider income taxes on business owners. Every dollar the government takes is a dollar that can't be 1)taken as profit 2)used to pay expenses like employee compensation and benefits 3)reinvested in the business.