Capital gains

[foolsguinea.livejournal.com]

Here there was a post about a capital gains tax rise being "suicidal."

And I said that the capital gains loophole actually hurts growth.

Well, which is it?

Capital gains is basically just interest. Let's try an example under US law. I'm not an accountant, so I'm probably going to get some details wrong, but I'll try anyway:

If I lend you $300 at 5% interest per annum, and you pay me back $315 at the end of the year, I made $15. That's short-term capital gains, and is taxed more like regular income, so (let's pretend I do this for a living and am already paying the top rate) I owe about 30% of it. So I made (roughly) $10 off the deal and the government made $5.

But if I lend you $300 at 5% interest per annum, and you pay me back $345 in about three years, I made $45. That's long-term capital gains, so even at the top rate, I only owe 15%. So I pay the government about $7 and clear $38 profit.

I get to keep a higher ratio of the interest because I let that particular loan mature for more than year. That's the only reason.

But if the top rate were the same as for short-term gains, I would pay the government $15 and keep $30. Would this harm growth?

Well, the lower rate is an incentive for long-term capital loans, and a tax reason not to demand one's money back so soon. That's it. Bringing long-term capital gains tax back in line with other taxes hardly seems to be the great economic distorter the Steve Forbes types claim it would be.

Now, let's be clear. Under US law, there are four different kinds of capital gains, and each has a personal exemption--an amount of capital gains income that is untaxed. If I don't lend much money, or buy much stock, and I make less than that exemption for each, I wouldn't even have to report it to the IRS as income, really. (I probably should, but since I don't owe anything, it's not a crime if I don't. [I am not accountant, don't take my advice on this.]) So my $45 is not going to be taxed if it's the only capital gain I made that year.

The real question is, what about someone who's lending $3 000 000 000? We can call it "buying bonds" or "investing in stock," but that's what he's doing. If he makes $450 000 000 profit, he's well into the top bracket. Do we really need to give that guy a deal where he pays a 15% rate instead of something in the 25%-35% range? Is incentivizing long-term loans really that good for the economy, that we should give up almost half the tax revenue?

Now, I said it was bad for growth. Maybe that's wrong. But I think it's dangerous to have too much money going into the hands of the lender/investor/owner class on a regular basis. If our tax code favors investors over those they invest in, we may find we are underpaying the actual workers and engineers in favor of a super-rich moneyed class. And history supports the idea that very high concentration of wealth eventually undercuts demand and crashes the economy, as in 1929 and 2008. But maybe I'm making too much of a correlation between the tax code and the wealth disparity in my country.

Comments

[badlydrawnjeff.livejournal.com]

But maybe I'm making too much of a correlation between the tax code and the wealth disparity in my country.

Probably. The problem is that the "investor class" you speak of also includes middle class homeowners, anyone with any investment-based retirement plan, etc. Wealth disparity shows no sign of actually mattering, and the question needs to be how we can generate more, better growth - disincentivizing investment further, at least to me, points in the wrong direction. Investment equals cash equals room for growth equals jobs.

[malakh-abaddon.livejournal.com]

Only when the investment is in the bank account. We need to re-prioritize how we invest. At one time, when tax rates were high business owners didn't always pocket profits, they went back into the company for upgrades in technology, more people, job training, and job perks, as the owner didn't want to show all the profit and wanted to pay lower taxes.

[badlydrawnjeff.livejournal.com]

This is amazingly backwards, as that investment you speak of just gets deferred until later instead. You can't incentivize investment when you're taking 25-35% off it off the top.

[a-new-machine.livejournal.com]

No signs of mattering (http://www.nytimes.com/2006/06/25/business/yourmoney/25view.html)?

[badlydrawnjeff.livejournal.com]

Correct.

[kylinrouge.livejournal.com]

That is a nice word salad. Too bad when put in that specific order it is both incorrect and incoherent.

[badlydrawnjeff.livejournal.com]

Why?

[foolsguinea.livejournal.com]

Capital gains taxes are progressive now, and would be progressive still if counted as regular income. Appealing to the small investor as a reason to cut rates on the large investor is disingenuous.

[underlankers.livejournal.com]

Marie Antoinette and Tsar Nicholas II and his family would have agreed with you it didn't matter, right up until they lost their heads and/or were riddled with bullets to a point that they weren't recognizable.

[caerfrli.livejournal.com]

The longer you money is out there, the greater your risk, so you get the break because the government considers it worth the cost to encourage you to take the risk. When money isn't risked, you get a situation like we have now with the banks, sitting on their money reluctant to lend any out.

[foolsguinea.livejournal.com]

And this requires a much lower top rate why?

[kylinrouge.livejournal.com]

There is no risk right now. The top investors are making record profits. The idea that they would stop investing if the rate was higher has no basis in reality.

[tcpip.livejournal.com]

The relative damage of capital gains tax depends on what is actually being taxed.

On produced goods it will have a deadweight loss.

On natural goods, it's actually beneficial as it will redirect investment towards productions (and therefore employment, net wealth & etc).