Capital Gains: Is it laffer curve or boom and bust that determines amounts of capital gains realized?

As readers of my comments on the Laffer Curve silliness well know, it is not at all established that cuts in taxes increase revenues.  In fact, the contrary is empirically the sounder position. 

Many of those who argue for low or even zero capital gains taxation do so ideologically--they appear to firmly believe that people with capital should pay no taxes and that only people who labor should pay taxes.  They argue that zero capital gains taxation encourages growth and that growth is good for everyone. 

Of course, each of those positions is questionable.  In a fair society, most of us believe that everyone should pay their fair share of taxes.  While we are not always sure what constitutes a fair share, most of us have a sense that fairness requires each to pay from the type of income they have.  To exempt capitalists--who most often are the richest in the society and are those with the greatest power to set the tax terms in their own favor--is anti-democratic and elitist.  It's not at all clear that low taxes on capital gains increases growth.  In fact, it may well be that low taxes on such gains just increases passive investment overseas and has little positive impact here.  Even if it somewhat encourages growth, growth is not a per se good--it can be destructive (e.g., the environmental pollution in China), it can appear good in the short term but lead to devastating changes that have not been adequately prepared for in the long term, it can be entirely enjoyed by one segment of the society at the expense of all other segments of society, as the growth in the US economy generally has been over the last few years.  On the other hand, equal taxation of capital gains and labor should put the worker and the boss on a more egalitarian playing field, and limit the power of capital to control the terms of work and social life.

Citizens for Tax Justice had a worthwhile discussion of the April Democratic debate between candidates Clinton and Obama. Charlie Gibson Repeats Misinformation at Democratic Presidential Debate, April 18, 2008, CTJ Digest. Most viewers think the debates were handled terribly by the media, in that they spent a considerable amount of time on trivial questions rather than providing an avenue for genuine discussion of issues of interest.  But CTJ points out another area of disservice--the commentators got used misleading ideas about taxation to question candidates!  Charlie Gibson asked Obama a question about capital gains that mistakenly treated the Laffer Curve idea (cut taxes and you get more money) as credible.   Read the story.  Then maybe we should all write the mainstream media to insist that they quit parroting misinformation when they address tax issues.

Comments

[Robert Wallace]

Why does it make sense to tax my assets when sold at a higher price than cost due to inflation?

[Stuart Levine]

Mr. Wallace may have a point,but it is likely a trivial one.

First, the relatively short holding period to qualify for long-term capital gains means that the tax break is far, far greater than is necessary to merely offset the inflation effect.

Second, capital assets generally (but not always) generate "interest," be it in the form of interest, rent, dividends, etc. Presumably, even after taxes, this income stream significantly mitigates the inflation effect.

Finally (and I will probably be struck dead by lightning for citing the Tax Foundation blog favorably), the problems inherent in indexing capital assets are reasonably well discussed here: http://snipurl.com/287xa [www_taxfoundation_org]

[LindaMBeale]

You are absolutely right on the inflation issue, Stuart. A number of studies have shown that the preferential rate significantly over-compensates for any inflation, which is generally fairly trivial to begin with in many cases because of the short holding period requirements. Also, wage earners pay upfront on their salaries through withholding (usually biweekly or monthly), so they have no advantage of any deferral, whereas capital gains are generally not subject to withholding, giving a significant deferral advantage that also compensates for any inflation disadvantage. Of course, as long as capital gains are not subject to social security or medicare taxes, they also do not merit the significant advantage of the preferential rate. The list goes on and on.

[Dave]

This whole discussion appears to treat capitalists and labor as two distinct groups. It also ignores the fact that most people who have capital acquired it after laboring. Why would we want to discourage saving and investing?

[J]

You know that was a really interesting article and helped my brain a lot because I have been struggling for a while now to reconcile what a lot of economists had been saying on the radio with what I know about the markets in general. I found it hard to believe that the average trader would stop trading because of capital gains rates.

[LindaMBeale]

Dave
First, the preferential rate for capital gains in the Internal Revenue Code requires us to distinguish between capital and labor. It is a hugely complicating factor that we would do well to eliminate, but it is there and thus we MUST treat capital and labor as distinct categories.
Second, your statement that "most capital is acquired by labor" is not necessarily correct and, even if correct not directly relevant. The question is not about how capital is acquired, but about how income earned on capital assets should be treated. I do not believe that the various reasons given for favoring capital over labor income stand up to scrutiny.
Third, you ask "why discourage saving and investing". You might just as well ask "why discourage labor". Taxes may well impact decisions to save, invest or work, but again, the arguments for favoring savings over favoring labor are not convincing. From both fairness and democratic institutionalism perspectives, the fact that the capital gains preference provides an extraordinarily unbalanced benefit to the top 1% of taxpayers weighs heavily against the capital gains preference.

[Dave]

Linda,

I never said anything about distinguishing between capital and labor. My point was that these post and comments make it seem as though those who acquire their money by labor NEVER have capital and those who earn income by capital NEVER labor. In my small town tax practice, it is a rarity to see anyone with an AGI over $200K, so most of my opinions are formed by looking through that prism. I see people who have similar lifetime earnings but different saving and investment habits. Becasue most of these people aren't in a top tax bracket anyway, the effective difference between their capital gains rate and ordinary rate is much smaller than the 1% of taxpayers from which you approach this discussion.

Also, these discussions seem to always overlook the risk factor. At the very least if you did away with the 'Preferential Treatment' of capital, you would have to do away with capping net captial losses at $3,000(1,500).

By the way, everytime I look at my pay stub I do ask 'Why discourage labor?'

[LindaMBeale]

Dave, Thanks for your clarification. You are right to point out that many of us are not "pure" capitalists or "pure" laborers, and I'll try to be clearer in the future. The reason one tends to think of members of our society in terms of their primary categories of income, however, is the fact that for the vast majority of Americans, very little of their income is made up of capital gains (or dividends). That proportion gets smaller and smaller as you go down the quintiles. And, as you note, the rates for ordinary income are lower in the lower brackets, so that the amount of preference for capital gains over ordinary income is less. Those two facts--fewer capital gains the lower you go down the income distribution and less of a benefit from the capital gains preference the lower you go--are strong support for removing the capital gains preference, since together they demonstrate that the majority of the benefit from the preference goes to people at the very top of the income (and wealth) distribution who have most of the financial assets, an outcome that undermines democratic egalitarianism.