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What is the modern argument for preferential tax treatment of capital gains? Arguments against it seem compelling to me: 1. The American dream is achievement

What is the modern argument for preferential tax treatment of capital gains? Arguments against it seem compelling to me: 1. The American dream is achievement through hard work. But taxation of capital gains privileges ownership over labor. That's just un-American. 2. This preferential taxation creates an anti-productive industry dedicated to re-casting ordinary income as capital gains, leading to misallocation of resources. 3. Many states including California tax capital gains at the same rate as ordinary income; CA is not exactly suffering from lack of investment income. 4. Optics are terrible: I and many other ordinary Americans pay a higher average tax rate than the very wealthy, including ex-presidential candidate Mitt Romney and in all likelihood President Trump.

deleted 8y ago
[deleted]
harryh 8y ago
https://en.wikipedia.org/wiki/Optimal_capital_income_taxation https://en.wikipedia.org/wiki/Optimal_capital_income_taxatio... is a good place to start. Right up top is a nice summary: "Starting from the conceptualization of capital income as future consumption, the taxation of capital income corresponds to a differentiated consumption tax on present and future consumption. Consequently, a capital income tax results in the distortion of individuals' saving and consumption behavior as individuals substitute the more heavily taxed future consumption with current consumption." Here is a simplified explanation of the above: http://www.thebigquestions.com/2010/01/27/a-quick-economics-lesson/ http://www.thebigquestions.com/2010/01/27/a-quick-economics-...
- millstone 8y ago
  These arguments use a simplified model where capital income occurs as the consequence of investing wage income. They don't address the modern reality that capital income replaces wage income, through accelerated depreciation, inheritance, carried interest, etc. And yes, of course taxing capital is distorionary; but so is taxing labor, and exponentially so when capital income may be substituted for labor.
  - harryh 8y ago
    You asked a question. I gave you an answer. I agree that it is a complex question with many competing arguments on both sides.
    - millstone 8y ago
      Agreed; not attacking you, I just feel like the pro-differential-taxation arguments are too theoretical and ignore political and economic realities.
      - harryh 8y ago
        My personal view is that the pro-differential-taxation theory mostly argues for zero taxes on cap gains. But you're right that this ignores political and economic realities. In particular, I find the discussion about the difficulty of distinguishing between capital and wage income (the topic of Fred's blog post!) particularly compelling. So a compromise is in order: lower taxes on cap gains but not all the way to zero. This is, not coincidentally, the status quo in the US and most other western/developed nations.
  - closeparen 8y ago
    35% of all financial assets in the US are precisely the consequence of investing wage income: retirement savings. [0] https://www.ici.org/research/stats/retirement/ret_17_q4 https://www.ici.org/research/stats/retirement/ret_17_q4
- crdoconnor 8y ago
  That argument would work in an economic environment with high inflation, high interest rates, low overall rates of investment and a high capital gains tax. The fact that we are currently operating under an environment with low inflation, low interest rates, too much capital floating around and a low capital gains tax rather suggests that it should actually be raised, and quite a lot at that. If raising capital gain actually did bring forward consumption then that would actually act as a form of economic stimulus (on top of filling up depleted state/city coffers), none of which would be unwelcome. Unless you're extremely wealthy.
WalterBright 8y ago
1. The higher the capital gains tax rate, the less money will be invested. 2. Higher rates make for less efficient economics, because people will hold on to poorly performing investments longer. 3. A big chunk of capital gains are actually inflation.
- Declanomous 8y ago
  The only point that seems unfair is point 3, which can be mollified by adjusting for inflation. If we reduce points 1 and 2 to their logical conclusion, capital gains should not be taxed at all. This is idiotic. Due to the structural advantages individuals with money have investing, you'd basically be creating a system where people with money would capture almost all of the wealth. The end goal shouldn't be the most efficient economy possible, it should be the highest standard of living for the individuals in your country. To that end, a certain amount of taxation is necessary.
  - harryh 8y ago
    > If we reduce points 1 and 2 to their logical conclusion, capital gains should not be taxed at all. This is idiotic. FWIW a great many people believe that capital gains should not be taxed at all. And while there are certainly fine arguments against that point of view, I don't think it's fair to say that "it's idiotic" when their p.o.v. is based on solid economic theory.
    - Declanomous 8y ago
      I'm familiar with the theory, but I think economic theories that only looks to maximize economic productivity while ignoring philosophical or ethical concerns are idiotic. If you don't take into account what is being produced and why, you are left with a line of tautological reasoning that more productivity is good because more productivity is good. The reason this is idiotic because there are a lot of ways to maximize productivity where the vast majority of people do not benefit. Not only that, but there is absolutely no reason that maximizing the productiveness of an economy results in maximum utility (in the philosophical sense). Even if you could demonstrate that economic productivity was positively correlated with (philosophical) utility, you'd have absolutely no guarantee that utility would be distributed equitably. You could literally have 1 super happy person with everyone else on the planet enslaved in perpetual (productive) agony. That's even before you get into the fact that maximizing production now probably ends up creating a hellscape of a planet tomorrow. Of course you could argue that you can account for all of this using negative externalities. In that case you might as well tax capital gains to account for the negative externalities. I suppose you could tax something else, like lifetime earnings, but the point is I feel comfortable making the claim that not taxing capital gains is idiotic.
tehlike 8y ago
American dream is actually using capital to make others work. That is the way to scale. Not necessarily hard, but smart work.
DenisM 8y ago
It used to be that we had shortage of capital for large projects. So capital accumulation was incentivized over consumption. This is probably no longer true with some companies sitting on hundreds of billions of dollars, but the system persists.

deleted 8y ago

[deleted]

harryh 8y ago

https://en.wikipedia.org/wiki/Optimal_capital_income_taxation https://en.wikipedia.org/wiki/Optimal_capital_income_taxatio... is a good place to start. Right up top is a nice summary: "Starting from the conceptualization of capital income as future consumption, the taxation of capital income corresponds to a differentiated consumption tax on present and future consumption. Consequently, a capital income tax results in the distortion of individuals' saving and consumption behavior as individuals substitute the more heavily taxed future consumption with current consumption." Here is a simplified explanation of the above: http://www.thebigquestions.com/2010/01/27/a-quick-economics-lesson/ http://www.thebigquestions.com/2010/01/27/a-quick-economics-...

millstone 8y ago
These arguments use a simplified model where capital income occurs as the consequence of investing wage income. They don't address the modern reality that capital income replaces wage income, through accelerated depreciation, inheritance, carried interest, etc. And yes, of course taxing capital is distorionary; but so is taxing labor, and exponentially so when capital income may be substituted for labor.
- harryh 8y ago
  You asked a question. I gave you an answer. I agree that it is a complex question with many competing arguments on both sides.
  - millstone 8y ago
    Agreed; not attacking you, I just feel like the pro-differential-taxation arguments are too theoretical and ignore political and economic realities.
    - harryh 8y ago
      My personal view is that the pro-differential-taxation theory mostly argues for zero taxes on cap gains. But you're right that this ignores political and economic realities. In particular, I find the discussion about the difficulty of distinguishing between capital and wage income (the topic of Fred's blog post!) particularly compelling. So a compromise is in order: lower taxes on cap gains but not all the way to zero. This is, not coincidentally, the status quo in the US and most other western/developed nations.
- closeparen 8y ago
  35% of all financial assets in the US are precisely the consequence of investing wage income: retirement savings. [0] https://www.ici.org/research/stats/retirement/ret_17_q4 https://www.ici.org/research/stats/retirement/ret_17_q4
crdoconnor 8y ago
That argument would work in an economic environment with high inflation, high interest rates, low overall rates of investment and a high capital gains tax. The fact that we are currently operating under an environment with low inflation, low interest rates, too much capital floating around and a low capital gains tax rather suggests that it should actually be raised, and quite a lot at that. If raising capital gain actually did bring forward consumption then that would actually act as a form of economic stimulus (on top of filling up depleted state/city coffers), none of which would be unwelcome. Unless you're extremely wealthy.

WalterBright 8y ago

1. The higher the capital gains tax rate, the less money will be invested. 2. Higher rates make for less efficient economics, because people will hold on to poorly performing investments longer. 3. A big chunk of capital gains are actually inflation.

Declanomous 8y ago
The only point that seems unfair is point 3, which can be mollified by adjusting for inflation. If we reduce points 1 and 2 to their logical conclusion, capital gains should not be taxed at all. This is idiotic. Due to the structural advantages individuals with money have investing, you'd basically be creating a system where people with money would capture almost all of the wealth. The end goal shouldn't be the most efficient economy possible, it should be the highest standard of living for the individuals in your country. To that end, a certain amount of taxation is necessary.
- harryh 8y ago
  > If we reduce points 1 and 2 to their logical conclusion, capital gains should not be taxed at all. This is idiotic. FWIW a great many people believe that capital gains should not be taxed at all. And while there are certainly fine arguments against that point of view, I don't think it's fair to say that "it's idiotic" when their p.o.v. is based on solid economic theory.
  - Declanomous 8y ago
    I'm familiar with the theory, but I think economic theories that only looks to maximize economic productivity while ignoring philosophical or ethical concerns are idiotic. If you don't take into account what is being produced and why, you are left with a line of tautological reasoning that more productivity is good because more productivity is good. The reason this is idiotic because there are a lot of ways to maximize productivity where the vast majority of people do not benefit. Not only that, but there is absolutely no reason that maximizing the productiveness of an economy results in maximum utility (in the philosophical sense). Even if you could demonstrate that economic productivity was positively correlated with (philosophical) utility, you'd have absolutely no guarantee that utility would be distributed equitably. You could literally have 1 super happy person with everyone else on the planet enslaved in perpetual (productive) agony. That's even before you get into the fact that maximizing production now probably ends up creating a hellscape of a planet tomorrow. Of course you could argue that you can account for all of this using negative externalities. In that case you might as well tax capital gains to account for the negative externalities. I suppose you could tax something else, like lifetime earnings, but the point is I feel comfortable making the claim that not taxing capital gains is idiotic.

tehlike 8y ago

American dream is actually using capital to make others work. That is the way to scale. Not necessarily hard, but smart work.

DenisM 8y ago

It used to be that we had shortage of capital for large projects. So capital accumulation was incentivized over consumption. This is probably no longer true with some companies sitting on hundreds of billions of dollars, but the system persists.