Taxing Capital Gains

The New York Times was, of course, correct to argue yesterday that private equity firm managers should need to pay the normal income tax rate rather than the much lower capital gains tax rate. The larger story, however, is that all income should be taxed according to a single rate schedule. Right now, capital income is taxed much more lightly than labor income, which is great if you're rich, but otherwise not such a hot idea.

Ron Wyden has a proposal to clean this up, which seems to be in some ways modeled on this older proposal from the Center for American Progress. I'd like to see presidential candidates take this issue up.

Comments

-There is a distinction to be made here, in that hedge fund managers are obviously skirting the purpose of the tax laws, and attempting to get their profits from labor (hedge fund management) taxed as if it were from capital. That's a story in itself.

-The fact that this country taxes gains from capital at a far lower rate than gains from labor is one of those things that should keep center-lefties from being two dismissive of the marxists to their left.

Posted by DivGuy | June 26, 2007 4:14 PM

I like two-and-a-half of Wyden's points, but is there any real reason to cut the number of tax brackets?

Posted by Matt Weiner | June 26, 2007 4:17 PM

"I'd like to see presidential candidates take this issue up."

Ummm...

One presidential candidate has been talking about raising the rates on capital gains for the past 5 years...

Posted by Petey | June 26, 2007 4:20 PM

It's good to see Matt come around to the Phil Gramm platform from '96.

Kids today.

Posted by Thomas | June 26, 2007 4:38 PM

The larger story, however, is that all income should be taxed according to a single rate schedule.

Why?

In the interest of fairness, why stop there? Why not have a single rate as well?
The answer, of course, is Matt is not interested in "fairness". He is interested in tilting the tax burden even more toward those who produce and less on those who don't.

Posted by Fred Jones | June 26, 2007 4:46 PM

You're wrong, Yglesias! And will be as long as we tax capital profits at the time of realization rather than as value of investments actually increases.

If you were to tax capital gains at the current rate for other income, people would simply realize their profits less often and stick with individual investments longer - and you'd get less revenue thatn you would at a rate between the current CG and normal income rates.

The CG rate should be higher, but not that high. It should be at the revenue-maximizing level. That might not have the same superficial appearance of equality, but it would actually be more effective.

Posted by aeroman | June 26, 2007 4:47 PM

Perhaps I misunderstood Mr Yglesias' comment and he concurred with Wyden on the one rate. If so, please accept my apologies.

Posted by Fred Jones | June 26, 2007 4:52 PM

Perhaps I misunderstood Mr Yglesias' comment and he concurred with Wyden on the one rate. If so, please accept my apologies.

Posted by Fred Jones | June 26, 2007 4:53 PM

He is interested in tilting the tax burden even more toward those who produce and less on those who don't.

What does this even mean? People whose income comes from labor don't "produce"?

Has the Republican fetish with wealth gone so far that now only capital income is "real" income in their book?

Posted by Steve | June 26, 2007 4:54 PM

There is another factor that argues in favor of a lower rate on CG - it promotes investment and risk taking. I don't know if there is a definitive study on whether it really does, but most countries have a favorable tax regime for CG, especially for long-term CG. Remember that even before the Bush tax cuts, there was a favorable rate for long-term CG for individuals.

If folks are proposing that the rates be equalized, at a minimum the gain should be indexed for inflation.

Posted by 2cynicalbyhalf | June 26, 2007 5:27 PM

I would like to agree with Matt. But the treatment of capital gains, outside of the tax rate, is one that I think should continue.
For example, if your business is 'flip this house' then by all means, tax the capital gains at the same rate as regular income.
but the law as is currently allows that you can take a one time sell out of your primary residence after you turn 65 as tax free. I think this should continue.
In addition the law allows offsetting profits v. losses for up to three years back. Simply file ammended tax returns. I think this should continue.
Business has plenty of risks and years of building up a business when your not making any money and the flexibility in accounting is important.
But the tax rate should be the same. whether you set bricks for an hourly rate or flip houses, or day trade. capital gains should be treated at the same tax rate as any other income.

Posted by Aaron | June 26, 2007 5:29 PM

Increasing capital gains taxes is a bad idea. First of all, the income of the rich is far more due to labor income (of the W-2 variety) than capital income. In fact, the capital share of income is currently at a historically low level. So raising capital gains taxes simply isn't a good way to get more money form the rich.

Second, the dynamic effects are important. If you increase labor taxes on the rich, they probably won't work any less or move to another country. However, if you increase capital tax rates, I bet they will save less or save their money overseas. That would be a big problem. I'm on board with changing the taxation of private equity managers (the word "manager" is key), but raising capital gains rates would not be a great idea. Stock ownership has been becoming more important to the middle class for years now, and that's a good thing. No point in ruining it with more taxes on their saving.

Posted by Ian D-B | June 26, 2007 5:31 PM

Capital-gains tax rates encourage saving of a certain kind, so I wouldn't be so quick to raise them. What I'd do instead might be to lower the tax rates on interest income, so that the forms of saving that poor people have easier access to (bonds, bank accounts, etc.) become more attractive. There's a lot of evidence that Americans save less than we should...

Posted by Mr. Noah | June 26, 2007 5:38 PM

"Right now, capital income is taxed much more lightly than labor income, which is great if you're rich, but otherwise not such a hot idea."

I guess the rich now include every american with an IRA or 401k plan?

Lower capital gains tax means also more investment and therefore more jobs.

Posted by Dave | June 26, 2007 6:29 PM

"Right now, capital income is taxed much more lightly than labor income, which is great if you're rich, but otherwise not such a hot idea."
I guess the rich now include every american with an IRA or 401k plan?

As far as I know, one doesn't pay taxes on a retirement account unless one makes a premature (i.e, before retirement age)withdrawal from it.

Posted by James Gary | June 26, 2007 6:47 PM

Sorry, that was unclear. My point is that retirement accounts are a special case, have their own rules, and are probably not germane to the present discussion.

Posted by James Gary | June 26, 2007 6:49 PM

I see matters have devolved down to the "we must repeal the estate tax to protect the family farm!" level of argumentation.

Posted by Steve | June 26, 2007 7:11 PM

Hey, I posted a constructive and useful comment. Come on moderator! You know you love the progressive consumption tax!

Posted by chris | June 26, 2007 7:54 PM

Matt's post certainly hit a nerve with the investor class here. But he's right there the idea that it is investment alone which creates wealth is wildly off base. With the caeat that there should be some deflator applied to one's nominal capital gains, income should be treated as income.

Posted by AJ | June 26, 2007 8:03 PM

"As far as I know, one doesn't pay taxes on a retirement account unless one makes a premature (i.e, before retirement age)withdrawal from it."

I think they are inseparable as lower capital gains tax means more investment and higher stock prices which means increased value for retirement accounts.

Posted by Dave | June 26, 2007 8:21 PM

I'm disappointed to see Wyden adopting the standard conservative trick of talking about reducing the number of tax brackets as important to tax simplification. The number of brackets doesn't effect the complexity of tax calculations, because everyone either looks up the tax in a table or calculates it with a computer program. There could be an infinite number of tax brackets (and there probably should be, to smooth out pointless jumps) and taxes wouldn't be any more complicated.

Posted by KCinDC | June 26, 2007 9:36 PM

Actually, withdraws from IRA and 401K accounts are treated as ordinary income. The capital gains rules do not apply. There is also no evidence that favorable tax rates for investments produce more investments. I agree with Matt, all income should be taxed at the same schedule. Investments should be made according to the risk/reward factor rather than tax rates.

Posted by MarvyT | June 26, 2007 10:03 PM

The Roth IRA is an exception, if you follow all the rules, withdraws are not taxed at all. It's odd that investment income is given huge tax preferences and yet the USA has an abysmal savings rate - at times it's even negative. The tax breaks mostly help people who can already afford to save.

Posted by MarvyT | June 26, 2007 10:14 PM

Why should playing games with money have a lower tax rate than the wages earned by actually working for a living?
I know, way too simplistic..

Posted by HeartlessB | June 26, 2007 11:50 PM

Can we quit pretending that any significant part of the income reaped out of capital gains taxes is investment? Human beings don't get in on IPO's, they can't. Actual founder's stock is a barely significant blip in a day's trading. Barely anyone is actually "investing" in anything in the sense of providing capital for some venture. Throw it in the same tax bracket you pay when you hit the trifecta at the track (I remember that one hurt), because a serious pony watcher will do about as well at that as a serious market watcher and it provides exactly as much benefit to society.

Posted by Ed Marshall | June 27, 2007 12:16 AM

John Edwards is talking about this.

Posted by benton | June 27, 2007 9:04 AM