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March 05, 2010

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The difference is that long term gains get taxed at a lower level to maximize the stability and attractiveness of the market

They get a lower rate because they (the rich) have the political power to enforce this artificial distinction.

The fact that it is called "unearned income" should be a big clue here.

Inflation is a component of the effective capital gains tax rate. During the '70's when the inflation rate was high, the effective tax rate was sometimes over 100%

The difference is that long term gains get taxed at a lower level to maximize the stability and attractiveness of the market, short term gains and labor get taxed because they are an immediate gain.

This is an argument for taxing long-term gains at lower rates than short-term gains. It really doesn't bear on the relationship between capital gains and labor income.

No Russell, if you sign an agreement to provide your labor for three years without getting paid, get a lump sum at the end I belive you could structure that as an investment and pay long term gains on it, probably. But if you take your money out of the company every two weeks it is a short term investment.

If I invest capital and get my return in the form of a dividend, I'm getting my return in less than three years. The dividend is money that isn't retained by the company, isn't invested in future company growth. From the point of view of the company, that money is gone. It's been "taken out" of the company.

Dividends are taxed at 15%.

And the kind of arrangement you describe actually exists, it's called deferred compensation.

If I'm not mistaken, non-ERISA deferred compensation is taxed as income, at normal labor income rates, when the money is paid out.

One reason for taxing capital at a lower rate than labor is that it is a lot easier for capital to pack up and leave the country than it is for labor.

Which is why all the credit card call centers are located in Wichita, KS.

One reason for taxing capital at a lower rate than labor is that it is a lot easier for capital to pack up and leave the country than it is for labor.

The "they'll take their bat and ball and go home" argument.

Generally employees get paid wages as they go along and can't lose money on the proposition.

Though when they do (e.g. someone defaults on a contract, as has happened to me), there's no deduction for the uncompensated labor. Why is that?

The problem with the idea that an increase in the capital gains tax will induce capital flight is that differences in the risk-adjusted return on investment are much more significant than differences in the tax rate. "Risk-adjusted return" is the key phrase here; essentially no other country on the planet offers the same combination of "potential for scalable growth" (in a market of 300 million people) and "relatively low-risk" (because of the comparative political and economic stability of the US, strong law-enforcement, strong patent, copyright, and trade secret enforcement, and stable investment markets). There are countries with one or the other of those - much of Europe is low-risk, China is huge - but no others with both. (Even the Eurozone is still divided by language and nationality when it comes to scaling.)

This is also why there is SO MUCH DAMN MONEY floating around in the US looking for something productive to invest in. This is why every other country buys American stocks and bonds as a stable investment. Yeah, if you want to open a labor-intensive factory making plastic crap that can be made in China by workers paid 1/10th as much, it's not so appealing, and that's a problem. But the problem is not the capital gains tax. It's that expected returns on that kind of investment are nil or negative because of competition.

A worked example of the difference that a mere couple of percentage points in risk-adjusted return makes:

An investor has $1,000 to invest. He has a choice between country A, with a 35% capital gains tax rate and a 6% risk-adjusted return, country B, with a 15% capital gains tax rate and a risk-adjusted return of 4%. He wants to invest his money for 10 years.

In country A, 10 years of compounded 6% returns leaves him with $1,791. With his gains taxed at 35%, he's left with gains of $514.

In country B, 10 years of compounded 4% returns leaves him with $1,480. With his gains taxed at 15%, he's left with gains of $408.

Pretty simple. It's better to be in a place where you can compound at a higher rate and pay a higher rate of tax in the end than to compound at a lower rate and pay a lower rate of tax at the end.

I'm not saying that a 1-2% difference in risk-adjusted return is peanuts, it's not, but to hear the way it's talked about by anti-tax crusaders, bumping the capital gains tax would induce mass capital flight and chaos. Even if there was some capital flight, the outcome might just be an increase in risk-adjusted return on investment here. (Cheaper investments with the same earnings potential mean a higher return.)

Which is why all the credit card call centers are located in Wichita, KS.

I think you forget about the call centers in Omaha, NE and Sioux Falls, SD.

I hate when you people have contentious tax discussions when I can't actively participate. **pouts**

Some points:

The (maximum) capital gains tax rate since 1986 has ranged between 28% and 15%. I don't think there has been a variance of capital investment in the U.S. that comes anywhere near to the variance in rates (and why would there be? Do you know what the rate on capital gains will be in, say, 2020?).

The rate on capital gains as signed into law by St. Ronaldus Maximus Reagonomicus was 28%. The ordinary income tax rate signed into law by the same pen was...28%. Communist.

The current maximum rate on ordinary income earned by C corporations is 35%. The current rate on capital gains earned by those corporations is...35%. So much for incentives.

The current capital gains rate on investments in U.S. capital gain property (other than real estate) by foreigners is 0%. Incentives are primarily for foreigners, I guess.

Some other points:

There are plenty of people who want to make a fncking lot of money. They will want to do this no matter the marginal tax rate (absent confiscation).

If money is all there is to work for why do we see CEOs of Goldman Sachs leave to be Treasury Secretary?

If you have surplus income, are you really going to buy tchotchkes instead of bonds due to the marginal rate on investment income?

The lower rate on capital gains is useless to those who own stocks in tax deferred accounts (401k, IRAs, Pensions). Which is, like, most of us.

Explain to me how jobs are created when I buy raw land in 1970 and sell it at a huge gain in 2010, and pay tax at the capital gain rate.

Feh. I'm cranky. Do marginal tax rates affect behaviour, e.g., willingness to invest in capital/labor/pokemon? Yes. How big of an impact is it? Minimal, in fact it's swamped by other considerations from just about everything I've ever read.

How big of an impact is it? Minimal, in fact it's swamped by other considerations from just about everything I've ever read.

This is, I think, the biggest obstacle in common understanding of economics- it's often easy to get the sign right, but not to understand the magnitude of the effect or if it's swamped by other, higher-order effects.
Thus, Kyl is right- unemployment insurance is a disincentive to find work. But my best guess is that it's a tiny effect and can be effectively ignored in weighing the policy. And it may well be swamped by beneficial second-order effects eg a higher willingness to work for small or startup companies that might go under.

Usually it is thought that the investor invests in the company which employs people, which is a good thing.

And doctors cure cancer, which is also a good thing. Labor is a good thing. Capital is a good thing.

I dont know why defenders of low cap gains continue to point out that "investment is good", as if that answered the question "why is investment income being privileged over labor income?"

Risk is also not a good answer- the market rewards risk-taking with additional returns. There are low-risk investments and high-risk ones. We reward both with the same lower cap gains rate. When someone takes high risks for high yields, they are already being rewarded with the high yields, we do not need to provide additional incentives.

One reason for taxing capital at a lower rate than labor is that it is a lot easier for capital to pack up and leave the country than it is for labor.

I dont think that's quite right. We're talking about individual cap gains- so we're talking about people emigrating and giving up their citizenship, not just investing in Morocco or something.
From wikipedia:
The United States is unlike other countries in that its citizens are subject to U.S. tax regardless of where in the world they reside. U.S. citizens therefore find it difficult to take advantage of personal tax havens. Although there are some offshore bank accounts that advertise[who?] as tax havens, U.S. law requires reporting of income from those accounts and failure to do so constitutes tax evasion.

I am not a wealthy man, but I come from four generations of small-business entrepeneurs, and my own career in computer engineering pays me well.

russell can speak for me on this topic; I am grateful for his eloquence.

Somehow it's always reasonable to hurt the poor as a way to make them shape up. Tougher bankruptcy laws, welfare reform, it's all good social engineering.
But if you talk about hurting the rich to make them reform, it's terrible. Taking money away from a guy with plenty more to spare is [apparently] worse than taking money away from a person with none
         "Christopher", somewhere on the Net, March 15, 2009 at 6:21 am


"What I do not see is why folks whose contribution to the economy is making their cash available for other folks to use should, uniformly and in all cases, have their gains treated more favorably than the folks who *do the thing that the enterprise gets paid for*.

I'm still waiting to hear a good argument."

For the most part, you can't lose money in employment. If you work for a month at a company, you get a month's worth of negotiated wages. And you'll get that pretty much every month unless the business goes under, and then you have a very high priority claim against the assets. You have essentially zero chance of working for a year on something and losing a year's worth of wages. That just can't happen to your typical employee.

That happens to capital investment *all the time*.

And really, I'm surprised you bother with the dividend argument. Dividends haven't been a major part of capital investment profit since about two major changes to the tax code ago. (Whether or not that was a wise shift--and that the government deincentivizing dividends may have contributed a huge amount to the short term horizon of modern capital markets is something for another day probably).

Also, neary all 'capital' income gets taxed as 'labor' income somewhere before it gets invested. So it isn' as if the government is somehow getting cheated out of its cut.

Will increased capital gains taxes discourage investment and inhibit economic growth?
No:
[...]
To attain a balanced economy, all forms of income, Capital, rent, interest and wages, should be taxed at the same rate, preferably as low as possible. This will remove the "tax incentive" for investments and leave everyone to make economic decisions based on economic conditions rather than the bottom line on their tax forms. A beneficial side effect would be simplification of the income tax form. Perhaps, the greatest hindrance to this concept coming to fruition, is also its greatest benefit; it is a simple solution that would advantage no particular group but would level the playing field for all. As good for "business" that a more equitable income tax rate would be, it certainly isn't the way we are used to "doing business"!

Yes:
[...]
Many experts and average citizens are critical of capital gains taxes because they represent dual and triple taxation on the same money. If someone earns and income and pays income tax, any savings they accrue have already been taxed. If the savings gain value through investment during a given year, those gains are taxed during the year they occur. At the end of holding the asset, capital gains taxes are levied again on the difference between the original purchase price and the sales price. So the dollar that started out in savings and grew over time through investment has been taxed multiple times. Since the individual who invests bears the chance of risk, there should be some incentive for taking that risk. Decreasing that incentive through taxes simply causes some people not to take the risk with investing the money and this affects the ability to grow our economy. In the short run, this collection of tax seems like a great idea, but over the long term it harms the country.

For the most part, you can't lose money in employment.

You keep explaining how they're *different*, not why they should be taxed a different rates. No one is saying that labor and capital are identical.
And, again- investments that have higher risks are rewarded by higher returns. We don't need to attach additional rewards for them, and we don't attach any extra tax benefits for taking risks as opposed to making safe investments.

If the savings gain value through investment during a given year, those gains are taxed during the year they occur. At the end of holding the asset, capital gains taxes are levied again on the difference between the original purchase price and the sales price.

That's not how cap gains works on my tax forms- you pay the tax once, based on the change in price. Have you ever paid cap gains?

So the dollar that started out in savings and grew over time through investment has been taxed multiple times.

Also incorrect; the original earnings are not taxed again, since they are the initial investment and cap gains are only levied on the profits. If you earn $100, put it in a stock, and then sell the stock for 200$, you'll have paid income tax on the first $100, and cap gains on the second $100.

Decreasing that incentive through taxes simply causes some people not to take the risk with investing the money and this affects the ability to grow our economy.

I addressed this when pointing out that much economic illiteracy comes from understanding the direction of a force without understanding its magnitude. Cap gains might push a small amount of money from investments to consumption, but I don't see how it could have a large effect given that 1)most middle-class investors are already using tax-sheltered accounts and 2)very wealthy investors presumably already have all of their appetites satisfied.

And on the third hand, the alternative to taxing cap gains is taxing labor, which is also a negative incentive and theoretically harmful to the economy. It's not like we're deciding on whether to punish investors for the hell of it (McKinney nonwithstanding), it's that we're deciding how to raise money fairly from the society at large. Keeping cap gains low means borrowing money or taxing it elsewhere or cutting spending.

That happens to capital investment *all the time*.

Yes, so what does that have to do with the government? Investors have to negotiate their own terms for return on an investment - interest payments, equity stakes in a venture, royalties - just like employees have to negotiate terms for compensation for work. Investors who don't like the terms they're offered can invest it in Treasuries. Again, what does the tax rate have to do with any of that?

You want to say that keeping the capital gains rate low encourages risk-taking. But it doesn't, because investors have a whole range of investments ranging from very risky to very safe, returns from which are also covered by capital gains tax*, so all that the low tax rate does is proportionately increase the gains from any kind of investment, and does not change the ranking of risk-adjusted investment returns, although it may compress the ranking. But Treasuries will still set the benchmark for risk-adjusted return, and riskier investments promising higher returns will still be ranked the way they would be with a higher tax.

* Not sure where those bond types (muni?) that are tax-exempt fit in, but I think it's not important to this point.

So as a lever for encouraging riskier investments, it's an extremely poor one. It doesn't change the relative desirability of safer or riskier investments because it affects them all proportionately.

Luckily, there is a lever for encouraging riskier investments, and it's called "the Federal funds rate". When you decrease the funds rate, you increase the relative desirability of riskier investments. A venture with a risk-adjusted return of 2% looks pretty crappy when you can buy Treasuries yielding 2%. If Treasuries yield 0.1%, 2% starts to sound pretty good.

Now oddly enough, conservatives tend to freak out when the funds rate is low, and start yelling about hyperinflation and starving fixed-income pensioners, which kinda gives the lie to the idea that you are all about encouraging risky investments, doesn't it? Sounds a hell of a lot more like a class of people who get a lot of their income from investments and want to protect their ability to get a risk-free return on Treasuries.

And there are limits to how far any government scheme to encourage risk-tolerant investment can work, including the funds rate as we see right now, short of outright insurance of investment losses (which is part of what the tax treatment of investment losses does, actually).

(If I've made any glaring errors in regards to the relative tax treatment of safe vs. non-safe investments, please point them out; I am not an expert on capital gains tax treatment since, uh, I seem to have misplaced my enormous inherited family fortune. I'm sure it'll turn up... maybe under the couch?)

For the most part, you can't lose money in employment. If you work for a month at a company, you get a month's worth of negotiated wages. And you'll get that pretty much every month unless the business goes under, and then you have a very high priority claim against the assets.

It's astonishing the number of things that Sebastian knows that aren't true. If your employer misses a payroll, you have two choices: quit, or believe them when they say that it won't happen again. If you quit, you have to

1. Find another job, with zero notice that you needed to do so. This was never an easy thing and is even harder these days. Until you do, there's no money coming in.

2. Convince the unemployment office that you're eligible even though you quit your job.

In the meantime, you can file for a claim against the (former) employer, but you're behind the government (since in many cases they'll also be in default on taxes) and the secured creditors. If they go through bankruptcy, you'll also be behind the bankruptcy lawyers, many of whom are experts in finding issues to raise until there are no assets left.

But there's no way to lose money in employment. That was asserted with no supporting evidence, so it must be true.

I couldn't even reply to that statement. I've known so many friends working low-end jobs who have been screwed by employers who don't pay them even the miserable amounts they were supposed to be getting paid, I just don't have words to describe someone who thinks that workers have "no risk" compared to someone with enough money in the bank that they can think of investing it.

You may have "first claim" on recovering money, but good luck actually doing so. Small employers know that low-end workers don't have the time or resources to pursue wage claims, so they do this kind of thing all the time. Do you know how much work is involved in trying to recover owed funds from a small business? Just getting the judgment can take months, and that's if the employer doesn't flat-out lie about what happened - "Oh yeah, we laid him off on the 14th, he never showed up for the last two weeks of the month" - and cause you to lose your claim. Once you have a judgment, actually collecting is extremely difficult. It took a friend of mine who got stiffed out of a month's pay more than a year just to get the judgment, and in order to collect she spent money on a P.I. to try to get the bank details for the firm, and eventually only found out by tricking them into giving her their account details by posing as a potential customer. (Which, to be fair, was awesome.) Even then she only recovered a portion of what they originally owed her, not the triple damages she was awarded. As I say, that kind of thing happens all the time, and most of the time the unpaid workers don't even pursue the claim, being a little busy with looking for a new job and all.

This doesn't happen much at the professional level unless you're an independent contractor, but it still happens. One place I worked at ran out of money and laid me off and didn't pay about a month of accrued vacation. What was I going to do, sue a bankrupt company? Guess I should've taken it earlier, huh? So much for "risk-free"...

You can lose a year's worth of pay periods that way Mike? I think you're a bit too loyal of an employee if you're willing to go along without the payroll or a year or two.

And in California, you'll get automatic penalty pay if it happens just once. And you'll have no trouble with the unemployment office because they have a whole category just for that very purpose. Now I know that CA isn't the WHOLE country. But it is in fact about 1/6th of it so it isn't a minor point.

Remeber, I said "For the most part, you can't lose money in employment. If you work for a month at a company, you get a month's worth of negotiated wages. And you'll get that pretty much every month unless the business goes under, and then you have a very high priority claim against the assets. You have essentially zero chance of working for a year on something and losing a year's worth of wages. That just can't happen to your typical employee."

Your characterization of that as "But there's no way to lose money in employment" can be left to other readers to judge if it was fair.

Sorry.

Carleton:

And, again- investments that have higher risks are rewarded by higher returns. We don't need to attach additional rewards for them, and we don't attach any extra tax benefits for taking risks as opposed to making safe investments.

This is the same economic mistake as saying that if half the payroll tax is levied on the employer, that it doesn't cost the employee anything. An employer will negotiate up to a certain amount to hire an employee. The payroll tax the employer will owe is part of that negotiated amount. Similarly, the risk/return level that an investor is willing to live with factors in the captial gains tax treatment.

Also incorrect; the original earnings are not taxed again, since they are the initial investment and cap gains are only levied on the profits. If you earn $100, put it in a stock, and then sell the stock for 200$, you'll have paid income tax on the first $100, and cap gains on the second $100.

This ignores the corporate tax of 35% (which is as high as income tax gets). And while every now and then $100 of stock goes to $200 without any profits being made, it really isn't very common.

[For the most part fortunes aren't made on that kind of profitless trading. One major exception is hedge fund managers. They have obtained a really weird ruling that their pay somehow counts as investment. I don't buy that. But unfortunately, the last time it was proposed that the government clarify that loophole away, Democrats were the ones who shot it down.]

I'm actually open to the idea that we should tax all profits at income rates when they actually get to people. If you want to get rid of corporate tax and treat all profit pass through as income, I'm ok with that. Incidentally the US government probably wouldn't lose any money under that treatment, (corporate taxes aren't actually a huge part of the whole--and you'd get increased amounts from captial gain). This would have two further positive effects: it would be hard to game (the money has to come out in dividends or pay or something at some point) and would be auditable at the corporate level (if you are misusing perqs to avoid tax treatment it will show up, especially under modern rule on them).

Ah, so now the argument is that corporate taxes mean that capital gains taxes are double-taxation. I see we've moved on from "principle", and "pragmatism", at least.

That would be a better argument if it weren't for the fact that 2/3 of US corporations don't pay any income taxes.

And of course the income of a corporation is only part of the fuel for expansion and therefore capital gains; the other part is what they pay employees. And guess what? The pay for employees? Also taxed! I'm sure a company could grow much faster if it could pay its workers in tax-exempt dollars, but that's not how it works.

"That would be a better argument if it weren't for the fact that 2/3 of US corporations don't pay any income taxes."

Nope, it is still an excellent argument, because most corporations that don't pay income taxes don't pay because they aren't making profits. I'm not sure what you think you want to do about that. Mandate profit making?

It isn't as if the money escapes the system. Pay to employees, taxed. Pay to the CEO, taxed. Most perks, taxed. Dividends (which pretty much don't exist without profits) taxed. If all of that is why the don't have profits, it is still being taxed elsewhere in the system.

"Ah, so now the argument is that corporate taxes mean that capital gains taxes are double-taxation. I see we've moved on from "principle", and "pragmatism", at least."

You make your distinction sound like it carries a lot of freight, but i'm not sure what non-emotional thing you are trying to get at. If we are talking about JUST the capital gains tax, I'd say that screwing around with it (especially when we want to encourage growth coming out of a recession [we hope]) is really really dumb. If we are talking about *taxation schemes in general* it would probably be fine to equalize the capital gains rate and eliminate the corporate tax rate. It isn't 'principle' vs 'pragmatic'. It is "how much of the tax structure are we talking about at once".

"I'm sure a company could grow much faster if it could pay its workers in tax-exempt dollars, but that's not how it works."

I'm not sure what this sentence means. What mechanism are you imagining? I don't see the economics of how paying employees tax-exempt dollars does anything for the company. (I see how employees would be thrilled). Employees aren't tying up their money in the company, nor do they have a very big chance of losin their money if the company goes under. Right?

"I addressed this when pointing out that much economic illiteracy comes from understanding the direction of a force without understanding its magnitude. "

Yes you have said this twice, stop please. In deciding on investments the tax implications are large enough to impact choices.

Both sides of this discussion have good points, but "the taxes aren't enough to matter" isn't one of them.

"I'm not sure what this sentence means. What mechanism are you imagining? I don't see the economics of how paying employees tax-exempt dollars does anything for the company."

I suppose if we imagine they would work for the same take home pay it would save the company a little money?

Seb,

I am willing to second your suggestion that we dispense with corporate income taxes, but only on this condition: every cent of operating profit gets paid out to the shareholders, who must report it as ordinary income.

If the corporation wants to invest in R&D, or buy another company, or build a new wafer fab, it can sell more shares of stock. The existing shareholders would be free to buy those new shares, with their after-tax dollars, just like anybody else.

What I can't agree to is something like this: a corporation buys $1 billion worth of goods and services this year; it sells $1.2 billion worth of goods and services this year; it spends its $200 million operating profit on new equipment or physical plant or technology or Treasury bills rather than paying it out as dividends; and doesn't get taxed on that $200 million.

I've worked for two large corporations in my life, and both had a "no dividends" policy. Their explicit argument was that it was "tax efficient" for the shareholders, that way. The shareholders, said these companies, obviously think their money will get better returns if it's invested in our business than if it's invested elsewhere. If we pay dividends to them, they must pay tax on the money before they can invest it back in us. They are better off if we use the money to "grow the business" instead of paying dividends. Their return will be in the form of a higher stock price.

Well, that's fine by me. Corporations and their shareholders can strike that sort of bargain between themselves if they want to. But the bargain involves the rest of us -- i.e. the non-shareholder taxpayers. That $200 million of "added value" accruing to the shareholders tax-free would not be in our interest. So we treat the corporation as a "person", and tax its income as it gets earned.

Are you against corporate personhood, all of a sudden?

--TP

"But the bargain involves the rest of us -- i.e. the non-shareholder taxpayers. That $200 million of "added value" accruing to the shareholders tax-free would not be in our interest."

But under the tax policy we are discussing, they will get taxed at full income rate upon sale, so why would it be necessary to bar investment in the business? What problem are you worried about? That isn't gaming the system, that is just deferring the tax until it actually becomes useable income. It seems like you are worried that the government won't get its cut, but it will at some point--when the investor sells the stock, when dividends are paid on the stock, when money is paid to the CEO or whomever, or when the company is sold. And if money is made, the tax total will be even higher at the end.

Yes you have said this twice, stop please. In deciding on investments the tax implications are large enough to impact choices.

They are large enough to cause people to shift choices in investment, but I doubt very much that they cause a significant shift from investment to consumption. Cap gains rates have changed significantly in the past without causing such a shift, and this makes perfect sense- when you have a lot of money, you don't need to defer consumption. It'd be a rare case where a small change in the cap gains rate would eg push a multimillionaire into buying a yacht instead of a competitor's company. At the rates we're talking about, anyway. At punitive rates, things change.

But under the tax policy we are discussing, they will get taxed at full income rate upon sale, so why would it be necessary to bar investment in the business?

Who or what is "they" in your sentence? I'm inclined to think you mean "the 200 million dollars", but I could be wrong.

As for deferring taxes, that would be no problem if we could also defer the costs that taxes pay for. To the extent we cannot defer those costs, those of us who don't get to defer our income have to take up the slack.

--TP

This is the same economic mistake as saying that if half the payroll tax is levied on the employer, that it doesn't cost the employee anything. An employer will negotiate up to a certain amount to hire an employee. The payroll tax the employer will owe is part of that negotiated amount. Similarly, the risk/return level that an investor is willing to live with factors in the captial gains tax treatment.

That's not what I said at all. What I said was that:
1)if low cap gains is supposed to encourage risky investments, it's very badly tuned since it also encourages relatively safe ones
2)the idea that low cap gains are necessary to support risky investments is belied by the existence of those relatively safe investments. The reward for risk is higher returns compared to those investments, so we don't need to add additional incentives. Or, if we do, you haven't explained why.


And while every now and then $100 of stock goes to $200 without any profits being made, it really isn't very common.

That is a legitimate problem with cap gains; they should be indexed to inflation. But it's sort of beside the point.

Sebastian's apparent conviction that employment compensation is risk-free is belied by the experience of everyone who ever worked for sweat equitey at a Silicon Valley startup that didn't make it (about 90 % of startups, IIRC). The outside investors put in cash, and the employees put in two or three years of their lives at unspectacular pay and horrific hours -- I say again, the employees invest their lives while the money boys put in only money.

When the enterprise folds, the money boys are out their money, and the sweat-equity employees are out two years of eighty hour weeks.

"if low cap gains is supposed to encourage risky investments, it's very badly tuned since it also encourages relatively safe ones"

I'm not sure this is a good statement of the case. If you formulate it as "low cap gains are supposed to encourage investment/savings over spending/consumption" does it change your analysis?

Marty: I suppose if we imagine they would work for the same take home pay it would save the company a little money?

Quite a lot of money, yes. Employee compensation buys one of the factors of expansion. Another factor of expansion is reinvestment. My point was that employee compensation is taxed even though the corporation might be able to expand faster if it was not. So is corporate income, to the limited degree that corporations pay any. (Sebastian, if you think that at any given time 2/3 of the corporations in the US are genuinely not profitable, I have a bridge, no, several bridges I would like to sell you...) Point is, we don't tax-advantage everything that might contribute to faster corporate expansion and more jobs, like employee wages, so it's not a strong point to say that because corporations may sometimes pay some income tax the capital gain is being "double taxed". The government takes tax revenues out at a lot of different points, there's nothing very novel about being taxed on something that kinda sorta got taxed once before. (I say "kinda sorta" because, again, most corporations don't pay much tax; they are heavily focused on increases in stock value through reinvestment that tends to obliterate major profits.)

A lot of these arguments amount to saying "taxes disincentivize people" and "investment is good". Those are both sometimes true and sometimes not, but they don't tell us anything very useful. "Work is good" is also true a lot of the time, but workers don't get to pay 15% total taxes on income.

The problem is, even if you hate taxes and think there shouldn't be any, that obtaining tax reductions that happen to affect you (or if not you, a class of people you think should be favored) isn't very nice. It's understandable, it's natural, but there's no reason anyone else should go along with it if there's nothing in it for them and they end up paying a larger share of taxes to make up for it.

Finally, on whether taxation makes a difference in decision-making, I'm sure it does, but you have to look at what exactly happens. What's the basis for the claim that reducing tax rates encourages riskier investment, when the ranking of different investment options remains the same no matter the eventual tax rate?

Unlike Carleton, I am not convinced at all that even very high rates of tax would discourage investment vs. consumption. When you're extremely wealthy, consumption is problematic. You can only acquire so many cars and boats and planes and hookers and blow and whatever; and everything you do acquire tends to come with an ongoing cost. Unless you want to be rapidly broke, a reduction in your likely income from investment is likely to result in a reduction in consumption and an increase in investment to try to maintain the income levels you're used to. (You don't stay rich very long if you treat your capital like spending money.)

So yeah, I think tax can have a powerful effect on incentives. Unfortunately, I think it's frequently a powerful effect in the exact opposite direction from what is claimed by conservatives and supply-siders. I think it's silly to expect a class of people who personally benefit from higher returns on investments across the board to give an honest account of their own incentives. It's like the employee who promises to work harder if he gets paid more; generally the opposite effect is observed. (I'm all for paying people more, but not based on the idea that it will make them work harder in any given case.)

Why should someone who earns money by doing the actual valuable thing, the thing that someone will pay good money to have done, have their income taxed at a higher rate than the person whose sole contribution is capital?

Because without that capital, there is no way for the worker to advertise her availability, pay for the equipment needed to do the work prior to paying customers placing and paying for orders or pay the worker to work at an unprofitable rate, until demand crosses over to create profit.

The worker is offering something that may be valued by others, while the investor is offering something that is guaranteed to be valued by others.

"(Sebastian, if you think that at any given time 2/3 of the corporations in the US are genuinely not profitable, I have a bridge, no, several bridges I would like to sell you...)"

Cite where you got the idea that only 2/3 pay corporate tax and then show me that they were making a profit, and then I'll worry about it.

The closest I can come is GAO study which suggested that 57% of corporations didn't pay tax in at least one year during the eight year period 1998-2005. And the major reason for that was operating losses.

And if you have trouble believing that 57% of corporations operate at a loss for at least one year out of eight, well I don't know what to say to that...

The rest of your argument turns on the idea that as a general rule profitable corporations aren't paying tax, so I'll wait until you can nail it down a bit better before responding further.

"When the enterprise folds, the money boys are out their money, and the sweat-equity employees are out two years of eighty hour weeks."

Did they fail to get paid? I'm pretty sure they got their wages for two years while the 'money boys' got absolutely nothing for their investment. And in the Silicon Valley case, the employees often got stock options, so they weren't missing out on the upside either if things went well.

The closest I can come is GAO study which suggested that 57% of corporations didn't pay tax in at least one year during the eight year period 1998-2005. And the major reason for that was operating losses.

Isn't that what tax lawyers are for?

the 'money boys' got absolutely nothing for their investment.

Assuming that their investment is in just one company and there's no such thing as managed risk or diversified portfolios. A little harder when you're a worker.

Isn't that what tax lawyers are for?

Uh, maybe.

...almost half of the growth of the American economy between 1948 and 1980 was directly attributable to the increase in U.S. capital formation (with most of the rest a result of increases and improvements in the labor force).
[...]
Between 1900 and 2000, real wages in the United States quintupled from around fifteen cents an hour (worth three dollars in 2000 dollars) to more than fifteen dollars an hour. In other words, a worker in 2000 earned as much, adjusted for inflation, in twelve minutes as a worker in 1900 earned in an hour. That surge in the living standard of the American worker is explained, in part, by the increase in capital over that period. The main reason U.S. farmers and manufacturing workers are more productive, and their real wages higher, than those of most other industrial nations is that America has one of the highest ratios of capital to worker in the world. Even Americans working in the service sector are highly paid relative to workers in other nations as a result of the capital they work with...“Because each worker has more capital to work with, his or her marginal product rises. Therefore, the competitive real wage rises as workers become worth more to capitalists and meet with spirited bidding up of their market wage rates.”2 The capital-to-labor ratio explains roughly 95 percent of the fluctuation in wages over the past forty years. When the ratio rises, wages rise; when the ratio stays constant, wages stagnate.
[...]
[F]or all the controversy surrounding the tax treatment of capital gains, that tax brings in surprisingly little revenue for the federal government. From 1990 to 1995, capital gains tax collections were between $25 billion and $40 billion a year, less than 3 percent of federal tax revenues.
[...]
The capital gains tax is different from almost all other forms of federal taxation in that it is relatively easy to avoid. Because people pay the tax only when they sell an asset, they can legally avoid payment by holding on to their assets—a phenomenon known as the “lock-in effect.”
[...]
...capital gains are not indexed for inflation: the seller pays tax not only on the real gain in purchasing power, but also on the illusory gain attributable to inflation. The inflation penalty is one reason that, historically, capital gains have been taxed at lower rates than ordinary income.
[...]
[W]hen taxpayers undertake risky investments, the government taxes fully any gain they realize if the investment has a positive return. But the government allows only partial tax deduction (of up to three thousand dollars per year) if the venture results in a loss. That introduces a bias in the tax code against risk-taking.
[...]
[S]o the $100,000 in profits is taxed twice—when the owners sell their shares of stock and when the company actually earns the income. That is why many tax analysts argue that the most equitable rate of tax on capital gains is zero.
[...]
Past reductions in the capital gains tax rates (e.g., in 1978, 1981, and 1997) stimulated the financing and start-up of new businesses, while new business activity stalled after increases in capital gains taxes (1969 and 1986).
[...]
Venture capital funds are the economic lifeblood of high-technology companies in industries that are critical to U.S. international competitiveness: computer software, biotechnology, computer engineering, electronics, aerospace, pharmaceuticals, and so forth. The high capital gains tax rate appears to have contributed to the drying up of funding sources for those promising new frontier firms following the 1986 tax hike.
[...]

Capital Gains Taxes

Because without that capital, there is no way for the worker to advertise her availability, pay for the equipment needed to do the work prior to paying customers placing and paying for orders or pay the worker to work at an unprofitable rate, until demand crosses over to create profit.

Conversely, without what the worker contributes, nothing happens *at all*. Period.

Nobody is lining up to pay the investor two dollars for the dollar he or she makes available for investment. Nobody.

Don't think so? Try it sometime. Offer $1,000 of your own money to anyone who will give you $1,100 for it.

You will hear the resounding chirp of crickets.

Somebody has to *do something* with the capital in order for additional value to be created.

Did they fail to get paid? I'm pretty sure they got their wages for two years while the 'money boys' got absolutely nothing for their investment.

It's true, if you invest $100 you can lose the entire $100. If you invest a year of your labor, you'll probably get paid for at least some of it. Probably most or all of it.

Other ways in which the two are unlike:

In general, folks who invest their money do so with funds that are not essential for keeping them housed, clothed, and fed. In general, folks who work for their income are not doing so with "surplus" or inessential time.

This isn't always true, folks starting small businesses will often invest funds that put them at significant *personal* risk. But by and large, that's not true of capital investors. And, sometimes people work when they don't really need to, just because they enjoy it.

But in general, what I've described is true.

It's also very rare for capital investors to be told that an enterprise they invested in doesn't need their money anymore, take whatever you've earned so far and go home.

I guess a buyback of stock is kind of like that, but it's the investor's choice to sell or not.

The equivalent thing happens to working folks every day. Happens to tens or hundreds of thousands of them a month, lately. And when it happens to them, unlike capital investors they can't just take their remaining time and plug it immediately into some other productive use. Jobs aren't that easy to come by, these days.

Nobody is arguing that the two are completely alike. They are not. They are quite unlike.

The thing I'm arguing is that there isn't a reasonable argument for giving income derived from investment -- *all* income derived for *all* types of investment, provided that the investment is made for a period longer than one year -- significantly better treatment under federal tax law than *all* income derived from *all* types of labor.

The range of tax rates for capital gains goes from 0 to 15%.

The range of tax rates for labor income goes from 10 to 35%.

Period. Across the board. Regardless of risk, the amount of the investment of either money or time, the nature of the thing invested in, etc.

Income from capital gets favorable treatment.

I don't see that that is either fair or reasonable.

The problem is, even if you hate taxes and think there shouldn't be any, that obtaining tax reductions that happen to affect you (or if not you, a class of people you think should be favored) isn't very nice. It's understandable, it's natural, but there's no reason anyone else should go along with it if there's nothing in it for them and they end up paying a larger share of taxes to make up for it.

Actually, I can understand people who argue for tax cuts for themselves. I have a harder time understanding people who want tax cuts for Warren Buffett, because not even Warren Buffett wants that.

I like the phrase "share of taxes" because it captures the zero-sum nature of tax "fairness". No matter how small we make the nation's total tax bill, we still have to divvy it up amongst ourselves. Less tax on Warren Buffett means more tax on people who are not Warren Buffett. Less tax on capital means more tax on labor. Less tax on incomes over $1 million means more tax on incomes under $1 million. However you slice the pie, more for some means less for others.

The conservative mantra is of course that we should make the pie smaller: cut the nation's total tax bill. Okay, Dubya did that big time. But it's still a pie.

--TP

"The range of tax rates for capital gains goes from 0 to 15%."

I am pretty sure that you don't object to a 0% cap gains rate for those in the 10 and 15% tax brackets. So we should stick to discussing the 15% tax brcket for long term cap gains. Lets also be clear that short term cap gains are taxed exactly as much as earned income (or labor or wages).

So, as reflected in Charles excellent post, we are discussing the value of long term capital investment which very directly drives the creation of jobs.

"It's also very rare for capital investors to be told that an enterprise they invested in doesn't need their money anymore, take whatever you've earned so far and go home."

This is not rare at all, it is the goal of most people who build companies on venture capital. Most venture funds have a defined life where they expect to extract their investment and profits from all of the investments they make.

we are discussing the value of long term capital investment which very directly drives the creation of jobs.

And the efforts and contributions of working people generate the value that make investments worth bothering with.

One hand washes the other.

And at the moment, an increase in demand would probably generate way more jobs than a further influx of investment capital.

Most venture funds have a defined life

Most layoffs don't occur on a scheduled basis, or on the basis of a "defined life".

Because without that capital, there is no way for the worker to advertise her availability, pay for the equipment needed to do the work prior to paying customers placing and paying for orders or pay the worker to work at an unprofitable rate, until demand crosses over to create profit.

This was in response on a question about tax rates. Did I miss the part where someone suggested we should eliminate capital investment in favor of labor in some sort of capital vacuum?

"And the efforts and contributions of working people generate the value that make investments worth bothering with."

And they get paid for it, every two weeks, with little or no chance of not ever getting paid. The most fundamental difference here is the one you obfuscate in every comment: Capital investment is a choice, it sometimess requires incentive. Capital can sit on the sidelines for a long time, it cost millions of jobs when it does.

I work every day with individuals who are constantly asked to invest in a myriad of opportunities, they don't "want to make a lot of money". They don't feel obligated to invest in "something" no matter what.

Most of these individuals want to make good investments, all of them could live off 2% interest quite nicely. The assumptions of their motivations are simply wrong.

My point is, everything we can do to convince them that the investments we are asking them to make have less risk OR higher reward positively impacts the likelihood they will make that particular investment. The medium and long term prospects for the very labor force you keep talking about is based on continuing to convince the people with capital to invest it. Taxing the potential upside 20% more would certainly not fall into the category of attracting investment.

As a last note, the discussion of capital flight has completely ignored how much of that investment is from foreign sources who don't have to emigrate, etc to not pay taxes. They simply have to remove their money.

"Most layoffs don't occur on a scheduled basis, or on the basis of a "defined life"."

This is really an argument for maximizing capital investment, finding the next job is a lot easier in an environment when a lot of new businesses are starting.

In general, folks who invest their money do so with funds that are not essential for keeping them housed, clothed, and fed. In general, folks who work for their income are not doing so with "surplus" or inessential time.

This isn't always true, folks starting small businesses will often invest funds that put them at significant *personal* risk. But by and large, that's not true of capital investors. And, sometimes people work when they don't really need to, just because they enjoy it.

My comment on this should be considered curiosity, not contentious. Is this really true? It might be true for a majority of capital investment dollars, but are you certain it is true for a majority of capital investors? I think there really are a very large number of people with significant capital investments in small to medium sized operations where if the operation fails, they are [email protected]#$ed because it is their business. I'm not sure how many people these are (as a fraction of the total number of capital investors) but I do know that if their business has trouble, it is very common for them to cut their own salaries while the other employees don't have their salaries cut. Compared to their employees, if their business goes under, they have normally had a year or years of declining wages (in the sense of what their business has paid them out of the operating budget) *AND* they will often have lost their life savings. Further, they aren't going to have any easier of a time getting a replacement job than any of their employees. Do we know what percentage of capital investors are like that, as opposed to the percentage of capital investors who are the fat cats that you seem to be thinking they all are?

Marty,

I don't know how much income you think it takes to live "quite nicely", but let's assume a low-ball number: $100K/year. If the people you know "could live off 2% interest quite nicely" then they have $5 million of spare cash, on top of any other assets they might own. Good for them.

Now, suppose we reject your advice. Suppose we DON'T give them tax incentives to "invest" their $5 million. So they park it in 2% deposits. (Interest income gets taxed, so if they really hate paying taxes they keep their $5 million in a mattress. But let's ignore that option just like they do.) What becomes of money that's deposited in savings accounts, or CDs, or Treasuries? Does it NOT get lent out to persons, companies, or governments who use it to buy things and hire people -- i.e. "create jobs"?

--TP

TP,

Lent and invested are two different and not equally effective things. Yes, that becomes the use of that money.

Lent and invested are two different and not equally effective things.

Yes, they are different, but it's not really correct to say they are not "equally effective." Both provide capital, and whether debt or equity financing is preferable depends on the specifics.

Small startups certainly need equity, because they don't have the cash flow to sevice debt, but in other cases, such as providing working capital financing, which banks do a lot of, debt works better. Similarly, larger corporations will often find long-term debt financing attractive.

So you can't say one is "better" than the other. Horses for courses.

"So you can't say one is "better" than the other. Horses for courses"

True enough.

"Study Tallies Corporations Not Paying Income Tax" - 2008 NYT article, the study is from the GAO.

Marty: they get paid for it, every two weeks, with little or no chance of not ever getting paid

I know this horse is already dead, but for a significant number of employees, especially those of small businesses, but also contractors, not getting paid is a significant risk with real consequences. 1/2-2/3 of households with less than $35k in income have no savings at all. (Kinda hard to accumulate savings when you're that poor and the prices of everything are gauged by and for people with a lot more money...)

Anyway, no savings + a month or even two weeks of unpaid income = disaster for a lot of people. If you're lucky you can run up some credit card debt. If not, you can avail yourself of the fantastic credit rates at your local pawn shop or payday lender AKA "franchised loan shark operation". And you may be able to get unemployment, but so far as I know it's not retroactive for a period when you were working but not getting paid. As I noted above, recovering unpaid wages is really tough in many cases.

Lots of people out there are dependent on getting every paycheck on time and in full to survive. Conservatives might show a little more sympathy for people who are, you know, working to improve their situation, which you guys claim to highly value. (This is another one of those weird little inconsistencies: the claim that working is a moral necessity and so welfare benefits are evil, combined with policies that work to keep unemployment high and a total lack of sympathy for low-income workers; why, it's almost as if the whole thing is motivated by an interest in maintaining a pool of desperately poor workers whose wage demands will be very limited. Funny how that works.)

Point is, for professional workers missing a month of income sucks but probably isn't a disaster, and finding a new job is relatively easy. But universalizing one's own experience in professional-level wage labor to all workers is a mistake.

Most of these individuals want to make good investments, all of them could live off 2% interest quite nicely. The assumptions of their motivations are simply wrong.

So what are their motivations?

Sincere question, I don't understand. If they are motivated by returns, then since across-the-board changes in capital gains tax rates have no effect on the ranking of returns for different investments, I don't see how their investment choices would differ. If they are motivated by a noble desire to grow the American economy, what difference does it make whether the eventual returns are taxed at 15% or 35%? I'll tell you from my experience, I don't think it makes any difference at all. People with money who are inclined to invest have no real idea what the eventual return might be other than somewhere between "very little" and "a whole bunch". If you could actually predict the returns from an investment, there wouldn't be any need for risk-adjusted returns.

For small businesses and entrepreneurs, I agree that some help might be in order, but I'm absolutely unconvinced that the capital gains tax is the right method, or even that it would make much difference at all to most small business owners. If we looked at who pays cap gains I seriously doubt that small business owners were more than a blip; most of the capital gains accrue to the people who own most of the capital, and by definition that isn't struggling small business owners.

Basically this is a snow job, and I think if you're genuinely sympathetic to small business owners, and I think you are, you should think about who is really benefiting from this rhetoric of "Keep capital gains tax low for Paris Hilton or we'll shoot this dog small business owner."

Let me add something to the "no risk in employment" argument.

When your company goes broke, you do lose something. Yes, you got paid for your labor, maybe, but you lose a lot of things like:

1. The skills you acquired that were specific to the company. (Think of a salesperson having to learn a new product line, establish new customer relationships, or a technician with great familiarity with how the products work, etc.)

2. Benefits accrued due to seniority and so on. Those extra two weeks of vacation or sick leave, vesting in 401(k)'s or years of service towards your pension, other things.

3. Personal benefits. There is the comfort of familiarity, an established reputation, relationships with co-workers that make your job easier. Just generally knowing your way around is valuable. You may also have been influenced in housing decisions by the commute. There are lots of ways that the specifics of your job affect your life.

4. In some cases you may lose your pension and continuing health coverage altogether.

5. This doesn't even measure the various losses due to unemployment.

The idea that the worker doesn't lose anything depends on the unrealisitic assumption that the weekly paycheck reflects absolutely everything earned. It doesn't. There really is an investment there.

Who Pays Capital Gains Tax?

"Fewer than one in seven individual taxpayers report taxable capital gains in any year."

"Many taxpayers with gains had modest incomes — more than half (52 percent) of those with taxable net gains or capital gains distributions
had incomes below $75,000. But high-income taxpayers accounted for the overwhelming share of capital gains. The 3 percent of tax returns with adjusted gross income exceeding $200,000 reported 31 percent of AGI and 83 percent of capital gains. The 0.3 percent of returns with AGI exceeding $1 million reported 15 percent
of AGI and 61 percent of capital gains. Capital gains represented less than 4 percent of AGI for gains recipients with income less than $200,000, but about 40 percent of AGI for those with income exceeding $1 million."

"Many more Americans accrue capital gains on corporate shares they hold within tax-deferred employer-sponsored retirement saving plans or individual retirement accounts. But capital gains from stock sales within those accounts are not subject to capital gains tax."

So only 17% of all capital gains accrue to people with AGI under $200,000. And surely not all of those are small business owners. Many are going to be people with small financial investments or property.

As I said, this is a snow job. Capital gains isn't about small businesses and entrepreneurs putting their own livelihood on the line. It's about very wealthy individuals with large investment income whose real personal risk from most investments is nil. ("Oh no, honey, we'll have to sell the seventh house!")

"Lots of people out there are dependent on getting every paycheck on time and in full to survive. Conservatives might show a little more sympathy for people who are, you know, working to improve their situation, which you guys claim to highly value. "

I suppose I should be insulted by this but I'll settle for, this has little, if not nothing at all, to do with the topic.

People who are unemployed are key beneficiaries of stimulating the economy to create jobs. I am not sure how all of those nasty conservatives are hurting the working man by trying to ensure there are plenty of jobs.

I'll tell you from my experience, I don't think it makes any difference at all. People with money who are inclined to invest have no real idea what the eventual return might be other than somewhere between "very little" and "a whole bunch".

Well I suspect we are trying to expand the group who are inclined to invest by giving them a tax incentive. The second half of this is absurd. There aren't wealthy investors who "don't have any idea what the eventual return might be", there is an expectation of return that is required to justify any invesstment. (if you really know people with money who fall into this category I would love their email addresses).

Basically this is a snow job, and I think if you're genuinely sympathetic to small business owners, and I think you are, you should think about who is really benefiting from this rhetoric of "Keep capital gains tax low for Paris Hilton or we'll shoot this dog small business owner."

Basically this is BS, once again it is a pure class based statement that belittles anyone who has enough capital to invest by comparing them to a caricature.

Under current law, 75 percent of capital gain on qualifying small business stock issued in 2009 (after February 17, 2009) and in 2010 is excluded from tax if the stock is held for at least five years. The other 25 percent of the gain is taxed at a maximum rate of 28 percent. The stimulus bill (the American Recovery and Reinvestment Act of 2009) temporarily raised the exclusion from 50 percent. After 2010, the exclusion is scheduled to return to 50 percent, and 60 percent for businesses in empowerment zones.
[...]
2010 Budget Tax Proposals: Eliminate capital gains taxes on investments in small business stock

Basically this is BS, once again it is a pure class based statement that belittles anyone who has enough capital to invest by comparing them to a caricature.

"Class based" works both ways, Marty. The people who "ha[ve] enough capital to invest" are NOT a "class"?? When they clamor for tax preferences for themselves, they are NOT making "class based statement[s]"??

The notion that only the non-rich engage in class warfare amounts to saying that the rich have no class.

--TP

From JDs link on who pays. Interesting conclusions.


Either way, the nearly 1,000 largest United States corporations were more likely than smaller ones to pay taxes.

In 2005, one in four large United States corporations paid no taxes on revenue of $1.1 trillion, compared with 66 percent in the overall pool. Large corporations are those with at least $250 million in assets or annual sales of at least $50 million.

Joshua Barro, a staff economist at the Tax Foundation, a conservative research group, said that the largest corporations represented only 1 percent of the total number of corporations but more than 90 percent of all corporate assets.

The vast majority of the large corporations that did not pay taxes had net losses, he said, and thus no income on which to pay taxes. “The notion that there is a large pool of untaxed corporate profits is incorrect.”

Marty: I suspect we are trying to expand the group who are inclined to invest by giving them a tax incentive

"Inclined to invest" as opposed to what? Taking the money into the back yard and burning it like so many dry leaves? Leaving it in the bank? (I hate to break it to you, but leaving your money in a checking account is investing it, just not a very high rate of return for you - but the bank certainly appreciates it.)

Again, look at the recipients of the largesse from treating capital gains income preferentially: 62% of the whole tax incentive goes to people with incomes over a million dollars. I'm all for encouraging people of more moderate means to become entrepreneurs and start businesses, but if this was a welfare program intended to target a particularly worthy group and yet nearly 2/3 of the benefits paid went to people clearly not in need, I think you'd say it was pretty inefficient.

If you want to suggest a mechanism for risk-compensating small-business entrepreneurs, I'm all ears, speaking as someone falling into that class. I'm just not buying in any way that shifting the tax burden from wealthy investors to workers is an effective way of doing so.

At $1 million levels of income (which implies maybe $10 million in investments), people flat out are not choosing between investment and consumption for the majority of their net worth. At the level of an investor with a few hundred K in the game, yes, it's a choice, because you could just go buy a Porsche instead - although my own experience suggests that the eventual capital gains tax on any eventual capital gain plays no part whatsoever in making that decision. But at the level where you have millions of dollars in net worth, not investing is just not an option. You said so yourself when you said that the people you were dealing with were choosing between sticking the money in the bank at 2% and actively investing it - both are investments, not consumption.

As for "class-based", I don't know what to say. In my experience the only people I hear seriously talking about "class" these days are wealthy Republicans, and it's generally code for "I've got mine, now get lost, you Commie bastard." Personally, I wouldn't be so fast to remind people that classes exist and their interests do not always coincide, but the rich have never been very smart about messaging.

Marty quoted an article quoting a conservative analyst: "The notion that there is a large pool of untaxed corporate profits is incorrect."

Even if this were true - I'm not entirely convinced that it is - it's irrelevant to the real point I was trying to make, which was that corporate taxes make very little difference to the process of expanding the business of a corporation. The fact that small businesses pay little in corporate taxes is evidence in favor of that idea. If you never paid any corporate taxes when expanding from a 1-man to a 100-man business, there is no "double taxation" involved in taxing your capital gains as income.

"Again, look at the recipients of the largesse from treating capital gains income preferentially: 62% of the whole tax incentive goes to people with incomes over a million dollars."

I don't recall anyone in this discussion suggesting that a substantial portion of these incentives would not go to people who have the money to make meaningful capital investments. That does not mean the benefit for others is not valid or the benefit to growing the economy is not worth it.

As for class it permeates the whole discussion. We have a somewhat progressive income tax structure that accounts in great part for the difference in income between the wealthy and the lower middle clas to poor, as they pay practically 0 federal income tax.

The upper middle class basically gets screwed pretty regularly because they make too much for government benefits but not enough to live off of capital gains or savings, so they are just a few more months away from poverty than the lower middle class.

The only group with the accumulated wealth to create investment driven growth is the "rich", so that is who gets the benefits of incentives to accelerate growth. Why this is such a bad thing is the part that escapes me. It is good for the economy, creates jobs, and supports innovation.

Because some people don't get the direct tax benefit doesn't mean it is bad.

The conservative mantra is of course that we should make the pie smaller: cut the nation's total tax bill. Okay, Dubya did that big time.

But he didn't. The wars, Medicare Part B, and his "tax cuts" just pushed the tax burden into the future.

By contrast, President Clinton reduced the nation's total tax bill by reducing the deficit, and by putting a brake on the growth of government.

Bush 43's policies and decisions increased the total bill that the American public will have to pay in taxes over the next quarter century. He bought his tax cuts on the nation's credit card.

He bought his tax cuts on the nation's credit card.

Of course. Which is why I keep suggesting that we split the check.

Notice that the very rich benefit two ways from Dubya's "tax cuts". Obviously they got to pay less tax while Dubya piled debt onto the nation's credit card. Less obviously, their lower rates (to the extent Obama lets them stand) mean that their share of the payments toward the credit card bill in the future will be lower than it otherwise would have been.

Oh, and Marty is right about one thing: the upper middle class is getting screwed, all right. But it's the very rich (who they often defend in debates like these) that are screwing them.

--TP

When the enterprise folds, the money boys are out their money, and the sweat-equity employees are out two years of eighty hour weeks.

That is, out the opportunity costs of having worked forty-hour weeks with better compensation in a non-startup. If the enterprise is sold for less than the amount that was invested in it, all of this goes to the money boys (who got preferred stock), and zero to the employees, even those who had purchased their stock or already exercised options.

But these employees took no risk: Sebastian has said so, and Sebastian is an honorable man.

"and zero to the employees, even those who had purchased their stock or already exercised options"

Hate to say it but once the employees buy stock they become investors with the associated risks.

If we're back to "Everyone should support lower capital gains because it leads to higher growth", while that may be what you really believe, there are pretty good reasons to think it's not actually true, as has been discussed here at length.

Basically it doesn't affect invest-vs-consume decisions very much, and it doesn't affect risky-investment-versus-safe-investment at all. And the truth of that is in the evidence from prior decades when capital gains rates were much higher and the country had plenty of economic growth.

"Reward for virtue" doesn't hold any water either, since the tax code does not otherwise distinguish between income derived from socially useful activities and socially harmful ones.

"Give me a tax break and I'll turn it into so much growth you'll never miss the revenue!" is not exactly a novel line, although it worked surprisingly well for conservatives for a while. But nearly everyone can make a superficially plausible case that a tax break for them would generate more growth for everyone. More evidence is required. So where is it? Where is the convincing argument that decreasing capital gains rates well below other income tax rates actually makes any difference at all?

On the other hand, the effect on tax fairness is incontrovertible. If you derive your income from investments, you pay a vastly lower rate than someone making the same amount from earned income. If we were talking about raising cap gains to 75%, you'd have grounds for some complaints about fairness. When we're talking about raising it to levels similar to (or the same as) earned income, I don't think "fairness" is on your side.

People who are unemployed are key beneficiaries of stimulating the economy to create jobs. I am not sure how all of those nasty conservatives are hurting the working man by trying to ensure there are plenty of jobs.

Is that when they're not standing on the senate floor trying to halt the extension of unemployment benefits?

"Basically it doesn't affect invest-vs-consume decisions very much, and it doesn't affect risky-investment-versus-safe-investment at all. "

Once again, you keep saying this, stop. It isn't true. You continuously repeating all the things it doesn't do doesn't mean you are right. Wasted time reading. No one is back to anything except you, because I never went anywhere else.

And the truth of that is in the evidence from prior decades when capital gains rates were much higher and the country had plenty of economic growth.

You haven't argued this very well, and that's not like you. You are the one who keeps asserting things that you don't back up and calling them words like "incontrovertible". Can you define "plenty" of growth, for example?

Marty, are you seriously suggesting that the word "incontrovertible" is unsupportable when saying that taxing one form of income less than another has an effect on tax fairness?

We can argue about whether it's a big effect or a little one or whether the effect is offset by other things, but I really don't think we can argue about whether there is an effect on fairness. Well, you can, I guess, but I'm not interested in arguing with people who deny things that are true by definition.

Can you define "plenty" of growth, for example?

Sure. Here.

"Arguments that the maximum CGT tax rate affects economic growth are even more tenuous: Capital gains rates display no contemporaneous correlation with real GDP growth during the last 50 years. Although the effect of capital gains on economic growth may occur with a lag, Burman (1999) tests lags of up to five years and finds no statistically significant effect. Moreover, any effect is likely small as capital gains realizations have averaged about 3 percent of GDP since 1960 and have never been more than 7.5 percent."

"Is that when they're not standing on the senate floor trying to halt the extension of unemployment benefits?"

(Just for Phil)

Yes, although getting ALL of the conservatives standing in front of the Senate blocking unemployment was really difficult so they just had one guy do it, trying to get the Senate to pay for it. Not a bad idea to try it really, before you unblock it and allow the bill, you vote for, to pass.

Hate to say it but once the employees buy stock they become investors with the associated risks.

Precisely, and with fewer of the associated rewards.

"Marty, are you seriously suggesting that the word "incontrovertible" is unsupportable when saying that taxing one form of income less than another has an effect on tax fairness?

We can argue about whether it's a big effect or a little one or whether the effect is offset by other things, but I really don't think we can argue about whether there is an effect on fairness. Well, you can, I guess, but I'm not interested in arguing with people who deny things that are true by definition."

So taxing things at different rates has an impact on tax fairness? Thats all you said? Thats all you meant by that statement? I would submit that, in context of the paragraph you led with it, you were stating that it waas incontrovertibly unfair.

If not mea culpa, and you are still wrong, the graph in your latest link completely disagrees with the words in the article.

"Precisely, and with fewer of the associated rewards."

No, with all of the same rewards, exactly the same by law, SEC regulation, etc.

I would submit that, in context of the paragraph you led with it, you were stating that it was incontrovertibly unfair.

I apologize if I was unclear, but no, I was saying that the fact that it has an effect on tax fairness is incontrovertible in the same way that the progressive income tax has an effect on tax fairness, that it's possible to compare pre- and post-tax incomes of different types and assess their relative tax treatment.

An assessment of "fair" or "unfair" is a judgment rendered after we look at the consequences of changes in tax fairness, and I'm not saying that's just a matter of definition, no. That's a question of assessing what the consequences of the tax treatment are.

I am saying, though, that when a policy has a definite "cost" - in tax fairness - and an uncertain, debatable "benefit", the burden of proof is quite high. There is a definite cost, there may or may not be a benefit, I don't want handwaving or discussions of the noble risk-taking investor, I want to see a real benefit for the 6/7 people who lose out on the deal.

I'm not sure why you think the graph in the article disagrees with the text of it. The point is that there is no correlation between changes in capital gains taxes and stock price growth or between capital gains taxes and economic growth. Being uncorrelated does not mean there are no times when the two move in the same direction at the same time; it just requires that there be just as many times when they move in opposite directions or one changes and the other doesn't.

Between 1976 and 1983 the capital gains tax rate drops from 40% to 20%; stock price growth is just about zero. Stock prices start rising modestly and the rate jumps from 20% to 35% around 1987; stock prices keep rising anyway.

The point about a statistical analysis is that we're drawn to those points on the graph that support our idea. I look at the point where it drops from 40% to 20% and nothing happens; you look at the big jump in stock price around the same time as the rate drops back to 20% in the 90s. Statistical analysis says it doesn't matter if you can pick a story you like; the two variables are uncorrelated, you might as well be looking at hemlines versus potato futures. Which makes a pretty poor case for the "benefit" exceeding the "cost" in fairness.

Marty, earlier: We have a somewhat progressive income tax structure that accounts in great part for the difference in income between the wealthy and the lower middle class to poor, as they pay practically 0 federal income tax.

No, it doesn't account for the difference in income between those groups at all, in any way.

The only way it could do so is if marginal rates exceeded 100% and pretty quickly at that. Otherwise what accounts for the difference in income is ... the difference in income. $1 more you get paid is still more income whether you pay 25c or 75c in taxes.

I can only think I'm misreading you. What is it you're trying to say?

"I am saying, though, that when a policy has a definite "cost" - in tax fairness - and an uncertain, debatable "benefit", the burden of proof is quite high. There is a definite cost, there may or may not be a benefit, I don't want handwaving or discussions of the noble risk-taking investor, I want to see a real benefit for the 6/7 people who lose out on the deal."

So despite your objection, you were saying it was unfair.

"Statistical analysis says it doesn't matter if you can pick a story you like; the two variables are uncorrelated, you might as well be looking at hemlines versus potato futures. Which makes a pretty poor case for the "benefit" exceeding the "cost" in fairness."

The assessment of correlation is actually pretty good based on the graph. It also has been the position of every administrations economic team since at least Kennedy, including the current one.

If you can't follow the inverse relationship in that graph, which is NOT hemlines or potatos, it is because you don't want to, not because it doesn't statistically exist. BTW, I wouldn't accept the results of that graph or that analysis because it doesn't seem to account for any other factors.

However, if jack could get that graph for his climate data he would tell us what day and time the world will end.

I am willing to discuss this as a fairness issue or some other principled position, I would disagree but respect the position.

But questioning whether lowering (or, in the current case, not raising)cap gains rates has a positive impact on investment is beating a dead horse. So if it's lack of benefit is necessary for your fairness argument, I won't be swayed.

"I can only think I'm misreading you. What is it you're trying to say?"

Purely from a fairness perspective. The rich pay xx% of income taxes, the lower middle class and poor pay, practically, 0%.

That creates a baseline for tax fairness.

No, with all of the same rewards, exactly the same by law, SEC regulation, etc.

C'mon, Marty, you know the difference between preferred stock and common stock.

"C'mon, Marty, you know the difference between preferred stock and common stock"

Which has nothing to do with the difference between investors and employees, which is what we were discussing.

you were saying it was unfair

Er... in what sense is raising taxes for 6/7 people in a group (otherwise undistinguished) and reducing them for the 7th not definitionally "unfair"? Progressive income tax rates are "unfair" in the exact same sense; however, since they both benefit a majority of people - you can decrease taxes for the poorer 4/7 of a group and raise them on the other 3 and still raise more revenue - and have good utilitarian justifications (a marginal dollar of income is worth less to a wealthy person than to a poor person) most people accept them as "fair" in the final analysis.

The question of whether lower capital gains taxes are unfair in the basic sense is definitional - "tax fairness" in this case being a comparison of how much of identical gross incomes are taken in taxes, and "fair" being identical rates. What possible other baseline can you suggest?

The final analysis of fairness is whether the claimed benefits compensate for the basic unfairness. That's a matter of opinion, data, and analysis, not definition.

"The question of whether lower capital gains taxes are unfair in the basic sense is definitional - "tax fairness" in this case being a comparison of how much of identical gross incomes are taken in taxes, and "fair" being identical rates. What possible other baseline can you suggest?"

I would suggest you are using words that aren't accurate. You aren't comparing "identical" gross incomes. Nor are you comparing how much of "equal" gross incomes are taken in taxes. In fact, the cap gains taxes are also progressive, just not as progressive. (0 in the two lowest tax brackets).

We already allow everybody to protect a baseline of capital gains by putting pretax earnings into 401k's etc. so you aren't comparing equal much of anything.

There are lots of variables here rather than a dollar is a dollar. Earned income is taxed progressively, unearned income is taxed progressively, just because some of the forms of income are more likely to be earned by one group rather than another it doesn't create an unfair tax advantage if all are taxed progressively.

Most important, it is ludicrous to cry foul when the bottom 47% of people pay no income tax at all, on ANY kind of income. The next tier begins to have actual cap gains so they don't want the rates raised either. In fact, most people who pay income taxes wouldn't want their cap gains taxed at a higher rate.

Jacob, I can see where you got your corporate tax number, but the NYT grossly misreported that.

The underlying report is here at the GAO

First of all, it includes S-corps, which represent nearly half of all corporations, and almost always use pass-through taxation. These are of course taxed at the full income rate and we wouldn't expect them to be paying the corporate tax. (That is why they are S corps and not C corps, so they can do simplified taxation.)

The study also shows that the large majority aren't paying tax because they don't have profit. Worrying about them is like worrying that welfare mothers aren't paying their fair share.

Rueters reported only the large corporations from the report (which means almost no S-corps). That shows that in any given year, 35-50 percent of the companies weren't paying tax, and the enormous majority of those (about 80%) had no profit income to tax.

Which suggests to me that the upper bound for 'problem corporations' (ones that are making at least some small bit of profit but aren't paying tax) is about 8% of what you think of as regular corporations. (Non S-corps). (Number derived from 40% [approximate number reporting no tax in a given year] multiplied by 20% [those that have at least $1 of profit].

Which you may or may not think of as important, but isn't as shocking as the 2/3 number you brought to the table. (To be clear, I'm not blaming you, the reporting in the article you linked was awful. Like "Doesn't the author know anything about tax at all" kind of awful.)

You aren't comparing "identical" gross incomes. Nor are you comparing how much of "equal" gross incomes are taken in taxes

Oh for god's sake, yes I am.

If you make $100,000 a year in capital gains income you pay a tax rate of 15%.

If you make $100,000 a year in wage income you pay a tax rate of about 22%.

If you make $1m a year in capital gains income you pay a tax rate of 15%.

If you make $1m a year in wage income you pay a tax rate of about 32%.

As for the lie-by-omission that is the statement that 47% of the population pay no income tax and by implication is getting something for nothing, very nearly everyone who works pays payroll taxes, which account for 36% of federal government revenues compared to 45% for the income tax.

Further, of the "next tier" - the 53% of the population paying income tax by your numbers - a majority certainly do not pay capital gains tax, since only 1/7 people pays capital gains tax, and last time I checked 0.53 > (2 * 0.14)

"C'mon, Marty, you know the difference between preferred stock and common stock"

Which has nothing to do with the difference between investors and employees, which is what we were discussing.

Sure, the difference between preferred stock, which the investors who put capital in get vs. common stock, which the investors who put labor in get, has no bearing whatsoever on the way in which capital and labor are treated differently. Whatever could I have been thinking of?

The study also shows that the large majority aren't paying tax because they don't have profit.

If I could deduct all my expenses, I'd have much less taxable income too. In fact, I could live pretty damned well and show no profit. Unfortunately, I'm a flesh-and-blood person instead of a corporate person, which means I get to pay more tax and vote. (Though if the Roberts court has its way, the second distinction will go away any time now.)

JD,

And now I am through, call someone else a liar and assume someone elses implications. I said EXACTLY what I meant and implied nothing. We were talking about comparing income taxes my description was 100% accurate and appropriate to the discussion,

Sebastian, someone more expert than me is going to have to answer the point about S-corps. From what I understand they have significant tax advantages of their own which is part of why so many of them are, on-paper, unprofitable.

The point is really that much of the expansion of an enterprise (of whichever sort) is totally unaffected by any income tax, because it comes in the form of items that appear in the cost side of the ledger before operating loss or profit is calculated. A business can lose money on paper every year by spending everything it earns and more on expanding, and still generate a large capital gain in the end, having never paid any corporate taxes. From what I understand this is a significant factor in why many businesses consistently show no net profit year after year. I have no real problem with that, but I don't think that at the end of 10 years of reinvestment the resulting income from capital gains should be treated differently to wage income.

Earned income is taxed progressively, unearned income is taxed progressively, just because some of the forms of income are more likely to be earned by one group rather than another it doesn't create an unfair tax advantage if all are taxed progressively.

Are you serious when you say that so long as both are taxed progressively, it doesn't matter what the actual rates are? If so, I'm happy to propose a maximum 75% rate for capital gains after the first $10,000. That's still progressive, so it's fair, right?

No Mike, I was just getting tired of the debate. It really is a philosophical discussion that is being framed as facts and graphs etc. Either you believe that it encourages investment AND that investment is a good thing for the overall economy, or you don't. If you don't believe both of those things that are a matter of economic discussion ad infinitum by experts, then it is just the rich getting over again.

Marty, I'm generally interested in reading what you have to say and have found this discussion worthwhile. While I found your comment misleading and irrelevant, "lie" was too strong of a word, and I apologize.

If you'll accept that apology, I say that "47% of people pay no income taxes" is misleading because it implies - implications being unavoidable consequences of all statements - that 47% of people pay no taxes, which is untrue.

I think you want to restrict the conversation to income tax rates, because if you bring in payroll taxes the difference in tax treatment between earned income and capital gains becomes even more stark at moderate income levels. I'm willing to let that go, because at the levels that matter - above $1m a year - payroll taxes are irrelevant to the comparison between earned and capital gains taxation. So I'm willing to ignore payroll taxes for simplicity, right up until the point where you bring that line about 47% of people not paying income taxes as if it was relevant. It's not relevant because in that 47% the treatment of earned income vs. capital gains is still skewed towards capital gains, and because the large majority of capital gains tax is paid by the top 14% of the income distribution, and so comparisons between the top marginal income tax rate and the capital gains rate are the most relevant to discussions of fairness.

Sebastian,

Looking at a corporate tax return really is not a very good way to determine whether a corporation made a profit or not. Sounds odd, but, as I suspect you know, it's true. The tax code has all sorts of funny stuff in it (yes - endless complications, but generally put there at the behest of corporations, so their complaints don't carry much weight).

I'd rather look at their reports to investors, which would provide a much rosier picture of corporate profitability than their tax returns. In fact, one of my favorite tax reforms is to require publicly held corporations to calculate their taxes using the same figures they report to investors. Think of the benefits just in simplification - only one set of books to keep. Alas, I doubt it will happen.

I said "the large majority of capital gains tax is paid by the top 14% of the income distribution", I should have said, "the large majority of capital gains tax is paid by the top 0.3% of the income distribution (those with incomes over $1m)."

The assessment of correlation is actually pretty good based on the graph....
If you can't follow the inverse relationship in that graph, which is NOT hemlines or potatos, it is because you don't want to, not because it doesn't statistically exist.

You're using the word "statistically" to mean "what I guess at when I see the graph". That's why they folks at that link used *actual* statistics, and they found no correlation.
As for your eyeballing- the rates get cut in the early 80s, then raised in the late 80s/early 90s, and then there's a boom in the late 90s, and then the rates get cut again, the boom peaks and crashes. Only someone already committed to the idea could see correlation there.
Occasionally they move in the same direction. And just as frequently, they move in the opposite direction.

No Mike, I was just getting tired of the debate. It really is a philosophical discussion that is being framed as facts and graphs etc. Either you believe that it encourages investment AND that investment is a good thing for the overall economy, or you don't.

This isn't f&%^ing Peter Pan. I have not seen a more explicit endorsement of innumeracy and fantasy when faced with bare facts in my life, I think.
Seriously, this is like arguing that whether the Colts won or lost the Super Bowl is just a philosophical discussion, you can believe whatever you want.

"Looking at a corporate tax return really is not a very good way to determine whether a corporation made a profit or not."

hmmmm, kinda. I strongly suspect that a majority of those corporations that don't have profits, really don't have profits. I'm not saying that loopholes aren't a problem, because they are--all over the tax code. But If you get to zero profit, you probably really don't have any. (In a huge majority of the cases).

You know what I hate?

I hate it when I'm in a publicly-funded restroom alongside the highway and I have to wait while a crystal statue of a little boy pees champagne into the urinal.

I suggest the following to test the relative incentives and disincentives of various taxation regimens on public urination.

Have one toilet charge the capital gains rate for those who live on capital gains. Have a second one charge the lowest marginal tax rate for those who live on nominal wages. Have a third charge the highest marginal tax rate for those whose wages push them into the highest bracket.

I wonder what it would be like to fly on the European airline that wants to charge to use the toilet and then land in Arizona and have to drive several hundred miles across toilet-less highway to reach home.

I haven't yet seen the private sector suggest ways (not enough incentives, I spose)to ameliorate this problem -- may I suggest dashboard catheters with a reservoir beneath the seat to collect urine, which then could be emptied in J.D. Hayworth's front yard -- or perhaps astronaut diapers for all beleaguered, whining taxpayers who find themselves without a pot to pee in.

I've got it: ropes, hung from saguaros, to piss up.

And in any case, whatever you think of the whole thing, there isn't call to exaggerate wildly into "2/3 don't pay taxes".

well carleton. I know actual flesh and blood people who make decisions on how and where to invest their money who have and would make different decisions if the capital gains tax was raised to 35%, and i know many of these people.

So if you think it is an endorsement of fantasy to let folks who don't believe what they want, it's ok with me.

And in any case, whatever you think of the whole thing, there isn't call to exaggerate wildly into "2/3 don't pay taxes".

For a second there, I wasn't sure whether Seb is talking about low-income corporations or low-income persons :)

--TP

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