Should taxes from capital gains realized from liquidating secondary market assets (like stocks not purchased in an IPO) be taxed differently that gains from direct capital investment or IPO stock purchases, etc.?
Thanks,
Rob
I’m curious why you ask?
I have another capital gains question. Whenever someone suggests that capital gains be taxed the same as earned income (usually during a rant about rich people paying less taxes), I usually follow-up with the following example: say you buy $10,000 of XYZ stock and sell it 20 years later for $20,000. You owe tax on the capital gain of $10,000, right? But the purchasing power of that “gain” is likely very close to zero (a doubling in 20 years works out to an annual gain of 3.5 percent).
So, why are we taxed on a nominal gain that represents no real gain at all from a purchasing/CPI standpoint? I think the answer, if there is one, is that a lower capital gains tax rate represents a compromise that inherently acknowledges that not all “gains” are equal. Or another way to look at it is why do you pay the same CG tax if your investment doubles in 13 months or 113 months? The alternative would be to index capital gains for inflation. This could be done, of course, but would represent a burden for tax filers and preparers.
I could make the same argument regarding taxing interest. If I deposit money in an interest-bearing account and earn 0.90 percent, I’m not even keeping up with inflation. I’m losing money on a real basis, but still have to pay taxes on the interest.
People always seem to underrate/value the presence of a secondary market. They think they don’t actually do anything, that it is just gambling and that it should be somehow penalized.
Secondary markets are VITAL! As important and maybe even more important than initial investment.
With a bad secondary market that means that people investing initially will know that they will have difficulty selling when they wish and if they can sell will probably get less than they think they should and it will take longer to get rid of it. It also keeps smaller players more out of the market because they can only really get into initial investments which is risky and probably would turn their noses at such a paltry amount of money.
Good secondary markets also let you know, in no uncertain terms what something is worth right now. If I have 1000 shares of PKG - Packaging Corporation of America it is worth $67,000. Yes, it might change tomorrow but I know precisely what it is worth right now and I could SELL IT for that right now, if I owned it.
That is a nice thing to have. Take it away and a chill will run through even initial investing.
Think of what a poor secondary market would have in housing.
Initial and secondary should be taxed nearly the same as they are both important.
Inflation is a hidden tax.
Furthermore, the gain accrued over 10 years, but the tax would be applied as though it happened in one year, if it was based on the personal marginal rate.
There are many good reasons for capital gains taxes to be different than personal income. I dislike the way that they encourage buy-and-hold rather than selling one stock and buying another (presumably better) one. It distorts the market (admittedly, mostly by influencing people more than it should, for psychological reasons rather than financial ones).
But I see no reason to tax primary and secondary markets differently.
Without a secondary market, there would be no primary market, to speak of. Stocks aren’t like toasters – they’re not consumable goods. The only value of a stock is its dividends and its resale value. Resale value dwarfs dividends.
Who said anything about eliminating secondary markets? I realize their value: they provide liquidity and incentivize direct investment. I want to know if there are any benefits to incentivizing direct investment more, um, directly.
Sure - the more you incentivize “direct investment” - the more it will occur. Not sure why it needs more. Generally the price for “direct investment” is less - as there is more risk. More risk = more reward (potentially). It seems like it works pretty well the way it is already.
Also - I’m not sure this would have the effect you think it would - assume you totally eliminated the cap gains tax on direct investment.
Would this make more people put money into IPOs? All things being equal - of course it would, but the problem (from the investors point of view) is that they would no longer be able to get the IPO at say $20 - they’d be paying $20 + what ever the increase in price was due to the IPO being more valuable due to tax consequences. You see the same thing in TIPS markets as well as tax free bonds.
Tax policy is a poor way to try and incentivize market behavior. Tax policy should be about raising taxes. Let the market behave without goverment intervention, we don’t need Washington continuing to pick winners and losers.
As you note, the treatment of interest highlights that concerns over inflation did not drive the preferential capital gains rate. Otherwise they would have had a preferential interest tax rate. There has never been any attempt that I can think of in the tax code to adjust for inflation.
There are several arguments for a capital gains tax but historically, the most compelling ones had to do with our historically steeply progressive tax system and double taxation. $100,000 of gain earned evenly over 10 years would be taxed at a much lower rate than the same $100,000 earned in one year.
Now that our tax system is relatively flat, the rationale for the preferential rate hangs on double taxation and some misguided notion of encouraging investment.
While I agree that trying to use the tax coded for things other than raising revenue distorts an already distortive necessary evil, I think there are several areas where tax incentives make sense. I also think that tax expenditures are far better made as direct spending so taht it is more transparent and better targetted.