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Old 12-11-2018, 11:45 AM
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How can the US justify a 20% long-term capital gains tax rate?

The explanation for why the capital gains tax rate should be lower than that for standard incomes basically (AFAIK) boils down to two arguments:
  1. Income from investments has already been taxed once, so taxing capital gains is double taxation
  2. The lower capital gains tax incentivizes investment, helping create jobs and grow the economy

I call bullshit on both:
  1. It's not double taxation, because, while the money I invest may already have been taxed, the money that investment earns is new. If I earn $100 on an investment of $1000, it's no different than earning $100 waiting tables.
  2. People don't need extra tax incentives to invest money that would otherwise sit idle -- the prospect of earning money on money is incentive enough. Would people really just stuff their money in mattresses if they had to pay full income tax on its earnings?
But I am not an economist. Can anyone here justify a top capital gains rate that's barely half the top income tax rate?
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Old 12-11-2018, 12:10 PM
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There are other uses for capital other than stuffing it into a mattress. You could put it in savings, tax free bonds, other safer investments, or spend it. You could also invest it in a country with a lower rate. The lower the taxes on investment the more investment there will be on the margin. The more investment the more the economy grows and everyone gets richer.

Last edited by puddleglum; 12-11-2018 at 12:11 PM.
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Old 12-11-2018, 12:26 PM
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It's not double taxation, because, while the money I invest may already have been taxed, the money that investment earns is new. If I earn $100 on an investment of $1000, it's no different than earning $100 waiting tables.
You are correct that you haven't paid tax on the earnings, but the reason the earnings are taxed at a lower rate than ordinary income is that you incurred more risk by investing, and also provided more stimulus to the economy and other people. So it is different from earning $100 waiting tables.

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Old 12-11-2018, 12:27 PM
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I'm not an economist either, but aren't you ignoring the risk factor? Investments can go down as well as up, and it's incentivising the investor to take the risk. To continue your example, there's no risk waiting tables, but you could lose all of that $1000 in a bad investment.
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Old 12-11-2018, 12:27 PM
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There are other uses for capital other than stuffing it into a mattress. You could put it in savings, tax free bonds, other safer investments, or spend it. You could also invest it in a country with a lower rate. The lower the taxes on investment the more investment there will be on the margin. The more investment the more the economy grows and everyone gets richer.
Not buying it. Capital investments already have an incentive over lower-risk investments: higher potential return. Why should ordinary earners subsidize that higher return with a lower tax rate?

Savings, bonds and other safer investments all contribute to growing the economy, too. So does spending, for that matter. If we lowered taxes on all of them, there'd be more of them, too, and everyone gets richer yada yada. Hell, if all taxes were eliminated the economy would grow like gangbusters.

So why lower taxes on one particular kind of income, when the investments that produce that income already come with the built-in incentive of higher returns?
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Old 12-11-2018, 12:29 PM
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I'm not an economist either, but aren't you ignoring the risk factor? Investments can go down as well as up, and it's incentivising the investor to take the risk. To continue your example, there's no risk waiting tables, but you could lose all of that $1000 in a bad investment.
Yes, but I could also double my investment. Why isn't higher potential return enough of an incentive? Why do I need a tax break on top of that?
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Old 12-11-2018, 12:34 PM
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Because the risk is also higher.

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Old 12-11-2018, 12:37 PM
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... Would people really just stuff their money in mattresses if they had to pay full income tax on its earnings? ...
Some number of them would certainly find something to do with it other than invest it in the stock market.
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Old 12-11-2018, 12:38 PM
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Because the risk is also higher.

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Saying the same thing over and over doesn't make your justification any more valid.
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Old 12-11-2018, 12:39 PM
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Because the risk is also higher.

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Isn't the risk balanced out with tax treatment of capital losses?

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Deducting Capital Losses.

“You can use capital losses (stock losses) to offset capital gains during a taxable year,” says CFP Daniel Zajac of Simone Zajac Wealth Management Group. “By doing so, you may be able to remove some income from your tax return. If you don’t have capital gains to offset the capital loss, you can use a capital loss as an offset to ordinary income, up to $3,000 per year. (If you have more than $3,000, it will be carried forward to future tax years.)”
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Old 12-11-2018, 12:56 PM
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Saying the same thing over and over doesn't make your justification any more valid.
You need a cite that investments carry risk?

Good luck with that.

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Shodan
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Old 12-11-2018, 12:58 PM
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I'm not sure I buy the "risk" argument either, since low or high risk is already priced into the potential rates of return.

My understanding is that there are a number of historic justifications for the lower capital gains rate: (1) the tax isn't indexed against inflation, so it is possible that you are taxed on a "gain" that isn't a gain at all when you take into account inflation; and (2) a higher tax would discourage savings by diminishing the benefits of long term investing; and (3) a higher tax would discourage liquidity: you wouldn't want to withdraw from a specific investment in order to invest elsewhere or say start a business if the resulting capital gains tax was too high.

Some of these seem like they could be mitigated (e.g. capital gains tax doesn't apply if you move the investment into another one). It's hard to be sure as a non-expert how valid these concerns are in the chaotic system that is the larger economy. But those are the justifications I've mostly seen.
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Old 12-11-2018, 01:02 PM
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Saying the same thing over and over doesn't make your justification any more valid.
Either way is saying the same thing over and over again without further explanation.

There's a quantitative relationship between risk and return. Investors on average (of invested $) will demand some particular additional return for a given increase in risk. Say there are a bunch of investment projects of a certain risk with expected returns of 6, 8 and 10%. None gteed, all equally uncertain. Say there are no taxes on investment returns. There are some investors for whom 6 is enough, for some 8 is enough, for some 10 is enough. Say in the particular market there are enough investors to fund all the 8 and 10% projects. Most projects get funded but the 6% projects don't get funded. Now put in a investment tax of 25%. The after tax returns are now 4.5%, 6% and 7.5%. Now only the the 10% pre tax/7.5% after tax projects can attract investment. There's less investment.

OTOH govts have to raise money and there are always competing ideas as to the 'fair' way to do this. So just *any* reduction in investment by raising taxes on capital is not necessarily a convincing argument against that tax on investment. But that is the effect at some point, taxes on capital returns reduce investment, long term productivity growth relies on investment. It's not very controversial that a negative effects kicks in somewhere.

Singapore is now about the richest country per head whose economy isn't based on extracting natural resources. No capital gains tax. That doesn't make it the right policy for any country, but the idea of taxing capital returns at a lower rate is not some scam. There is an economic basis for it.

Also, zero taxes on capital returns doesn't necessarily mean less progressive taxation. You could have a system where all savings including *reinvested* capital returns could be deducted from taxable income, but the remaining amount was taxed at progressive rates. Income-savings would be what was taxed, and there would not have to be any lower rates depending where that net amount came from, nor would the rate have to be as low as now for a given net amount to prevent disincentives to investing.

Last edited by Corry El; 12-11-2018 at 01:05 PM.
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Old 12-11-2018, 01:03 PM
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Saying the same thing over and over doesn't make your justification any more valid.
Both sides would benefit by providing some data rather than just throwing out the pro/con side. But the risk of investing is well known and documented, so IMHO the side opposing the tax rate is more in need of support.
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Old 12-11-2018, 01:19 PM
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Both sides would benefit by providing some data rather than just throwing out the pro/con side. But the risk of investing is well known and documented, so IMHO the side opposing the tax rate is more in need of support.
For pete's sake, I'm not arguing against the idea that capital investments involve risk. That's an obvious given. My argument is that the potential reward of a riskier investment is incentive enough to engage in that investment without an additional tax incentive.
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Old 12-11-2018, 01:20 PM
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It's meant to maximize revenue, because capital gains income is much more discretionary than, say, wages. Congress's concern is that if it were to raise the tax on capital gains to be equivalent to the tax on ordinary income, some significant fraction of transactions just would not happen. Some number of people would decide to hold onto their stock at least for another year and leave their gains unrealized. Thus far, Congress has generally decided that the higher rate of taxation would be outstripped by the shrinkage in realized gains, such that the government would lose revenue overall.
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Old 12-11-2018, 01:35 PM
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For pete's sake, I'm not arguing against the idea that capital investments involve risk. That's an obvious given. My argument is that the potential reward of a riskier investment is incentive enough to engage in that investment without an additional tax incentive.
The basic flaw in your argument is treating the issue as binary. People will invest, or they won't invest. It doesn't work that way. Rather, higher taxes on capital will make *some* investment opportunities which were just barely attractive at the old tax rate now outright unattractive at the new one. Some opportunities will be attractive before and after. Others will be unattractive before and after.

The question is how big is that middle ground of investments that won't be made at the higher tax rate compared to the revenue collected.

Also for capital gains (as opposed to all taxes on capital returns) as they usually work, Tom Tildrum's point is very important. If the tax is levied only when people sell the investment, a high tax is an incentive to postpone selling it. That can have a dramatic effect on revenue in the shorter term (no way does a 40% cg tax levied that way collect anywhere twice as much as a 20%, nobody serious claims so, it could actually be less at 40% than 20% at least for quite awhile). But it also makes the economy less efficient to hinder investors' moving their capital to the best opportunities as soon as they see them.

All to be weighed against the subjective needs for revenue and what's 'fair'. But saying it's just obvious 'people would invest anyway' at any capital gains rate, implying it would have no effect on investment, is a non-serious argument, sorry.

Last edited by Corry El; 12-11-2018 at 01:35 PM.
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Old 12-11-2018, 01:36 PM
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I will say one thing on the double taxation argument. The taxation on the front end lowers the value of your eventual return on the gain. If I start a business with 100 thousand dollars. I get taxed on the profit from that business. If it's a public company, I also get taxed on my dividends (so double taxed). This cuts into my profit margin. When I go to sell my company, the taxes I paid earlier depress the value for which I can sell my company. After I sell my company, I get taxed again. The value that was added to the company was added due to profits that were taxed and lower my company value, so it's a double dip. Of course, a double dip is not necessarily a bad thing. It's pretty common really. I buy a TV from a company and the TV costs x amount to make, but I pay customs to import it. The company that sells it pays taxes on its profits which it passes through on the price of the TV. I pay taxes on my income to buy the TV and then I pay a sales tax on top of it. The same transaction is really getting hit four or more times depending upon how many hands it passes through. So while the double dip argument is true, that isn't necessarily a reason not to pay capital gains tax. The dividend tax was the one that I really disliked, but it is much better since Bush II so no real complaints.
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Old 12-11-2018, 02:01 PM
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Thank you everyone who's replied with substantive comments! I'd like to dig in a little deeper on my "potential reward is incentive enough" argument.

The average annualized total return for the S&P 500 index over the past 90 years is about 10 percent. (I know there are capital investments beside stocks -- I'm just using the S&P as an easy example.) So if I have $10,000 to invest, I can reasonably expect to earn $1000 a year. At the current CG rate, that $1000 becomes $800, or an 8% return. Taxed as standard income, it becomes $630, or a 6.3% return.

Yes, 6.3% sucks compared to 8.0%. But where else can I get a 6.3% return? CDs offer 2.6% (pretax), which works out to 1.64% after taxes.

I still get nearly 4x the return on stocks vs a risk-free investment. I suspect many investors would find that sufficient incentive.
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Old 12-11-2018, 02:10 PM
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Wealthy investor-type people have better lobbyists than those who rely on ordinary income.
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Old 12-11-2018, 02:16 PM
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Wealthy investor-type people have better lobbyists than those who rely on ordinary income.
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Old 12-11-2018, 02:18 PM
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Thank you everyone who's replied with substantive comments! I'd like to dig in a little deeper on my "potential reward is incentive enough" argument.

The average annualized total return for the S&P 500 index over the past 90 years is about 10 percent. (I know there are capital investments beside stocks -- I'm just using the S&P as an easy example.) So if I have $10,000 to invest, I can reasonably expect to earn $1000 a year. At the current CG rate, that $1000 becomes $800, or an 8% return. Taxed as standard income, it becomes $630, or a 6.3% return.

Yes, 6.3% sucks compared to 8.0%. But where else can I get a 6.3% return? CDs offer 2.6% (pretax), which works out to 1.64% after taxes.

I still get nearly 4x the return on stocks vs a risk-free investment. I suspect many investors would find that sufficient incentive.
Phrasing to set my understanding to avoid conusion:

If you sell within a year, and are in the income bracket where your long term capitol gains rate is 20% the short term rate is 39.6% or the same as standard income. (ignoring the 3.8% net investment income tax for high value individuals)

The government has good reason to offer that lower long-term rate to encourage long term investments and saving but short term capitol gains are treated as normal income to avoid abuse. Note that the short term rate is also to avoid people with lots of money avoiding taxes by structuring their income as investments to avoid that extra 19.6% from income tax.

Last edited by rat avatar; 12-11-2018 at 02:19 PM.
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Old 12-11-2018, 02:20 PM
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The only thing that justifies it to me is inflation. If you buy and hold a stock for 20 years it will probably have doubled from inflation alone but you'll be no better off when you sell it. In fact if it merely kept pace with inflation you'll be down 10% cause you'll be taxed on 50% of the entire worth which in actuality hasn't changed.

My solution is to tax capital gains the same as income but indexed to inflation. That way the little old lady with a nest egg of safe stocks won't get hammered if her only income is investment, but the hedge fund manager who makes millions gambling on a lucky year won't get to avoid a lot of taxes by recharacterizing his income as capital gains.
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Old 12-11-2018, 02:27 PM
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Phrasing to set my understanding to avoid conusion:

If you sell within a year, and are in the income bracket where your long term capitol gains rate is 20% the short term rate is 39.6% or the same as standard income. (ignoring the 3.8% net investment income tax for high value individuals)

The government has good reason to offer that lower long-term rate to encourage long term investments and saving but short term capitol gains are treated as normal income to avoid abuse. Note that the short term rate is also to avoid people with lots of money avoiding taxes by structuring their income as investments to avoid that extra 19.6% from income tax.
You're right -- in my haste to put together a simplistic example, I forgot about the "long-term" aspect of the CG rate.

But my argument holds true over the length of time required to achieve CG status. The overall expected return rate still vastly exceeds what you can get for a risk-free investment, whether it's taxed at normal or CG rates.
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Old 12-11-2018, 02:29 PM
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The only thing that justifies it to me is inflation. If you buy and hold a stock for 20 years it will probably have doubled from inflation alone but you'll be no better off when you sell it. In fact if it merely kept pace with inflation you'll be down 10% cause you'll be taxed on 50% of the entire worth which in actuality hasn't changed.

My solution is to tax capital gains the same as income but indexed to inflation. That way the little old lady with a nest egg of safe stocks won't get hammered if her only income is investment, but the hedge fund manager who makes millions gambling on a lucky year won't get to avoid a lot of taxes by recharacterizing his income as capital gains.
This makes a lot of sense to me.
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Old 12-11-2018, 02:55 PM
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My understanding is that there are a number of historic justifications for the lower capital gains rate: (1) the tax isn't indexed against inflation, so it is possible that you are taxed on a "gain" that isn't a gain at all when you take into account inflation; and (2) a higher tax would discourage savings by diminishing the benefits of long term investing; and (3) a higher tax would discourage liquidity: you wouldn't want to withdraw from a specific investment in order to invest elsewhere or say start a business if the resulting capital gains tax was too high.
Re: (1), I recall just one country (Ireland?) indexes capital gains for inflation. It's extra work but doable.
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Old 12-11-2018, 03:12 PM
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Thank you everyone who's replied with substantive comments! I'd like to dig in a little deeper on my "potential reward is incentive enough" argument.

The average annualized total return for the S&P 500 index over the past 90 years is about 10 percent.
The average annualized return over the last 90 years is not at all the same thing as the ROI on any given investment. Maybe index funds are better for the average investor than venture capital overall, but that is not the same thing.
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Yes, 6.3% sucks compared to 8.0%. But where else can I get a 6.3% return?
That is exactly the question that investors ask. And the answer is not necessarily "nowhere".

See also what Corry El has to say - it is not binary. Economics operates largely at the margins. There is going to be a group of people for whom 8% is enough to overcome their fear of risk, but 6% isn't. That isn't everybody, but it is somebody, or somebodies. Maybe they will invest overseas, or take their compensation in non-taxable ways, or spend it on hookers and blow.

Sure, maybe we tax capital gains at ordinary rates. And people will adjust. But keep something else in mind - people will adjust. They won't necessarily just shrug their shoulders and accept a lower ROI.

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Old 12-11-2018, 03:19 PM
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Thank you everyone who's replied with substantive comments! I'd like to dig in a little deeper on my "potential reward is incentive enough" argument.

The average annualized total return for the S&P 500 index over the past 90 years is about 10 percent. (I know there are capital investments beside stocks -- I'm just using the S&P as an easy example.) So if I have $10,000 to invest, I can reasonably expect to earn $1000 a year. At the current CG rate, that $1000 becomes $800, or an 8% return. Taxed as standard income, it becomes $630, or a 6.3% return.

Yes, 6.3% sucks compared to 8.0%. But where else can I get a 6.3% return? CDs offer 2.6% (pretax), which works out to 1.64% after taxes.

I still get nearly 4x the return on stocks vs a risk-free investment. I suspect many investors would find that sufficient incentive.
Many investors would find that sufficient incentive, but tolerance for risk varies greatly among the population. There are always going to be marginal cases.
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Old 12-11-2018, 04:18 PM
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Many investors would find that sufficient incentive, but tolerance for risk varies greatly among the population. There are always going to be marginal cases.
However, that's the case for all sorts of income - and the government, if it wants to pay for anything, has to get its income from somewhere.

If it forgoes, say, a million dollars of capital gains tax income by having a CGT rate slightly lower than it could be, then they either have to raise more money from sales tax (meaning some people at the margins will buy less than they would) or income tax (some people at the margins will work less than they would), or borrow it it (so they'd pay interest) or forgo spending that million dollars (which you can't keep doing indefinitely and still have a government).

If you're making an economic incentives argument, you should really show that investing is a more useful thing to the economy than working, spending, or any other sort of economic activity that is taxed, which seems non-obvious to me.
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Old 12-11-2018, 04:27 PM
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If you're making an economic incentives argument, you should really show that investing is a more useful thing to the economy than working, spending, or any other sort of economic activity that is taxed, which seems non-obvious to me.
This.

Having a CG tax rate significantly lower than the general rate seems to me like a case of the government picking winners and losers among investment types. I thought conservatives were opposed to that.
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Last edited by Akaj; 12-11-2018 at 04:28 PM.
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Old 12-11-2018, 04:32 PM
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If you're making an economic incentives argument, you should really show that investing is a more useful thing to the economy than working, spending, or any other sort of economic activity that is taxed, which seems non-obvious to me.
Actually if the suggestion is raising taxes on investment, you should really show that government spending overall is more useful to the economy than investment.

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Old 12-11-2018, 04:43 PM
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Thank you everyone who's replied with substantive comments! I'd like to dig in a little deeper on my "potential reward is incentive enough" argument.

The average annualized total return for the S&P 500 index over the past 90 years is about 10 percent. (I know there are capital investments beside stocks -- I'm just using the S&P as an easy example.) So if I have $10,000 to invest, I can reasonably expect to earn $1000 a year. At the current CG rate, that $1000 becomes $800, or an 8% return. Taxed as standard income, it becomes $630, or a 6.3% return.

Yes, 6.3% sucks compared to 8.0%. But where else can I get a 6.3% return? CDs offer 2.6% (pretax), which works out to 1.64% after taxes.

I still get nearly 4x the return on stocks vs a risk-free investment. I suspect many investors would find that sufficient incentive.
Lets do a little more (simplified) math*.

Lets say you have 1 million in investments. You do well and make %10 a year. So you earn $100,000. (Note, it is likely that the earnings are more like 8% these days for most investors so this is being optimistic)

Rich! Wildly Rich! You can buy *anything*!!!!! says the person who soon ends up poor.

First, inflation. Inflation runs roughly 3% a year, historically. That means to keep your 1 million in buying power you need to add at least 3% onto the principle every year. 3% of 1 million is $30,000.

100,000 - 30,000 = 70,000 spendable.

Second, taxes. We will assume that the investments are long term holdings. That puts the tax rate at either 0, 10, 15 or 20%. Most people are likely to fall into the 15% bracket if they have a million in the market.

70,000-15,000 = 55,000 spendable.

State taxes. This is variable. For California, it is 9.3% for 100,000 (if the website I looked at is correct). Nevada is 0. New York is 6.85 (state) and 1.9 (local) = 8.75. We will do California.

55,000- 9,300 = 45,700

Fees. Fees can run between 1 and 2% of the total value of the account, sometimes much higher.

45,700- 10,000 = 35,700.

Wow, suddenly your $100,000 is ~$35,000 spendable.

Now, keep in mind that folks who live off of investments are likely to be too old to run out and get a job. If the capital gains rate is changed from 15% to 25%, the spendable amount drops from ~$35,000 to $25,000. A 10% hike in federal capital gains taxes causes a ~30 drop in spendable money for this scenario. That *really* hurts retirees. If you raise to to 35%, spendable drops to ~$15,000. At some point, people are going to say the return isn't worth the risk and start living off of the principle which means investing less.

Now, I suspect the real problem isn't the actual capital gains rate but rather folks like Bill Gates who are gazillionaires, the wealth gap. A big part of this (or at least as far as I can tell) is that in the 90s, the marginal tax rate increase from 28% to 39.6%. Folks who are in this category started taking stock options instead of large salaries. The reason is that incentive stock options are taxed as a long term capital gain instead of as income if held long enough. So, %20 max tax rate instead of %39.6. So CEOs started taking small salaries and large stock grants. Over time the value of the stock grants grew while the tax on the stock options stayed low and the owners of the stock grants got really, really rich. Now, people want to tax those really, really rich people by raising capital gains taxes. However in the process Grandma and Grandpa, who worked hard and saved their whole lives to retire, get killed. So politicians are stuck, cause if they go after the really rich people, they hurt poor Grandma and Grandpa. Grandma and Grandpa also happen to be very loud about these kinds of things.

Slee
*This a very simple run through and won't be 100% correct, but it will be in the ballpark.
  #33  
Old 12-11-2018, 04:45 PM
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Some number of things that the government wants to do are always going to be more worthwhile than others. But if it turns out that raising money from having higher income tax is more economically damaging than raising money from capital gains, one thing you would never do is forgo spending the money and then lower CGT. You would forgo spending the money and lower income tax, or actually spend the money and keep both rates the same.

ETA: @Shodan, obviously
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  #34  
Old 12-11-2018, 07:09 PM
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I don't see that there is any argument based on risk or on the encouragement of investment that would justify having a lower tax on capital gains than on dividends. I don't see any risk-based argument that wold justify the same capital gains tax rate on stock and on Treasury bonds selling at a discount. So I believe those arguments to be ex post justification.

In a related matter, I see no justification for both eliminating estate taxes and simultaneously allowing the cost basis of assets to be updated to the price at the time of death.
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Old 12-12-2018, 09:49 AM
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But the risks are not all equal, yet the "reward" for risk is. Maybe that's what needs to change. Investing in Coca Cola ought not to be treated the same as investing in Space-X.
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  #36  
Old 12-12-2018, 10:16 AM
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It's not double taxation, because, while the money I invest may already have been taxed, the money that investment earns is new. If I earn $100 on an investment of $1000, it's no different than earning $100 waiting tables.
Unless I've missed it, I don't think anyone has corrected this factual error in the OP. The double taxation issue is not what you describe here. It is the fact that both corporations and shareholders are taxed on the same earnings.

Corporations must pay pay tax on their earnings. Then shareholders must pay tax again on those earnings, either through the taxation of dividends if the corporation distributes those earnings, or through the taxation of capital gains if the corporation retains the earnings (retaining earnings implies a higher stock price).
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Old 12-12-2018, 10:28 AM
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If you want something to get angry about with cap gains tax, it's the step-up basis, which is the way that the U.S. tax system wipes out any capital gains tax liability for assets with unrealized gains at death. Nominal U.S. estate tax rates are already low (or at least the exclusion is large), and this loophole makes the effective estate tax rate even lower, allowing wealth to be retained by wealthy families.

Last edited by Riemann; 12-12-2018 at 10:30 AM.
  #38  
Old 12-12-2018, 10:55 AM
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Unless I've missed it, I don't think anyone has corrected this factual error in the OP. The double taxation issue is not what you describe here. It is the fact that both corporations and shareholders are taxed on the same earnings.

Corporations must pay pay tax on their earnings. Then shareholders must pay tax again on those earnings, either through the taxation of dividends if the corporation distributes those earnings, or through the taxation of capital gains if the corporation retains the earnings (retaining earnings implies a higher stock price).
You're right -- that does make more sense as a reason people would cite double taxation.

However, I still don't agree it's a good argument for a lower capital gains tax rate. (Although it is, IMO, a good argument for a lower rate on dividends, and maybe even a good argument for the Friedman-esque idea of abolishing corporate taxes altogether.) There are lots of investments other than stocks that qualify as capital gains. If I buy a Van Gogh and sell it ten years later at a profit, the Van Gogh wasn't paying taxes all those years. Why should my profit be treated differently than ordinary earnings?
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Old 12-12-2018, 11:15 AM
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However, that's the case for all sorts of income - and the government, if it wants to pay for anything, has to get its income from somewhere.

If it forgoes, say, a million dollars of capital gains tax income by having a CGT rate slightly lower than it could be, then they either have to raise more money from sales tax (meaning some people at the margins will buy less than they would) or income tax (some people at the margins will work less than they would), or borrow it it (so they'd pay interest) or forgo spending that million dollars (which you can't keep doing indefinitely and still have a government).

If you're making an economic incentives argument, you should really show that investing is a more useful thing to the economy than working, spending, or any other sort of economic activity that is taxed, which seems non-obvious to me.
Exactly, this loss of economic activity is called deadweight loss and should be the primary factor in the type of taxes leveled. Conventional economic theory is that the deadweight loss of taxation varies by the elasticity of what is taxed and is proportional to the square of the tax rate.

Most economists agree that the elasticity of labor supply is less than it is for capital because it is much harder to change jobs than it is to sell a stock. Thus the deadweight loss for capital gains is much higher than loss from income taxes. Since the loss is proportional to the square of the rate this means that the rates for capital gains should be much lower than for income. In theory the optimal tax rate on capital is zero, however it is probably not actually zero because reality is not fully matched by the model.
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Old 12-12-2018, 11:30 AM
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I've never understood the idea that investors should have a lower rate because they have higher risk, because they don't. When Warren Buffett makes an investment, his risk is extremely small. When a single mother works as a waitress, her risk is extremely large. Nothing that Warren Buffett does could possibly lead to him losing his home, for instance, but the waitress could lose her home just from one capricious decision by a manager. That's what real risk looks like.
  #41  
Old 12-12-2018, 11:46 AM
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Exactly, this loss of economic activity is called deadweight loss and should be the primary factor in the type of taxes leveled. Conventional economic theory is that the deadweight loss of taxation varies by the elasticity of what is taxed and is proportional to the square of the tax rate.

Most economists agree that the elasticity of labor supply is less than it is for capital because it is much harder to change jobs than it is to sell a stock. Thus the deadweight loss for capital gains is much higher than loss from income taxes. Since the loss is proportional to the square of the rate this means that the rates for capital gains should be much lower than for income. In theory the optimal tax rate on capital is zero, however it is probably not actually zero because reality is not fully matched by the model.
Interesting. Let me see if I understand.

Since it's much harder for me to change jobs (or quit working altogether) than it is for me to sell a capital asset, taxation on my work-derived income is less of a disincentive than taxation on selling capital assets. In other words, you can go ahead and tax my income at a higher rate because I don't have the option of not working, but you have to sharply reduce capital gains taxes because I have the option of not investing in capital at all.

Makes sense as a model. In practice, isn't it kind of perverse?
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Old 12-12-2018, 11:47 AM
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Its really the inflation argument. And we should index it, in the modern world where nearly everyone who invests uses software to file their taxes, creating index tables and applying them to capital gains wouldn't even be hard.
  #43  
Old 12-12-2018, 12:16 PM
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Makes sense as a model. In practice, isn't it kind of perverse?
It depends on your definition of "perverse". The idea of taxing something for which demand is more inelastic is that it tends less to lead to people avoiding the tax. That's why we tax cigarettes and liquor, because demand for those doesn't vary as much.

The government needs to collect revenue. Therefore, it makes sense to tax things with inelastic demand because people are less likely to engage in unproductive behavior just to avoid the tax. As you point out, people in general have to work, whereas they don't have to invest.

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  #44  
Old 12-12-2018, 12:20 PM
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Its really the inflation argument. And we should index it, in the modern world where nearly everyone who invests uses software to file their taxes, creating index tables and applying them to capital gains wouldn't even be hard.
Ludovic explained this perfectly in post #25. It's the fairest proposal I've heard yet.
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Old 12-12-2018, 03:18 PM
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The explanation for why the capital gains tax rate should be lower than that for standard incomes basically (AFAIK) boils down to two arguments:
  1. Income from investments has already been taxed once, so taxing capital gains is double taxation
  2. The lower capital gains tax incentivizes investment, helping create jobs and grow the economy

I call bullshit on both:
  1. It's not double taxation, because, while the money I invest may already have been taxed, the money that investment earns is new. If I earn $100 on an investment of $1000, it's no different than earning $100 waiting tables.
  2. People don't need extra tax incentives to invest money that would otherwise sit idle -- the prospect of earning money on money is incentive enough. Would people really just stuff their money in mattresses if they had to pay full income tax on its earnings?
But I am not an economist. Can anyone here justify a top capital gains rate that's barely half the top income tax rate?
Another common rationale for the capital gains tax is that you earned the capital gains over several years but taxing them at the marginal tax rate.

Considering the generous exemptions for home appreciation and tax free savings vehicles (and corporate dividends received deductions) almost every rationale for the capital gains tax has been undermined over the years. Its hard to justify a large capital gains rate differential these days.
  #46  
Old 12-12-2018, 03:37 PM
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When Warren Buffett makes an investment, his risk is extremely small. When a single mother works as a waitress, her risk is extremely large. Nothing that Warren Buffett does could possibly lead to him losing his home, for instance, but the waitress could lose her home just from one capricious decision by a manager. That's what real risk looks like.
The analogous risk is not being fired, it's things like not being paid for the labor she had already put in. Which is nonzero.

Last edited by Ruken; 12-12-2018 at 03:38 PM.
  #47  
Old 12-12-2018, 06:04 PM
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  1. Income from investments has already been taxed once, so taxing capital gains is double taxation
Who says this? I've never heard anyone say that taxing capital gains is double taxation.

I HAVE heard it said that taxing dividends is double taxation, and have some sympathy for that argument. But it doesn't apply to CG. If I sell stock for more than I bought it for, the company that issued the stock has not paid taxes on any money I get, because that money comes from another investor that I'm selling it to.

I was around and paying attention back when they lowered the capital gains rate, and from my memory, the justification was solely to encourage investment in industry.
  #48  
Old 12-12-2018, 06:24 PM
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It depends on your definition of "perverse". The idea of taxing something for which demand is more inelastic is that it tends less to lead to people avoiding the tax. That's why we tax cigarettes and liquor, because demand for those doesn't vary as much.
If that's the case, I'd suggest a wealth tax. You either give it to a charity benefiting people or spend it paying sales tax and stimulating the economy or keep it and get taxed on it. I'm sure yo'd support a wealth tax, right?
  #49  
Old 12-12-2018, 06:32 PM
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Who says this? I've never heard anyone say that taxing capital gains is double taxation.

I HAVE heard it said that taxing dividends is double taxation, and have some sympathy for that argument. But it doesn't apply to CG. If I sell stock for more than I bought it for, the company that issued the stock has not paid taxes on any money I get, because that money comes from another investor that I'm selling it to.

I was around and paying attention back when they lowered the capital gains rate, and from my memory, the justification was solely to encourage investment in industry.
Riemann offered up a more accurate "double taxation" argument in post #36.

Nevertheless, I have heard people say things along the lines of "I already paid taxes on the money I earned, so why should I have to pay more taxes on the money that money earns?" Your rebuttal to that argument aligns with mine.
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Old 12-12-2018, 09:00 PM
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I believe the LTCG tax is only 15% if earning under $425,000
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