Then they’d never pay taxes on the gain.
Its supposed to be a timing issue (we tax you when you bring the money back. And corporations have decided they just won’t bring the money back. Bernie’s proposal seems to be to impose that tax currently rather than waiting for them to bring the money back.
The argument I have heard is that raising capital gains rates will lead to a flight of capital as money seeks more hospitable environments. This didn’t really happen when Clinton did it or when Obama did it but we are told that those are aberrations and that normally, raising capital gains rates will led to the collapse of America’s dominance as the world’s center of capital.
There is an arms race between countries as developed countries engage in tax competition. I have long said that tax competition between countries is a race to the bottom (and tax competition between states within a country is cannibalism).
Well that is the current proposal for eliminating the corporate tax of course the problem is that you can earn income inside a corporation and never pay taxes on it. If you are suggesting a flow through taxation of corporate income, I think that would gum up the stock market quite a bit.
With that method, I could buy stock at $10 and sell at $20 but if there has been more than 100% of accumulated inflation while I held the stock, then I would actually suffer a loss (that I could use to offset other income).
Would you similarly reduce my interest income by the inflation rate? So if I had a bond that paid 5% and the inflation rate was 3%, I would only be taxed on the 2%? If inflation skyrockets, do I incur a loss every time I get a bond payment?
What happens if I hold the stock for less than a year? How about an hour?
Not necessarily. You already expect form DIV from most of your investments and some (like mutual funds) pass through all kinds of different income items. Also, publicly traded partnerships (PTPs) are becoming increasingly common, with their multi-line K-1 forms (and generally multi-state tax issues as well).
What would almost certainly happen is that companies would say “We used to spend $30 billion on taxes, which is now paid by our shareholders. So we will increase our dividend payments by $30 billion to compensate shareholders for their tax obligation.”
So, yes, it would change some procedures and expectations, but it wouldn’t make for an insurmountable problem. The biggest problem might be timing: investors already wait to Feb 15th for their 1099 B/DIV/INT/substitutes, but the PTPs that file K-1s have as late as Sept 15th (the extended due date). But, again, there are plenty of PTPs on the market and this hasn’t been an insurmountable issue.
I don’t know if this addresses your hypothetical but for many small businesses, the primary asset is a developed small business is real estate and equipment. There are very few small businesses worth a million dollars where the value of the business is largely going concern value or inventory. The primary thing people will be buying is the real estate and equipment with some key money for going concern, inventory and other intangibles. Section 1031 provides these business owners a way of annuitizing the value of their small business.
E.g. small business owner sells risky small business and buys another small business with predictable revenues like a laundromat. Or buys the Laundromat and leases it to someone else to operate in exchange for rent. Its not a clean as selling 10% of your stock every year but there are plenty of ways for small business owners to effectively annuitize the value of their small business.
The ideal case is to have money flow reflect economic fundamentals outside of the tax system - ie we would like to incentivize people to move their money to the place where it is used most efficiently. The problem is that no one knows where that is, so you can’t plan to do it - you can just try to make the tax system as transparent to economic decision-making as possible while still raising the amount of revenue you need.
Capital gains should not be taxed as income for one simple reason - the price of risk. Income is guaranteed: Capital gains are not. Now, for institutional investors or wealthy people who make many investments, hedge their bets, and in general have returns approximating the statistical average, this might not matter much - capital losses offset capital gains assuming that proper rules are in place for forward averaging and such.
But for small investors making one large investment that has great risk, and who will have no use for capital losses if they fail, the capital gains tax can be very distorting.
A perfect case for this is someone investing in their own business. If the business fails, they’re bankrupt and won’t be able to use the capital loss to offset other gains (they have no other investments). If it succeeds and they sell, they have to pay a capital gains tax. This creates a deadweight loss due to taxation.
Consider this scenario: You are considering opening up a restaurant. It costs you $100,000 - your life savings. Nine times out of ten, a similar investment will fail and you lose everything. But one time out of ten you’ll succeed and be able to sell the restaurant for $1,000,000. Let’s look at the basic math.
The expected value of your investment is $1,000,00 - (9 X $100,000), or $100,000. In other words, if you made this investment an infinite number of times, on average you would make $100,000 for each one.
But what happens if there’s a 25% capital gains tax? in that case, if you ‘win’ and sell the restaurant, the state takes $250,000 of your million bucks. So now, your expected value is $750,000 - $900,000, for a net loss of $150,000. So a 25% capital gains tax on a one-time risky investment just turned your investment from a net winner to a net loser, and any new businesses that fell within those parameters would not be opened - and the economy would lose all that value.
The people who make trades constantly and who invest in many ventures to spread their risk around are not as badly affected by capital gains taxes, but the small investor taking his ‘big shot’ at business gets crushed. Small wonder financial firms don’t care as much about this, while the Chamber of Commerce does.
Note that even under the other scenario where gains are balanced by losses, the capital gains tax still has a disadvantage in that it disproportionately takes money away from the people who have proven to be the wisest in investing it. Capital accumulation by people best equipped to manage capital is a feature, not a bug.
That said, you don’t want a zero percent capital gains tax, because that would create other distortions because it would be fundamentally a tax shelter. What you want is a rate or a set of rules that makes all taxes equal, after correcting for the differences between types of income and capital. In a perfect system, people would be able to make financial decisions based on their merits, and not based on how different decisions will be punished or rewarded by the government. That’s easier said than done, but that’s the basic idea.
Mutual funds and publicly traded partnerships are pass through entities that hold a bunch of investments. I don’t think you can have an operating business as a publicly traded partnership.
I KNOW when a dividend is earned and who is should be taxed to. I don’t know how much of GM’s earnings to allocate to the day trader or the guy that buys and sells between earnings reports.
Sure, that is one possibility. But considering that this is not what almost certainly happens with mutual funds and PTPs I think that there may be a few slips between the cup and the lip.
And how many people do you think have taxable accounts that hold PTPs? Nothing is insurmountable but it would gum things up considerably.
In the end, the capital gains preference is a tax benefit for those in the top sliver of income earners.
If you earn $75k-$100K/year you are on average paying ~$300/year or less in capital gains tax.
If you earn less than $50,000/year you are paying on average ~$10 in capital gains per year.
If you are making over $200/year, your average capital gains tax is ~$20,000/year.
If you start to push the income levels to the millions you see capital gains account for a larger and larger percentage of taxes paid by the higher income earners.
Capital gains ARE the reward for risk. Subsidizing investment with preferential tax rates is contrary to free market principles. Income is income.
All taxes are distortive and we would ideally fund our society with government revenues generated by selling some natural resource that the government pumps out of the ground. But we can’t all be Saudi Arabia.
I’m sorry, but you’re wrong on most of these points. Many of the oil and gas operations in the US are currently operating as publicly traded partnerships. Here is one of their investor information pages: http://www.buckeye.com/InvestorCenter/PartnershipTaxK1Info/tabid/85/Default.aspx
As explained there, you know your taxable share of partnership activities thanks to form K-1 rather than form 1099. Pass-through entities all use form K-1, whether we’re talking trusts, estates, partnerships or S Corporations. We could apply the same requirement to a C corporation like GM with few simple edits to the tax code.
In terms of increasing payments to partnership owners, that is a specific claim in that link: “Compared to a corporate form of organization, the partnership form enables Buckeye to distribute to investors a greater percentage of cash generated by the business.” And that claim is true if only because the partnership can distribute money a corporate would have paid in taxes.
How many people hold these? A lot, and many of them don’t even realize it. If you have a diversified portfolio of individual equity holdings (i.e. individual stocks rather than mutual funds) then my guess is you have at least one PTP. And if you hold mutual funds, then it’s even more likely that you have an ownership stake in many PTPs, but the K-1s are sent to the fund rather than the fund’s investors.
I guess you didn’t get any of the points I made. There is a huge difference in risk between a capital investment and employment income. That’s why you are allowed to deduct capital losses from capital gains. But in the case of small business investors, they may not have any offsetting capital losses because it was a one-time investment. That makes the capital gain much riskier.
Or ask yourself this: Let’s say in my restaurant example you plan to sell the restaurant in five years as part of your business plan. Of course, in five years it may be worth nothing.
So, you are faced with two choices:
- Invest $100,000 of savings and open up your restaurant.
- Keep working at your current job and leave your money in the bank.
Let’s say your bank account earns 5% interest. After five years, you will earn $27,600 in interest. Guaranteed. Zero risk. If you invest it in your restaurant, after five years you have an expected value of $100,000. That is, there’s a 10% chance you’ll make a million dollars, and a 90% chance that you’ll lose it all.
Now, if you make the million dollars, it looks like you won the lottery. But that ignores the fact that for each ten of you who tried this, nine of them went bankrupt. So you really have to look at expected value in terms of decision-making, and the expected value after five years is $100,000. So, the ‘extra’ profit you made over a zero-risk investment was $72,400.
Any capital gains tax that causes your expected profit to drop by more than $72,400 would cause your decision to change from ‘open the restaurant’ to ‘stay in my job’.
Now obviously individuals may have passions and other reasons to open their restaurant. But over society as a whole, that tax would punish this class of investments and change behaviour such that some investments that would have been good for society will not happen at all.
The biggest area of the economy hit by this is small business and entrepreneurial endeavours. It doesn’t hurt the speculators and the billionaires, as they have hedges and many trades and can take full advantage of using offsetting losses to essentially price the risk out of their capital gains. But for one-time investors or small business owners, the capital gains tax changes their investment rewards dramatically.
Another way to look at it: If you were thinking of putting your money in a savings account, and were told that there was a 90% chance that your money would be gone in five years, what kind of interest rate would you demand on your money to make that investment sensible? Now ask yourself how much interest you would demand if in the 10% case you still lost 25% of your initial investment? Obviously the two rates will be different. Any savings account that offered an interest rate above the zero tax value but below the rate that would be required to make the investment positive when 25% is taken off the top at the end will be an account that sees all its investment money vanish.
The people who had enough money to open a hundred such accounts don’t care if the rules allow them to reduce the winning amounts by the losing amounts. For them, it all comes out in the wash. But for the person taking his one big shot at an investment, that tax is huge.
You might say, “So what? Risk is bad. There’s too much risk in society already.” But a healthy economy needs a mix of activities, including high risk/high reward activities. And innovation requires entrepreneurs taking big risks. For every Mark Zuckerberg there’s a thousand people who tried to set up a web business and failed and lost everything. Sad for them, but necessary for a healthy economy. And those are the very people who will be most incentivized to stop taking risks when the capital gains tax goes up.
The other factor is that you’re reducing capital accumulation by the people who have proven they know how to invest the money, manage businesses, etc. If Elon Musk had not had enough capital from Paypal, he wouldn’t have started Tesla or SpaceX. Would that have been a good thing for the country? How many other companies of huge economic value to society would not have existed if the people who created them could not accumulate capital? Silicon Valley is built on venture capital. How much money would you like to take away from the venture capitalists and put in the hands of politicians, and what effect do you think that might have on our ability to capitalize risky but potentially valuable ventures?
Which is why I said ‘ideally’. Just because you can’t get to zero is not an excuse for ‘anything goes’. The less distortion we introduce through the tax system, the better.
Why are you opening a business with expected value of $100,000 if you already have a risk-free $100,000? Market price of risk means that you need an expected value of significantly more than $100,000 to assume a 90% risk of failure.
Any taxation at all will shift some investments from winners to losers. In fact, in your scenario a tax of 0.1% shifts the restaurant investment from “winner” (or at least “break even”) to loser. A fact that holds true even if the investment was 100% certain to give the expected value, rather than 10% certain to give a much larger value.
(Also, capital gains taxes are only paid on the capital gains, not the value of the business. So you would be paying 25% of 900,000 in the “winning” case, but that’s not so important).
I was assuming that you’d get your $100,000 back plus the million. In that case, there will be a range of capital gain taxes that lower your profit but do not eliminate it. Other investments with less expected value may be eliminated, but not yours.
You’re right in all the details, including the fact that any capital gains tax at all can cause this. But the higher the tax, the greater the profit threshold required before anyone will invest.
I was providing a simplified example to illustrate the point. The larger point is tat for every level of capital gains tax there are investments that will go from positive expectation to negative, and that in turn means those investments will not happen. That makes society poorer. Now, you’re free to argue that the extra revenue to the government will be used so intelligently that it will more than offset these types of losses - that’s a political debate. But economically speaking, you can’t ignore that these types of taxes do have disproportionate impact on different types of investment and will therefore distort the economy to the effect of reducing the riskiest investments that have no offsets - typically entrepreneurial activity. Too many advocates of activist government fail to recognize any downsides to taxation at all, or even that entrepreneurial risk-taking is better than government ‘investment’.
Oh, I got 'em, I just didn’t think they are valid. Capital gains are the compensation for taking risk. That is all you are entitled to. It is not the function of government to subsidize your risk with preferential tax rates.
Wait a minute… You are clearly advocating that you are NOT entitled to all your capital gains, because you want to tax a pretty good chuck of them away. And you refuse to acknowledge that you can go from ‘subsidizing risk’ to ‘punishing risk’ if you make the tax high enough. By your own logic, you can’t ‘subsidize risk’, because the investor is entitled to the capital gains from the investment.
You are also flatly not addressing the very simple math I posted to show you how this can change investment behavior. You don’t get to just decide that math ‘isn’t valid’. If you disagree with it, show me how. Explain why the scenarios I outlined aren’t valid. If you can’t, then you’re just stamping your feet and demanding that the rich folks pay more, regardless of the consequences to investment, innovation, etc.
That’s right, investors are not entitled to every damn dollar their investments earn, same as employees. And no amount of Common Core math will mitigate that. Investors should pay their taxes like the rest of us.
FWIW - since I don’t think this position has been represented here - I’m in principle opposed to any tax breaks being given for the purpose of incentivizing anything. That includes capital gains as well as giving huge tax breaks to big corporations to incentivize this or that development that will supposedly spur economic activity, and the like.
And one of the reasons (though not the only one) I’m opposed to all this is that i’m skeptical as to whether they really work out on a net basis.