That’s actually a good point. If taxes on investment are a bit higher, but smart investing is still profitable, then why would an investor choose to invest less money? In the long term, investing (unless the investor is really dumb) is ‘free’ and effort-free money. If the profit is still positive but slightly less, it’s still free and effort-free money. What else is that money going to do?
Last year my colleagues at the Kauffman Foundation and I published a widely read report, “We Have Met the Enemy…and He Is Us,” about the venture capital industry and its returns. We found that the overall performance of the industry is poor. VC funds haven’t significantly outperformed the public markets since the late 1990s, and since 1997 less cash has been returned to VC investors than they have invested. A tiny group of top-performing firms do generate great “venture rates of return”: at least twice the capital invested, net of fees. We don’t know definitively which firms are in that group, because performance data are not generally available and are not consistently reported. The average fund, however, breaks even or loses money.
We analyzed the Kauffman Foundation’s experience investing in nearly 100 VC funds over 20 years. We found that only 20 of our funds outperformed the markets by the 3% to 5% annually that we expect to compensate us for the fees and illiquidity we incur by investing in private rather than public equity. Even worse, 62 of our 100 funds failed to beat the returns available from a small-cap public index.
If they lose money they can’t whine about paying taxes, can they?
You’re missing the point, deliberately.
One receives lower economic growth for the economy as a whole.
Ok - not addressing the specific example, can we put to bed the line of discussion that wage workers also incur risk when they go to work? Because they don’t in any meaningful way. That’s the point I and others were trying to make.
The point is that even if taxes are higher on investing, there’s still no incentive to not invest. Making money in the long term investing is very easy.
For most investors, the money is not “effort-free”, since they earned the money through employment before they invested it.
You really don’t understand this stuff, do you? I’m not going to invest in a risky venture if I can earn the same return putting my money into a safer one. Therefore, risk has a price. That means riskier investments have to return a higher profit when they succeed. Any tax on that profit raises the threshold under which the investment becomes a positive expectation bet and investments on the margin will not be carried out.
The other problem with highly risky investments is that the capital gains tax does not factor in the price of risk. So even offsetting losses may not make up the difference.
Consider an investment that has a 1 chance in 10 of paying off. If I lose $100 every time it fails, I need to gain $1000 when it ‘wins’, just to break even. So you’re probably thinking, “Okay, so you lose $900, then you gain $1000. You deduct your losses, and only pay tax on the $100 extra. So what’s the problem?”
There are many potential problems. First of all, it’s highly unlikely that you lose exactly 9 times before ‘winning’. I could lose once, then win. Then lose 8 more times. In that case, in the year that I ‘won’, I only had $200 to offset my $1000. Now I pay capital gains on the $800 at 35% or $280. So my ‘win’ is actually only $720. Now I lose the other 8 times, and lose $800 but I have no capital gains to offset.
So in total, I invested $1000, and got back a total of $720. I’m now $280 in the hole even though my investment actually returned a ‘profit’, due to the timing of when the investment gains came through. To calculate the actual expected value of this investment I would have to consider the probabilities of when the investment comes through and what the tax rules will allow me to deduct for each case. It is entirely possible for an investment to show an expected loss even though without taxation it would be profitable. So a 35% tax on ‘profits’ can actually turn a profit into a loss.
More to the point, if I have an option of parking my money in a safe investment with a guaranteed positive return, my risky investment must return more money than the safer investment, with the amount more determined by the level of risk. As the level of risk goes up, the taxes have an increasingly greater chance of making the investment non-viable.
There are also limits on how long you can carry losses forward which has a big impact on risky long-term bets. And inflation has an even greater impact because I’m having to invest more capital over a longer period of time with risky investments, so inflation has more opportunity to degrade its value.
One of the reasons investment in nuclear dried up is because nuclear requires huge up-front capital investment (billions of dollars), but takes years or even decades before the plant is operational and able to start paying investors back. So the carrying cost of capital becomes significant. But more to the point, nuclear has become a very risky investment because the protests and lawsuits and regulatory burdens can cause the timeframe of the investment to balloon out, or in some cases to prevent the plant from opening at all. Therefore, the actual cost of the investment is not easily knowable, which drives up risk, which drives up the amount of profit required before anyone will invest. If that profit is also taxed at a high capital gains rate, that raises the bar for investment even further.
Another example is investment in drug research. This is an incredibly risky type of investment, as it now costs over a billion dollars and over 10 years for an average drug to make it through all the FDA trials. And there is significant risk that the drug will go through all that and be turned down. Because of all that risk, the requirement for profit is higher for the drugs that make it through, and this has biased drug research towards ‘lifestyle’ drugs that can reach a wide swath of the population, rather than drugs that attack much more serious problems but have a limited profit upside because of the smaller affected population. Capital gains taxes only make that problem worse.
Yes it is. The money they earned through work was through effort. The money earned through investing is (mostly) effort-free.
But as Sam Stone pointed out, it’s not risk-free. Investors need to be compensated for the risk.
In the long-term, investing is risk-free, unless the investor is an idiot.
They are- by higher returns and by the deductions for losses.
And, just to point out - most “investing” is just gambling on the Stock Market, which is rarely directly benefiting industry.
I dunno why this sort of gambling should be “compensated”. What benefit does it have to society?
This is a particularly bad example. A large drug company who hits it big on a new drug is going to see the profit on the bottom line, and not have to worry about capital gains. They also have R&D Tax credits to help offset the cost of research. But no conceivable cut in the capital gains tax is going to make expensive drugs with tiny user bases a good thing to invest in, unless you can crank up the price so much as to make them unaffordable for anyone without great insurance. If we want to support development of these drugs, we need to get government involved somehow, at least to sponsor research to reduce the risk.
All the other stuff you mention discourages relatively high risk, lower return investments. Unless there is a shortage of low risk reasonable return and high risk high return investments, this is probably a good thing.
Cite? How much more risk? Can you give me an estimate by aggregating past investment data? Can we use the S&P as a proxy to make an estimate of risk? Why not?
Why? Does income tax have to account for all ways income is earned? Some jobs are riskier than others, does the law take that into account or just the average?
Cite? How much incentive does it remove per 5% of tax increase? The graph I posted did not seem to have much correlations between rates and investment.
The ignorance of this post is stunning.
Over the long-term (decades), what’s the risk in investing in bonds or an index fund?
Those “higher returns” are being arbitrarily reduced by capital gains taxes.
Risk has to be compensated, or the investors won’t invest.
What benefit does a higher capital gains tax have to society? Be specific.
He’s talking about day-traders and other short-term investors… what’s the harm if there is less day-trading? How is lots of day-trading better than less day-trading?
Most people invest for retirement. If you were scheduled to retire in 1987, or 2007, and the market tanks, you don’t have the amount of money you were expecting to live on for X number of years.
That’s the risk.