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This article is quite odd: income appears to be taxed "more progressively"...One justification for this is that investors risk losing much or all of their capi

This article is quite odd: income appears to be taxed "more progressively"...One justification for this is that investors risk losing much or all of their capital. Workers, on the other hand, are guaranteed their wages This is not the primary justification at all, and I'd be rather surprised to see many economists arguing it. The actual reason capital should be taxed less than income (specifically, at 0%) is because there is no reason to tax savings. If you tax income only, you tax a person who earns $100 and spends it today the same as you tax a person who earns $100, saves it and spends it tomorrow. When you tax capital, you charge the second person a higher tax rate. This is doubly true in the presence of inflation - if a person earns a 1% nominal return in a 1% inflationary economy, then they break even. If you impose a capital gains tax, suddenly their rate of return needs to exceed (inflation + cap gains) just to break even.

jdreaver 12y ago
Exactly. The way I see it, if someone has a large pool of wealth, then they have already been taxed when they earned it. Taxing capital gains is double-dipping. Furthermore, I don't see how we can justify having a very low interest rate set by the federal reserve in the interest of encouraging investment, but then decide to tax capital gains more which would discourage investment. However, trying to make any sense of our tax system is probably not a fruitful endeavor :)
- runeks 12y ago
  As I see it, the real problem is differentiating "income" and "capital gains". We all have a general sense of what each category refers to, but there are a lot of edge cases where it's difficult to say whether it's one or the other. If I'm a day-trader, buying and selling stocks, and making a living on this, is the profit income or capital gains? If we go by the logic that one shouldn't pay the same tax twice, then it's capital gains, because income tax has already been paid on the money used to invest. I'm not saying this is the wrong conclusion -- that the income of day-traders selling and buying stocks should be taxed as capital gains -- but it seems to me that this constitutes favoring one profession over another. Surely, if I earn my living buying apples cheaply and selling them for more money, my income would be taxed as income, and not capital gains. So why should income from selling and buying apples be taxed differently than income from selling and buying stocks? Again, I don't claim to have the answer. It just seems like a hard problem to me.
  - gamblor956 12y ago
    If I'm a day-trader, buying and selling stocks, and making a living on this, is the profit income or capital gains? This is not an edge case; it's a well-settled point of law. Capital gains are related to the disposition of assets intended to be held for investment. Stocks are generally such assets and the disposition of stocks results in capital gain income (or capital losses). Apples are not intended for investment; they are intended for consumption. Ergo, the sales of apples results in normal income. (Note that for stockbrokers, stocks are also treated as inventory because by definition they are not in the business of holding stocks for investment.) Buying and selling stocks as a day trader is not the type of capital trading that governments want to incentivize, so they treat income arising from this type of activity as "short term capital gains." In most countries, including the US, short term capital gains are taxed at the same rates as normal income, which is the scenario that would apply to your day traders. Consequently, the day traders and apple sellers are taxed in essentially the same manner. It is only if capital assets are held for a sufficiently long period of time (in most countries 1 year, though in some countries as little as 6 months) that the true capital gains rates apply. This is where the day traders may come out ahead--if they hold on to some of the stocks traded for at least 1 year.
    - runeks 12y ago
      > Stocks are generally such assets and the disposition of stocks results in capital gain income (or capital losses). Apples are not intended for investment; they are intended for consumption. Wheat is also intended for consumption, but it -- as with many other goods, consumable or not -- is also a commodity that is traded. I realize I may have pointed out some edge cases that weren't actually edge cases. I am not a tax attorney, so I don't know what the law says. I am only trying to point out that determining what is income and what is a capital gain is a hard problem, even though laws exist that try to put various activities into one of the two categories. The US uses an arbitrary 1-year limit, while the tax code of my country of residence (Denmark) says the tax rate is determined, not by how long the assets are held, but by trying to determine whether the profit constitutes ones primary source of income. If the answer is "yes", it's taxed as income. So different countries use different methods to solve this problem of discerning income and capital gains, but I still maintain that it's a hard problem, that has not been solved adequately anywhere. And that there are many edge cases, resulting from current law, that are counter-intuitive.
- Brian-Puccio 12y ago
  I don't understand. If you make $500, then pay $100 in income tax, you're left with $400. If you invest the $400 in a stock and sell later for $500, you're not taxed on the $400 you've already made (and were taxed on), you're taxed on the $100 capital gain, which you haven't paid taxes on. Or am I misunderstanding things? ----- Further ... Is your argument is that once a pool of money has been taxed, that pool of money should never be taxed again? If so, does that mean you don't believe anyone should pay sales tax on anything they've purchased (since they're purchasing it with post-income tax dollars)? ----- Lastly, you mention that if "someone has a large pool of wealth, then they have already been taxed when they earned it". This is not necessarily so thanks to dynastic wealth, an issue others have brought up in other comments. The issue is exacerbated when someone inherits wealth (and pays little to no taxes on it), then invests it and has a capital gain of say $40k -- enough to cover basic living expenses in many parts of the country for a year. That person's tax rate is lower than a person who worked for an employer and made $40k. The question is, why is the government incentivizing this through tax code?
youngtaff 12y ago
There's an assumption in your argument that the earnings that funded the capital gains were taxed at an appropriate rate to start with. In the case of VC/PE etc. it can be argued that much of the capital gains are actually income and should have been taxed as such to start with - lets face it most partners in those businesses are risking other people's money rather than their own anyway. Problem I have with tax is we tax people on their income rather than their wealth so people with low incomes regardless of their wealth pay lower taxes.
unchocked 12y ago
Your argument is circular. Essentially, you say that capital should be untaxed because it was already taxed as income. But that's a value judgement that assumes your conclusion. There is a good case for taxing capital (savings). See Picketty.
- yummyfajitas 12y ago
  The actual detailed argument is that only two things can be taxed - consumption and investment. Consumption is the right thing to tax, since it measures the benefits a person receives from society. My argument isn't circular, however - it merely shows that once you have an income tax you don't need a savings tax. Piketty's argument, near as I can tell, is merely that we might live in a world where the best way to create wealth is to allow super smart uber rich people to direct nearly all investment [1]. Further, if we allow wealthy people to do this, they won't actually consume the fruits of their labor - they'll allow the rest of us to. Why that's an argument for taxing capital I have no idea. [1] His book doesn't justify this at all, it merely assumes it. http://www.chrisstucchio.com/blog/2014/piketty_and_inequality.html http://www.chrisstucchio.com/blog/2014/piketty_and_inequalit... But he has a couple of academic papers with models that I haven't fully read yet.
  - gamblor956 12y ago
    No, the correct argument is that many things can be taxed: creation, value enhancement, consumption, disposition, investment, wealth, transfers, transfers across borders, etc. (You're also still confusing savings taxes with investment taxes, which are not even remotely the same thing.)Which of these is taxed is a function of political ideology. If you tax consumption, you might also tax wealth, if a large portion of the income of the economy is concentrated in the hands of those who consume very little. Indeed, that is the entire point of having a wealth tax--to force consumption which can then be taxed. You have misstated Piketty's argument, as has Chris Stucchio. Piketty's argument is that allowing wealth to concentrate in the hands of a few is the biggest threat to the stability of modern economic systems because it ultimately means that less money is available to everyone else, which restricts growth. He is very much in favor of wealth taxes to force the distribution of this wealth to a wider range of the economy precisely to keep the cash flowing. He's not arguing for capital gains taxes--indeed, he opposes them, and has argued that capital gains should be taxed no differently from ordinary income.
jekdoce 12y ago
Why is interest on savings accounts taxed at income rates? Why is short-term capital gains taxed at income rates? While long-term capital gains are taxed at much lower rate. Seems like risk has something to do with it, no?
- SamReidHughes 12y ago
  Short-term capital gains can be taxed more because there's less of a chance that you're just taxing inflation on capital that didn't grow very much, or shrank.
api 12y ago
I thought capital gains taxes only applied to gains. You're not taxing savings, and losses can be written off against gains. The inflation problem could be mitigated with a structure that takes this into account. I can think of other reasons that low capital gains taxes are good, like encouraging investment, but the "taxing savings" argument doesn't seem like it works. IMHO what we really need is a way to distinguish rentier income from investment income derived from investing in growth. The former should be taxed as income or maybe even higher, while the latter should be taxed at a lower rate or not at all.
legacyfruit 12y ago
Agreed. The primary reason economists argue for taxing capital gains, is that income can be disguised as capital gains. Startups are probably the best example of this. Even this reason, however, is probably exaggerated. Suppose for example that the CEO owns 10% of a company's stock. While they have a greater incentive to work hard, there is also no reason to think the stock price will rise faster than any other stock (by the efficient market hypothesis). This apparent contradiction is resolved by that fact that the market already knows that the CEO is incentivized to work hard. So as long as the CEO isn't awarded shares before it is announced publicly, the capital income from these shares should be no different to any other share. The same applies to startups, however in the case of the startup there is no market signal so it is easier to cheat accounting rules and claim that the value of the awarded shares are lower than they really are.
- gamblor956 12y ago
  Shares paid as compensation are taxed as ordinary income pretty much everywhere that they have an income tax. Capital gains are only imposed on the later sale of those shares, and only if the CEO sells those shares for more money than they were worth when they were given to him.
gamblor956 12y ago
Capital gains taxes are not savings taxes. They are taxes on income arising from the disposition of capital assets. They are subjected to lower rates than normal income to incentivize capital investment income streams over normal income streams. Only a few countries impose savings taxes (also known as "wealth taxes"): France, Spain, the Netherlands, Norway, and Switzerland. There might be two or three more that I'm missing. Wealth taxes are intended to prevent the concentration of wealth by essentially forcing a minimum level of capital investment by the extremely wealthy. In your example, the person who earns and saves $100 is not taxed any differently than the person who earns $100. The saver has not invested any capital (yet), he is simply sitting on the money. Both were taxed at the appropriate tax rates (0% or their applicable marginal rate), so both have the same amount of money. If the saver then invests the money in a capital producing asset, when he later disposes of the asset, he may be taxed on the gain, if any, he recognizes on the income (i.e., the increase in the price of the capital asset over the price he paid for it). If the saver sold the capital asset for the same price, or for less, he is not taxed on the sale--in those situations, he is not treated any differently than the spender. It is only if the saver realizes a capital gain that he is subject to a capital gains tax, and when he is, he pays a far lower rate on that income than he would if he had earned the income (max 20% rate vs 25% rate or higher assuming saver is above the poverty line).
- dllthomas 12y ago
  In the presence of inflation, capital gains serve as a low (tax rate * inflation rate) tax on saving in something that is not cash. (Inflation itself is kinda sorta a tax on savings that are cash.)
akgerber 12y ago
Why is it the case that there 'no reason to tax savings'? Tools rust, food rots, houses fall down. One can't save useful things indefinitely without cost. Why, then, is it inherently true that a government (or other entity) should provide citizens a mechanism to store the means to buy those things indefinitely for free?
- hueving 12y ago
  Tools don't rust because the government wants people to buy more tools. Your comparison is nonsensical. Inflation is already the cost to save money.
ScottBurson 12y ago
This point could also be addressed by subtracting the increase due to inflation -- or even the risk-free rate of return, which one hopes is slightly higher than inflation -- from the amount to be taxed on, before multiplying by the tax rate. In a low-inflation environment this wouldn't make much difference, but in a high-inflation environment (like the 1970s) it would make quite a large difference.

jdreaver 12y ago

Exactly. The way I see it, if someone has a large pool of wealth, then they have already been taxed when they earned it. Taxing capital gains is double-dipping. Furthermore, I don't see how we can justify having a very low interest rate set by the federal reserve in the interest of encouraging investment, but then decide to tax capital gains more which would discourage investment. However, trying to make any sense of our tax system is probably not a fruitful endeavor :)

runeks 12y ago
As I see it, the real problem is differentiating "income" and "capital gains". We all have a general sense of what each category refers to, but there are a lot of edge cases where it's difficult to say whether it's one or the other. If I'm a day-trader, buying and selling stocks, and making a living on this, is the profit income or capital gains? If we go by the logic that one shouldn't pay the same tax twice, then it's capital gains, because income tax has already been paid on the money used to invest. I'm not saying this is the wrong conclusion -- that the income of day-traders selling and buying stocks should be taxed as capital gains -- but it seems to me that this constitutes favoring one profession over another. Surely, if I earn my living buying apples cheaply and selling them for more money, my income would be taxed as income, and not capital gains. So why should income from selling and buying apples be taxed differently than income from selling and buying stocks? Again, I don't claim to have the answer. It just seems like a hard problem to me.
- gamblor956 12y ago
  If I'm a day-trader, buying and selling stocks, and making a living on this, is the profit income or capital gains? This is not an edge case; it's a well-settled point of law. Capital gains are related to the disposition of assets intended to be held for investment. Stocks are generally such assets and the disposition of stocks results in capital gain income (or capital losses). Apples are not intended for investment; they are intended for consumption. Ergo, the sales of apples results in normal income. (Note that for stockbrokers, stocks are also treated as inventory because by definition they are not in the business of holding stocks for investment.) Buying and selling stocks as a day trader is not the type of capital trading that governments want to incentivize, so they treat income arising from this type of activity as "short term capital gains." In most countries, including the US, short term capital gains are taxed at the same rates as normal income, which is the scenario that would apply to your day traders. Consequently, the day traders and apple sellers are taxed in essentially the same manner. It is only if capital assets are held for a sufficiently long period of time (in most countries 1 year, though in some countries as little as 6 months) that the true capital gains rates apply. This is where the day traders may come out ahead--if they hold on to some of the stocks traded for at least 1 year.
  - runeks 12y ago
    > Stocks are generally such assets and the disposition of stocks results in capital gain income (or capital losses). Apples are not intended for investment; they are intended for consumption. Wheat is also intended for consumption, but it -- as with many other goods, consumable or not -- is also a commodity that is traded. I realize I may have pointed out some edge cases that weren't actually edge cases. I am not a tax attorney, so I don't know what the law says. I am only trying to point out that determining what is income and what is a capital gain is a hard problem, even though laws exist that try to put various activities into one of the two categories. The US uses an arbitrary 1-year limit, while the tax code of my country of residence (Denmark) says the tax rate is determined, not by how long the assets are held, but by trying to determine whether the profit constitutes ones primary source of income. If the answer is "yes", it's taxed as income. So different countries use different methods to solve this problem of discerning income and capital gains, but I still maintain that it's a hard problem, that has not been solved adequately anywhere. And that there are many edge cases, resulting from current law, that are counter-intuitive.
Brian-Puccio 12y ago
I don't understand. If you make $500, then pay $100 in income tax, you're left with $400. If you invest the $400 in a stock and sell later for $500, you're not taxed on the $400 you've already made (and were taxed on), you're taxed on the $100 capital gain, which you haven't paid taxes on. Or am I misunderstanding things? ----- Further ... Is your argument is that once a pool of money has been taxed, that pool of money should never be taxed again? If so, does that mean you don't believe anyone should pay sales tax on anything they've purchased (since they're purchasing it with post-income tax dollars)? ----- Lastly, you mention that if "someone has a large pool of wealth, then they have already been taxed when they earned it". This is not necessarily so thanks to dynastic wealth, an issue others have brought up in other comments. The issue is exacerbated when someone inherits wealth (and pays little to no taxes on it), then invests it and has a capital gain of say $40k -- enough to cover basic living expenses in many parts of the country for a year. That person's tax rate is lower than a person who worked for an employer and made $40k. The question is, why is the government incentivizing this through tax code?

youngtaff 12y ago

There's an assumption in your argument that the earnings that funded the capital gains were taxed at an appropriate rate to start with. In the case of VC/PE etc. it can be argued that much of the capital gains are actually income and should have been taxed as such to start with - lets face it most partners in those businesses are risking other people's money rather than their own anyway. Problem I have with tax is we tax people on their income rather than their wealth so people with low incomes regardless of their wealth pay lower taxes.

unchocked 12y ago

Your argument is circular. Essentially, you say that capital should be untaxed because it was already taxed as income. But that's a value judgement that assumes your conclusion. There is a good case for taxing capital (savings). See Picketty.

yummyfajitas 12y ago
The actual detailed argument is that only two things can be taxed - consumption and investment. Consumption is the right thing to tax, since it measures the benefits a person receives from society. My argument isn't circular, however - it merely shows that once you have an income tax you don't need a savings tax. Piketty's argument, near as I can tell, is merely that we might live in a world where the best way to create wealth is to allow super smart uber rich people to direct nearly all investment [1]. Further, if we allow wealthy people to do this, they won't actually consume the fruits of their labor - they'll allow the rest of us to. Why that's an argument for taxing capital I have no idea. [1] His book doesn't justify this at all, it merely assumes it. http://www.chrisstucchio.com/blog/2014/piketty_and_inequality.html http://www.chrisstucchio.com/blog/2014/piketty_and_inequalit... But he has a couple of academic papers with models that I haven't fully read yet.
- gamblor956 12y ago
  No, the correct argument is that many things can be taxed: creation, value enhancement, consumption, disposition, investment, wealth, transfers, transfers across borders, etc. (You're also still confusing savings taxes with investment taxes, which are not even remotely the same thing.)Which of these is taxed is a function of political ideology. If you tax consumption, you might also tax wealth, if a large portion of the income of the economy is concentrated in the hands of those who consume very little. Indeed, that is the entire point of having a wealth tax--to force consumption which can then be taxed. You have misstated Piketty's argument, as has Chris Stucchio. Piketty's argument is that allowing wealth to concentrate in the hands of a few is the biggest threat to the stability of modern economic systems because it ultimately means that less money is available to everyone else, which restricts growth. He is very much in favor of wealth taxes to force the distribution of this wealth to a wider range of the economy precisely to keep the cash flowing. He's not arguing for capital gains taxes--indeed, he opposes them, and has argued that capital gains should be taxed no differently from ordinary income.

jekdoce 12y ago

Why is interest on savings accounts taxed at income rates? Why is short-term capital gains taxed at income rates? While long-term capital gains are taxed at much lower rate. Seems like risk has something to do with it, no?

SamReidHughes 12y ago
Short-term capital gains can be taxed more because there's less of a chance that you're just taxing inflation on capital that didn't grow very much, or shrank.

api 12y ago

I thought capital gains taxes only applied to gains. You're not taxing savings, and losses can be written off against gains. The inflation problem could be mitigated with a structure that takes this into account. I can think of other reasons that low capital gains taxes are good, like encouraging investment, but the "taxing savings" argument doesn't seem like it works. IMHO what we really need is a way to distinguish rentier income from investment income derived from investing in growth. The former should be taxed as income or maybe even higher, while the latter should be taxed at a lower rate or not at all.

legacyfruit 12y ago

Agreed. The primary reason economists argue for taxing capital gains, is that income can be disguised as capital gains. Startups are probably the best example of this. Even this reason, however, is probably exaggerated. Suppose for example that the CEO owns 10% of a company's stock. While they have a greater incentive to work hard, there is also no reason to think the stock price will rise faster than any other stock (by the efficient market hypothesis). This apparent contradiction is resolved by that fact that the market already knows that the CEO is incentivized to work hard. So as long as the CEO isn't awarded shares before it is announced publicly, the capital income from these shares should be no different to any other share. The same applies to startups, however in the case of the startup there is no market signal so it is easier to cheat accounting rules and claim that the value of the awarded shares are lower than they really are.

gamblor956 12y ago
Shares paid as compensation are taxed as ordinary income pretty much everywhere that they have an income tax. Capital gains are only imposed on the later sale of those shares, and only if the CEO sells those shares for more money than they were worth when they were given to him.

gamblor956 12y ago

Capital gains taxes are not savings taxes. They are taxes on income arising from the disposition of capital assets. They are subjected to lower rates than normal income to incentivize capital investment income streams over normal income streams. Only a few countries impose savings taxes (also known as "wealth taxes"): France, Spain, the Netherlands, Norway, and Switzerland. There might be two or three more that I'm missing. Wealth taxes are intended to prevent the concentration of wealth by essentially forcing a minimum level of capital investment by the extremely wealthy. In your example, the person who earns and saves $100 is not taxed any differently than the person who earns $100. The saver has not invested any capital (yet), he is simply sitting on the money. Both were taxed at the appropriate tax rates (0% or their applicable marginal rate), so both have the same amount of money. If the saver then invests the money in a capital producing asset, when he later disposes of the asset, he may be taxed on the gain, if any, he recognizes on the income (i.e., the increase in the price of the capital asset over the price he paid for it). If the saver sold the capital asset for the same price, or for less, he is not taxed on the sale--in those situations, he is not treated any differently than the spender. It is only if the saver realizes a capital gain that he is subject to a capital gains tax, and when he is, he pays a far lower rate on that income than he would if he had earned the income (max 20% rate vs 25% rate or higher assuming saver is above the poverty line).

dllthomas 12y ago
In the presence of inflation, capital gains serve as a low (tax rate * inflation rate) tax on saving in something that is not cash. (Inflation itself is kinda sorta a tax on savings that are cash.)

akgerber 12y ago

Why is it the case that there 'no reason to tax savings'? Tools rust, food rots, houses fall down. One can't save useful things indefinitely without cost. Why, then, is it inherently true that a government (or other entity) should provide citizens a mechanism to store the means to buy those things indefinitely for free?

hueving 12y ago
Tools don't rust because the government wants people to buy more tools. Your comparison is nonsensical. Inflation is already the cost to save money.

ScottBurson 12y ago

This point could also be addressed by subtracting the increase due to inflation -- or even the risk-free rate of return, which one hopes is slightly higher than inflation -- from the amount to be taxed on, before multiplying by the tax rate. In a low-inflation environment this wouldn't make much difference, but in a high-inflation environment (like the 1970s) it would make quite a large difference.