Why not lower income taxes and increase capital gains taxes?
August 21, 2012 9:08 AM Subscribe
Has there been any serious discussion or analysis of "swapping" capital gains tax rates (by raising them) and income tax rates (by lowering them)?
In all of the tax policy rhetoric - the Buffett Rule, Mitt Romney's 13% average tax rate paid, Bush Tax Cuts, etc. - there is an unavoidable distinction between how the richest people are treated and how the lower and middle class are treated. A big part of the issue, it seems, is that Capital Gains are taxed at only 15%, and once you become supremely rich that's where a lot of your money comes from.
As I understand it, people argue that the lower capital gains tax is appropriate because (a) the investment is made with money that has already been taxed once and (b) it encourages people to invest by letting them keep more of the gain. So, as long as the income tax remains high (a subjective "high," I realize), the capital gains tax should remain low.
But it always seemed backwards to me that we should give up a bigger portion of the money we made with our own hands (something most everybody does) than the money that we made afterwards from buying stocks or investments (something that a privileged minority does). And given that most people don't even invest fully in their 401(k)s, IRAs, etc., the "encourage investing" logic doesn't really hold. And with a higher threshold tax - the income tax - taking a bite out of earnings, that leaves a smaller pool of discretionary money to invest or spend right off the bat.
Wouldn't an easy way to alleviate the "rich paying their fair share" and the middle class income problems be to just raise the capital gains tax to 25 or 35% and then lower the income tax rate to offset it? Everyone would take home more of the money that results from their actual labor (as opposed to their money working for them), people would have more money to either invest or to spend up front, and there would theoretically be less ammunition for a "war on the rich" taxation argument because the capital gains tax would affect everyone the same.
Has there been any serious discussion or analysis of this concept? Am I missing some key component other than "it would disproportionately affect the rich so it won't ever happen"?
In all of the tax policy rhetoric - the Buffett Rule, Mitt Romney's 13% average tax rate paid, Bush Tax Cuts, etc. - there is an unavoidable distinction between how the richest people are treated and how the lower and middle class are treated. A big part of the issue, it seems, is that Capital Gains are taxed at only 15%, and once you become supremely rich that's where a lot of your money comes from.
As I understand it, people argue that the lower capital gains tax is appropriate because (a) the investment is made with money that has already been taxed once and (b) it encourages people to invest by letting them keep more of the gain. So, as long as the income tax remains high (a subjective "high," I realize), the capital gains tax should remain low.
But it always seemed backwards to me that we should give up a bigger portion of the money we made with our own hands (something most everybody does) than the money that we made afterwards from buying stocks or investments (something that a privileged minority does). And given that most people don't even invest fully in their 401(k)s, IRAs, etc., the "encourage investing" logic doesn't really hold. And with a higher threshold tax - the income tax - taking a bite out of earnings, that leaves a smaller pool of discretionary money to invest or spend right off the bat.
Wouldn't an easy way to alleviate the "rich paying their fair share" and the middle class income problems be to just raise the capital gains tax to 25 or 35% and then lower the income tax rate to offset it? Everyone would take home more of the money that results from their actual labor (as opposed to their money working for them), people would have more money to either invest or to spend up front, and there would theoretically be less ammunition for a "war on the rich" taxation argument because the capital gains tax would affect everyone the same.
Has there been any serious discussion or analysis of this concept? Am I missing some key component other than "it would disproportionately affect the rich so it won't ever happen"?
Best answer: The size of the base might also be an issue. If you raised the capital gains tax to 25%, an offsetting income tax rate reduction might be quite small- maybe a couple of percentage points? The income you'd get from an extra ten percent of capital gains income might be a drop in the bucket compared to the income the government gets from the income tax.
I should say that I have no idea if this is actually the case, I just suspect it might be a factor.
posted by MadamM at 9:35 AM on August 21, 2012
I should say that I have no idea if this is actually the case, I just suspect it might be a factor.
posted by MadamM at 9:35 AM on August 21, 2012
Best answer: This approach in its simplest form will not address our economic issues, even though it's become a more prominent political rallying point as of late (I say this as a bleeding heart liberal).
It is estimated that in 2002, capital gains accounted for only 4-7% of all income tax, and 2-3% of total federal tax revenue. In 2006, only 13% of all income tax returns even included capital gains. If you were to double, and assume that it wouldn't harm the landscape of capital flow and investment, and that total income would remain unchanged, the amount you could offset income taxes for the "middle class" would probably be relatively unimpressive.
On preview, what MadamM said.
posted by drpynchon at 9:44 AM on August 21, 2012
It is estimated that in 2002, capital gains accounted for only 4-7% of all income tax, and 2-3% of total federal tax revenue. In 2006, only 13% of all income tax returns even included capital gains. If you were to double, and assume that it wouldn't harm the landscape of capital flow and investment, and that total income would remain unchanged, the amount you could offset income taxes for the "middle class" would probably be relatively unimpressive.
On preview, what MadamM said.
posted by drpynchon at 9:44 AM on August 21, 2012
A swap doesn't really work since the money just follows the taxes. Romney could have been a multi-million dollar salary on a W2 from Bain very easily.
posted by smackfu at 9:56 AM on August 21, 2012
posted by smackfu at 9:56 AM on August 21, 2012
Take a look at this NPR list:
Six Policies Economists Love
You're likely better off if you eliminate income and corporate taxes and replace these with a consumption tax. This will lead to a more efficient economy, and will better target taxes to the thing that you perhaps should care more about when talking about inequity, which is differences in consumption.
Also, take a look at this discussion of capital gains taxes:
Capital Gains Taxes
One relevant section is:
posted by chengjih at 10:02 AM on August 21, 2012 [1 favorite]
Six Policies Economists Love
You're likely better off if you eliminate income and corporate taxes and replace these with a consumption tax. This will lead to a more efficient economy, and will better target taxes to the thing that you perhaps should care more about when talking about inequity, which is differences in consumption.
Also, take a look at this discussion of capital gains taxes:
Capital Gains Taxes
One relevant section is:
Take, for example, the capital gains tax paid on a pharmaceutical stock. The value of that stock equals the discounted present value of all of the company’s future proceeds. If the company is expected to earn $100,000 a year for the next twenty years, the sales price of the stock will reflect those returns. The “gain” the seller realizes from the sale of the stock will reflect those future returns, and thus the seller will pay capital gains tax on the future stream of income. But the company’s future $100,000 annual returns will also be taxed when they are earned. So the $100,000 in profits is taxed twice—when the owners sell their shares of stock and when the company actually earns the income. That is why many tax analysts argue that the most equitable rate of tax on capital gains is zero.Anyway, raising capital gains taxes will reduce capital formation, which, in the long run, will make us worse off. You can't think of the economy as static, and that the current income distribution is what we will always have to work with.
posted by chengjih at 10:02 AM on August 21, 2012 [1 favorite]
There is no economist consensus on capital gains rates. Some contextual info, though. 15% is a historic low for US capital gains rates. See Wikipedia, in particular this graph which shows the US rate varying between 15% and 35% over the past 40 years. Also for context, international capital gains rates from 2009 showing rates varying from 0 to 45%, even between European countries.
posted by Nelson at 10:22 AM on August 21, 2012
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posted by Nelson at 10:22 AM on August 21, 2012
Best answer: Wouldn't an easy way to alleviate the "rich paying their fair share" and the middle class income problems be to just raise the capital gains tax to 25 or 35% and then lower the income tax rate to offset it?
No. Not at all. Four obvious reasons.
First, capital gains represents a relatively small percentage of federal revenue. In 2007, when the feds collected more from capital gains than ever before or since, it only accounted for $259 billion in tax revenue. By comparison, total individual income taxes for that year--capital gains is included in there--counted for $1.16 trillion. But social insurance taxes--also technically an "income tax" but counted separately--counted for another $870 billion. All told, personal income taxes including capital gains represented a total of $2 trillion in revenue. Capital gains was only about 13% of the total. Even doubling the capital gains rate would have only brought that up to about 22% of the total. To make it revenue neutral, a doubling of the capital gains rate would let you cut the income tax rate by about 15%. So, the top bracket would go from 35% to like 31.5%. Not a huge difference. There's just not enough capital gains in any given year to justify a significant decrease in income tax rates.
Second, the reason rich people tend to receive more of their income as capital gains is because it's taxed less. If it started to be taxed more, they'd just demand salaries instead of stock. The point is tax avoidance. There isn't anything inherently interesting getting paid in stock. If you impose higher capital gains tax rates, they'll just take more of their compensation in income taxes. This would probably be true even if the income tax rates stayed the same, because part of what's going on with compensation via stock is that the employee takes on higher risk than they otherwise would. Salary is money in my pocket. Stock might, at some point, be converted into money, but it's hard to say how much or when. Even options can be dicey unless they're really, really sweet deals. So I'm thinking that any increase in capital gains taxes would just encourage a change in the structure of compensation packages away from stock and towards salary.
Third, capital gains are only assessed when capital is sold. The sell price is compared to the buy price, and any increase is assessed as a capital gain in the year it was sold. Capital losses can be used to offset this. But if you just buy stock and sit on it, you won't pay any capital gains. You may pay income tax on the dividends the stock pays, but the capital gains as such would be zero. So if there were higher transaction costs, people would just sell less stock and sit on it longer.
Lastly, capital gains revenues track the stock market. When it's up, taxes are up. When it's down, taxes are down. Short-term capital gains in 2008 were about half what they were in 2007, and 2007 was about 14% up from 2006. That's some freakishly big moves. The government really can't afford to have that kind of spikiness to its revenue. People's salaries, by contrast, are pretty stable and largely immune to the temporary gyrations of the stock market. They go up and down, sure, but they don't go down 33% in one year and then up 17% the next. While one individual's salary might--say if they got fired or switched jobs--aggregate salaries are pretty damn stable.
So no. Trying to largely fund the government with capital gains is a bad idea. We might decide for other reasons that we want to tax capital gains more than we are now, but we shouldn't think that this is any kind of solution to our fiscal problems. Nor can we realistically expect to be able to significantly lower income taxes as a result. The about of revenue we're talking about just isn't big enough, but it does fluctuate pretty wildly. And the whole capital gains dodge is just a means of tax avoidance, so if you start taxing it, they'll just do something different.
posted by valkyryn at 11:26 AM on August 21, 2012 [2 favorites]
No. Not at all. Four obvious reasons.
First, capital gains represents a relatively small percentage of federal revenue. In 2007, when the feds collected more from capital gains than ever before or since, it only accounted for $259 billion in tax revenue. By comparison, total individual income taxes for that year--capital gains is included in there--counted for $1.16 trillion. But social insurance taxes--also technically an "income tax" but counted separately--counted for another $870 billion. All told, personal income taxes including capital gains represented a total of $2 trillion in revenue. Capital gains was only about 13% of the total. Even doubling the capital gains rate would have only brought that up to about 22% of the total. To make it revenue neutral, a doubling of the capital gains rate would let you cut the income tax rate by about 15%. So, the top bracket would go from 35% to like 31.5%. Not a huge difference. There's just not enough capital gains in any given year to justify a significant decrease in income tax rates.
Second, the reason rich people tend to receive more of their income as capital gains is because it's taxed less. If it started to be taxed more, they'd just demand salaries instead of stock. The point is tax avoidance. There isn't anything inherently interesting getting paid in stock. If you impose higher capital gains tax rates, they'll just take more of their compensation in income taxes. This would probably be true even if the income tax rates stayed the same, because part of what's going on with compensation via stock is that the employee takes on higher risk than they otherwise would. Salary is money in my pocket. Stock might, at some point, be converted into money, but it's hard to say how much or when. Even options can be dicey unless they're really, really sweet deals. So I'm thinking that any increase in capital gains taxes would just encourage a change in the structure of compensation packages away from stock and towards salary.
Third, capital gains are only assessed when capital is sold. The sell price is compared to the buy price, and any increase is assessed as a capital gain in the year it was sold. Capital losses can be used to offset this. But if you just buy stock and sit on it, you won't pay any capital gains. You may pay income tax on the dividends the stock pays, but the capital gains as such would be zero. So if there were higher transaction costs, people would just sell less stock and sit on it longer.
Lastly, capital gains revenues track the stock market. When it's up, taxes are up. When it's down, taxes are down. Short-term capital gains in 2008 were about half what they were in 2007, and 2007 was about 14% up from 2006. That's some freakishly big moves. The government really can't afford to have that kind of spikiness to its revenue. People's salaries, by contrast, are pretty stable and largely immune to the temporary gyrations of the stock market. They go up and down, sure, but they don't go down 33% in one year and then up 17% the next. While one individual's salary might--say if they got fired or switched jobs--aggregate salaries are pretty damn stable.
So no. Trying to largely fund the government with capital gains is a bad idea. We might decide for other reasons that we want to tax capital gains more than we are now, but we shouldn't think that this is any kind of solution to our fiscal problems. Nor can we realistically expect to be able to significantly lower income taxes as a result. The about of revenue we're talking about just isn't big enough, but it does fluctuate pretty wildly. And the whole capital gains dodge is just a means of tax avoidance, so if you start taxing it, they'll just do something different.
posted by valkyryn at 11:26 AM on August 21, 2012 [2 favorites]
No. From a tax policy perspective it makes sense for the code to be as simple as possible That is, capital gains should be taxed as the same rate as salary income, so that there is no incentive to manipulate income between salary and capital gains.
Unfortunately from a political perspective it makes sense to have as many complications as possible.
posted by RandlePatrickMcMurphy at 1:15 PM on August 21, 2012 [1 favorite]
Unfortunately from a political perspective it makes sense to have as many complications as possible.
posted by RandlePatrickMcMurphy at 1:15 PM on August 21, 2012 [1 favorite]
Incidentally, a lot of people seem to be making the case that rich people are skirting taxes by being compensated in stocks instead of cash income. While I'm sure there are some ways to divert one's income in either direction, the reality is that it is not so simple. If you get compensated in stocks from an employer, the law is that you have to pay INCOME TAX on the value of those stocks, plus capital gains tax if there any gains if/once those stocks are sold. This is also true for stock options as far as I know.
In short, with the exception of folks working in private equity where there are unfortunate loopholes to this, I don't think switching from income to stocks as compensation magically saves you from income tax.
posted by drpynchon at 4:58 PM on August 21, 2012 [1 favorite]
In short, with the exception of folks working in private equity where there are unfortunate loopholes to this, I don't think switching from income to stocks as compensation magically saves you from income tax.
posted by drpynchon at 4:58 PM on August 21, 2012 [1 favorite]
If you get compensated in stocks from an employer, the law is that you have to pay INCOME TAX on the value of those stocks. . . .
I don't think switching from income to stocks as compensation magically saves you from income tax.
That's trivially true, but it isn't really how it works. The main way companies do this is conferring options, not shares, and the IRS generally doesn't consider options to be taxable. The reason is that (1) options are generally non-transferrable, so it's not like there's a "fair market value" for an option, and (2) the amount the employee is actually going to benefit won't be known until the option is exercised at some point in the future.
posted by valkyryn at 5:53 PM on August 21, 2012
I don't think switching from income to stocks as compensation magically saves you from income tax.
That's trivially true, but it isn't really how it works. The main way companies do this is conferring options, not shares, and the IRS generally doesn't consider options to be taxable. The reason is that (1) options are generally non-transferrable, so it's not like there's a "fair market value" for an option, and (2) the amount the employee is actually going to benefit won't be known until the option is exercised at some point in the future.
posted by valkyryn at 5:53 PM on August 21, 2012
My understanding is that that only applies to qualified stock options (incentive stock options or ISOs), and that there are restrictions on those, including a maximum of $100k/yr. Again, I'm not an expert, but it doesn't apply to non-statutory options, on which you either pay income tax at the time they are given or exercised depending on if they can be valued. For the super rich, there are probably limits to how much they might be granted in tax-privileged options.
posted by drpynchon at 6:37 PM on August 21, 2012
posted by drpynchon at 6:37 PM on August 21, 2012
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