Uncommon Sense

September 25, 2011

A Not So Capital Idea

Currently the federal tax code allows money earned based on investments, the so-called capital gains, to be taxed at the lowest rate of income taxes, 15%, lower than the average rate ordinary tax payers pay on their income. This has not always been so. None other than Ronald Reagan allowed capital gains to be taxes the same as “ordinary income,” that is the income you earn by the sweat of your brow. So why do we favor income earned by the investment of money over income earned by labor (by taxing it less). This in what we have designed to be a “progressive” tax system. In a progressive tax system, the more you earn, the higher the rate of your taxes. So, you pay 10% federal income tax on the first 8500 dollars you make, then 15% on the next $26,000, then a 25% rate kicks in for earnings over $34,500, 28% for earnings over $83,600, 33% for earnings over $174,400, and 35% for $379,150 and above (2011 rates). Obviously rich people earn more in capital gains than do poor people and some very rich people live off of their capital gains entirely, which gives some very rich people a lower tax rate than everybody else which is in direct opposition to the design of the tax system. In one case, a hedge fund manager “made” over $1 billion dollars in one year and paid only 15% federal tax. Yes, that is $150,000,000 (max, I am sure he had some deductions). But if those earnings were taxed like everybody else, his taxes would have been a little under $350,000,000. So, one man received a benefit from the federal government to the tune of $200,000,000 because . . . because. . . . (For those of you who weep over the government “confiscating” this poor guy’s “hard earned money,” he still would be making over $340,000 per hour after taxes.)

This is a very good question. Are we favoring rich people because they are the “job creators,” and we want to encourage their behavior of investing their money? Or have rich people bought off enough politicians to stack the deck on their behalf?

The basic argument for the lower tax rate on capital gains is that when people invest their money and earn interest/dividends/whatever thereby they are stoking the economic engine of the country and creating jobs. To Republicans this behavior takes on mystical or religious overtones. They think there shouldn’t be any taxes on capital gains for the most part.

But does this argument hold water? Did not Wall Street bankers using a veritable sea of such money manipulate the rules to enrich themselves and almost bankrupt the country, destroying trillions of dollars of wealth (other people’s wealth, they kept theirs) at the same time. Is this what we want to encourage?

Disregarding current Wall Street excesses, corporations are amoral creations that are designed to profit their owners, either private individuals or public stockholders, and only profit them. If you look at many of the biggest corporations they are multi-national beasts. And for many the monies invested in them actually results in jobs being exported overseas. Those corporations don’t distinguish between profits earned from overseas labor from profits earned from domestic labor. A dollar is a dollar is a dollar. So, we are subsidizing the abilities of these corporations to export jobs overseas by giving tax breaks to people who invest in them.

My personal preference would be to stop using the tax code altogether to promote behaviors. If the government, representing all of us, wishes to promote something, incentives other than tax incentives should be used, such as expedited permitting, R&D at federal research facilities, grants of federal land, building roads and bridges to connect business facilities, etc. But, if we are going to use the tax code, shouldn’t we do it using some smarts? Shouldn’t we tie the lower tax rates to investments that are doing what we want, instead of what we don’t want? Why should we subsidize the undermining of our own well-being?

A small capital tax rate for everyone is not a capital idea. I am not even sure a small capital tax rate for anyone is a capital idea.

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