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Imagine there are two products on the market: "the promise of $130 in 5 years" and "$100 today." The fact that people choose to exchange one product for the oth

by enoch_r 12y ago

Imagine there are two products on the market: "the promise of $130 in 5 years" and "$100 today." The fact that people choose to exchange one product for the other every day suggests that the two products have equal value.[0] Capital gains taxes mean that these two products of equal value are taxed at different rates. Although I work a lot of hours too, I find that quite unfair. [0] http://en.wikipedia.org/wiki/Time_value_of_money http://en.wikipedia.org/wiki/Time_value_of_money

ScottBurson 12y ago
Ah, but there are different ways to solve that problem. One is to reduce the capital gains tax rate, perhaps to zero. The other is to subtract the expected return (based on the risk-free rate of return) from the gain, and then apply some nonzero tax rate to the remainder. Here's why the latter makes more sense to me. It's only at the risk-free rate of return that the two products you describe are of equal value. In order to realize returns higher than the risk-free rate, investors must do work. I think that the extra gain beyond the risk-free rate should be taxed as ordinary income, because that's really what it is: income produced by work. Of course, actually implementing this policy isn't quite trivial: it requires a running estimate of the risk-free rate of return that can be agreed on politically, and it requires knowing exactly when assets changed hands (down to the nanosecond, for HFT). But it's well within our computational capabilities at this point. So, should people who just stick their money in the bank at 0% for some period of time be able to claim a small loss on it? I would be fine with that, actually.
- enoch_r 12y ago
  > In order to realize returns higher than the risk-free rate, investors must do work. 1. Are you claiming that taking risk is a form of work? Because the correlation between risk and expected return holds up very well empirically, and it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on. Even if risk and expected return had no correlation, it'd still only require luck, not necessarily skill, to often realize returns higher than the risk-free rate--just purchase one share of each of 100 risky stocks, and I guarantee that you'll have a significant return on at least one of them. 2. There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck, not work. Mutual fund managers, for example--whose literal job it is to earn excess returns--perform in aggregate roughly as well as the market, and the very best performers, at the extreme tail of the distribution, in one year are barely more likely than chance to do better than average the following year, and people in the bulk of the distribution are essentially flipping coins.[0] Again, these are people whose job it is to beat the market, and they're failing miserably. 3. In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value. [0] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021
  - ScottBurson 12y ago
    > Are you claiming that taking risk is a form of work? Yes, because you have to decide what risk to take. > it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on It would take a lot to convince me that you should pay a lower tax rate than I do on the money you make, just because the work you do is trading the stock market. (Essentially all my income is ordinary income.) You may have a theory that says that your expected return from buying ETFs right now is higher than your expected return from buying T-bills. But if so, you had to do some work to develop that theory. In the absence of that work, the best predictor you have of the future value of the ETF is its present value. > There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck Fine. I have even less problem with taxing luck than I do with taxing work. > In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value. Making money consistently in the market takes work. If you don't believe me, ask a trader. But again, I don't care about the distinction between luck and work. I don't care what your effective hourly rate is. Taxation is based on the amount of income, not on the amount of work it took to obtain it. Let me make that concrete. I have a side business, with a partner, that brings in a mid-five-figure annual amount that we split roughly equally. (It's a support contract for a product we used to work on, sold to one of the last people in the world using that product; the company we worked for that produced the product is defunct.) In recent years I have needed to spend about 10 hours a year on this business. I wouldn't call it life-changing, but it's a nice little piece of change and I feel very lucky to have it. But the IRS doesn't tax me at a lower rate just because luck was involved or because my effective hourly rate is so astronomical. There is a big difference, of course, between this business and trading: I have no money invested in it that I could lose. But this points up what the real question here is: how much do we want to subsidize risk-taking as opposed to other kinds of productive activity? And I don't see why, at the moment, we would want to subsidize it at all. Our economy is already over-financialized, and this shows no sign of changing soon. I'm sure there are some macroeconomic circumstances in which incentivizing risk-taking would make sense, but the present day is not one of them.

by enoch_r 12y ago

ScottBurson 12y ago

Ah, but there are different ways to solve that problem. One is to reduce the capital gains tax rate, perhaps to zero. The other is to subtract the expected return (based on the risk-free rate of return) from the gain, and then apply some nonzero tax rate to the remainder. Here's why the latter makes more sense to me. It's only at the risk-free rate of return that the two products you describe are of equal value. In order to realize returns higher than the risk-free rate, investors must do work. I think that the extra gain beyond the risk-free rate should be taxed as ordinary income, because that's really what it is: income produced by work. Of course, actually implementing this policy isn't quite trivial: it requires a running estimate of the risk-free rate of return that can be agreed on politically, and it requires knowing exactly when assets changed hands (down to the nanosecond, for HFT). But it's well within our computational capabilities at this point. So, should people who just stick their money in the bank at 0% for some period of time be able to claim a small loss on it? I would be fine with that, actually.

enoch_r 12y ago
> In order to realize returns higher than the risk-free rate, investors must do work. 1. Are you claiming that taking risk is a form of work? Because the correlation between risk and expected return holds up very well empirically, and it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on. Even if risk and expected return had no correlation, it'd still only require luck, not necessarily skill, to often realize returns higher than the risk-free rate--just purchase one share of each of 100 risky stocks, and I guarantee that you'll have a significant return on at least one of them. 2. There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck, not work. Mutual fund managers, for example--whose literal job it is to earn excess returns--perform in aggregate roughly as well as the market, and the very best performers, at the extreme tail of the distribution, in one year are barely more likely than chance to do better than average the following year, and people in the bulk of the distribution are essentially flipping coins.[0] Again, these are people whose job it is to beat the market, and they're failing miserably. 3. In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value. [0] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021
- ScottBurson 12y ago
  > Are you claiming that taking risk is a form of work? Yes, because you have to decide what risk to take. > it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on It would take a lot to convince me that you should pay a lower tax rate than I do on the money you make, just because the work you do is trading the stock market. (Essentially all my income is ordinary income.) You may have a theory that says that your expected return from buying ETFs right now is higher than your expected return from buying T-bills. But if so, you had to do some work to develop that theory. In the absence of that work, the best predictor you have of the future value of the ETF is its present value. > There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck Fine. I have even less problem with taxing luck than I do with taxing work. > In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value. Making money consistently in the market takes work. If you don't believe me, ask a trader. But again, I don't care about the distinction between luck and work. I don't care what your effective hourly rate is. Taxation is based on the amount of income, not on the amount of work it took to obtain it. Let me make that concrete. I have a side business, with a partner, that brings in a mid-five-figure annual amount that we split roughly equally. (It's a support contract for a product we used to work on, sold to one of the last people in the world using that product; the company we worked for that produced the product is defunct.) In recent years I have needed to spend about 10 hours a year on this business. I wouldn't call it life-changing, but it's a nice little piece of change and I feel very lucky to have it. But the IRS doesn't tax me at a lower rate just because luck was involved or because my effective hourly rate is so astronomical. There is a big difference, of course, between this business and trading: I have no money invested in it that I could lose. But this points up what the real question here is: how much do we want to subsidize risk-taking as opposed to other kinds of productive activity? And I don't see why, at the moment, we would want to subsidize it at all. Our economy is already over-financialized, and this shows no sign of changing soon. I'm sure there are some macroeconomic circumstances in which incentivizing risk-taking would make sense, but the present day is not one of them.