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Looking Back — And Forward
May 15, 2013 | 19 comments
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Lies About Libya
May 14, 2013 | 80 comments
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Bouncing Ball Politics
May 8, 2013 | 16 comments
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Words That Replace Thought
May 7, 2013 | 57 comments
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Is Thinking Obsolete?
May 1, 2013 | 36 comments
The Public Policy
Capital Gains Taxes
If a country wants investors to invest, it cannot treat capital gains as ordinary income.
One of the many false talking points of the Obama administration is that a rich man like Warren Buffett should not be paying a lower tax rate than his secretary. But anyone whose earnings come from capital gains usually pays a lower tax rate.
How are capital gains different from ordinary income?
Ordinary income is usually guaranteed. If you work a certain amount of time, you are legally entitled to the pay that you were offered when you took the job. Capital gains involve risk. They are not guaranteed. You can invest your money and lose it all. Moreover, the year when you receive capital gains may not be the same as the years when they were earned.
Suppose I spend ten years writing a book, making not one cent from it in all that time. Then, in the tenth year, when the book is finished, I may sell it to a publisher who pays me $100,000 in advance royalties.
Am I the same as someone who has a salary of $100,000 that year? Or am I earning $10,000 a year for ten years’ work?
It so happens that the government will tax me the same as someone who earns $100,000 that year, because my decade of work on the book cannot be documented. But the point here is that it is really a capital gain, and it illustrates the difference between a capital gain and ordinary income.
Then there is the risk factor. There is no guarantee to me that a publisher will actually accept the book that I have worked on for ten years — and there is no guarantee to the publisher that the public will buy enough copies of the book to repay whatever I might be paid when the contract is signed.
Even the $10,000 a year — which is less than anyone can earn on an entry level job — is not guaranteed. If my years of work produced an unpublished manuscript, I would not even have been among the first thousand writers who met this fate.
Very similar principles apply to businesses. We pay attention to businesses after they have succeeded. But most new businesses do not succeed. Even those businesses that eventually turn out to be enormously successful may go through years of losing money before they have their first year of earning a profit.
Amazon.com spent years losing money before turning a profit for the first time in 2001. McDonald’s teetered on the edge of bankruptcy more than once in its early years. Desperate expedients were resorted to by the people who ran McDonald’s, in order to just keep their noses above the water, while hoping for better days.
At one time, you could have bought half interest in McDonald’s for $25,000 — and there were no takers. Anyone who would have risked $25,000 at that time would be a billionaire today. But there was no guarantee at the time that they wouldn’t be just throwing 25 grand down a rat hole.
Where a capital gain can be documented — when a builder spends ten years creating a housing development, for example — then whatever that builder earns in the tenth year is a capital gain, not ordinary income. There is no guarantee in advance that the builder will ever recover his expenses, much less make a profit.
There are whole industries where no one can expect to make a profit the first year — publishing a newspaper for example. Virtually every major American airline has lost money in some years, and some of the biggest and most famous airlines have ended up going bankrupt.
If a country wants investors to invest, it cannot tax their resulting capital gains the same as the incomes of people whose incomes were guaranteed in advance when they took the job.
It is not just a question of “fairness” to investors. Ultimately, it is investors who guarantee other people’s incomes in a market economy, even though the investors’ own incomes are by no means guaranteed. Reducing investors’ incentives to take risks is reducing the jobs their investments are likely to create.
About the Author
Thomas Sowell is a senior fellow at the Hoover Institution, Stanford University, Stanford, CA 94305. His website is www.tsowell.com. To find out more about Thomas Sowell and read features by other Creators Syndicate columnists and cartoonists, visit the Creators Syndicate Web page at www.creators.com.
oldeham| 10.3.12 @ 7:35AM
Mr. Sowell - your analysis is spot on. But when did the facts every get in the way of a Democrat and more tax revenue?
Highest Income Taxes
#10 - Maryland
# 9 - Virginia
#8 - Hawaii
#7 - New Jersey
#6 - Minnesota
#5 - California
#4 - Oregon
#3 - Massschusetts
#2 - Connecticut
#1 - New York
Are these states places of economic growth? Are these states retirees seek when on fixed incomes?
Not likely.
But these are states with the most people on public assistance. These are states with high unemployment. These are states that are show no to negative population growth.
What the blazes are they teaching for economics in our halls of lower learning these days?
Stuart Koehl| 10.3.12 @ 9:26AM
Your facts regarding Virginia are certainly wrong. Virginia is not only gaining population, but has also seen tremendous business growth over the past decade. In fact, Virginia is one of those states operating in the black. In contrast, Maryland, which you say has lower income taxes than Virginia (something I dispute), has been losing both population and businesses, particularly outside the I-95 corridor. Where did most of those businesses go? Virginia. Why? Because Maryland taxes just about everything in addition to income, and piles on with lots of onerous, anti-business regulations as well.
JP| 10.3.12 @ 10:55AM
Could it be that Virginia's fortunes mirror that of the federal government? In 2001 the federal budget was $1.8 trillion. Today, we approach $4 trillion (of which, $1.2 trillion is borrowed). In the past decade, the size of the federal government has exploded. And places like Northern Virginia are one of the beneficiaries. From increased federal payrolls (which now average over $100,000/year), to contractors, lobbyists, lawyers, to increases in organizations that live off taxpayers money, the surrounding areas of the Beltway thrive today. One of the few areas not hit by the Bush Recession was the Beltway and surrounding counties. Maryland may not know how to control its spending; but, that doesn't mean that Virginia is a poster-boy for self-reliant captialism. I have a feeling if the federal budget was trimmed by 30%, Virginia would be in no better fiscal shape then say, Illinois or Nevada.
oldeham| 10.3.12 @ 11:53AM
Point taken, me bad - that should be total tax burden. Maryland does not have a personal property tax.
oldeham| 10.3.12 @ 12:03PM
The movement of business to Virginia to Maryland is a reflection of the major differences between taxes on business in Maryland and Virginia. Maryland taxes the dickens out of any business.
That is a different issue than personal taxes.
Taxguy| 10.3.12 @ 8:07AM
Dr. Sowell, I am a great admirer of yours and I have always wondered what your views on capital gains tax rates were. I am a tax practitioner, a tax lawyer with an LLM in Taxation from the University of Florida and I respectfully disagree.
There is really no justification for taxing one kind of income differently from another. There are qualitative differences between all jobs, earning ordinary income or capital income, that are imposible to categorize or quantify and these should not be the concerns of tax policy persons.
JD| 10.3.12 @ 12:23PM
I agree that there shouldn't be a need to tax capital gains different from ordinary income. But there are two problems.
1. Ordinary income is taxed too much
2. Investment income is more mobile than salaries
If people were taxed fairly - that is, they paid the government for the value of what government does for them, no more, no less - then taxation wouldn't even be based on income, and the whole conversation would be moot. Even with income taxes, a flat rate with no exceptions would eliminate much of the problem. Otherwise we have problems like the one Sowell describes, where capital gains are more concentrated in time than ordinary income, and are thus unfairly subjected to "progressive" tax rate spikes.
More than that, though, we all know that investors can go live in other countries and invest from there, meaning that our capital gains taxes must compare favorably with those of other countries if we're to keep investors in America. Matching our income tax rates won't do that.
The more mobile a form of work is, the more one must tax that work with foreign competitors' tax rates in mind.
Taxguy| 10.3.12 @ 8:08AM
The double tax issue is a ruse. Dividend income is new income to a shareholder just as the wages earned by the grocery store clerk are new income to that person notwithstanding that everyone who shops at the grocery store pays with previously taxed dollars.
The real issue on the corporate level is that debt expense is deductible by corporations but the cost of equity is not. But a dividend by definition is a distribution of net income, hence, after tax profit.
Corporations used to complain that they could not deduct dividend payments above the line, but then such payments would not be dividends which should rightfully be made from net profit.
Look at the cap gain issue this way: it is not that cap gain income should be taxed at the higher ordinary rate, but that ordinary income should be taxed at the lower cap gain rate.
Only taxing all income at the same rate produces a truly fair and equitable income tax system.
continued:
Your argument is an issue of the level of the tax rate, not that cap gain should be taxed at a different rate from ordinary income. To improve the ecomomy, tax all income at the same rate, and lower that rate.
Pecos Pete| 10.3.12 @ 9:37AM
Taxguy; Interesting comments and generally I agree with you. The problem with the tax code is that Congress has tried to manipulate the code for social purposes. Example: The deduction for interest on home mortgages. The answer, as you point out, is some form of a simple flat tax on income or a national sales tax ... eliminate any and all deductions ... forget about the fantasy of calculating taxable income.
Taxguy| 10.3.12 @ 10:13AM
Are you aware of any tax that congress has not or could not manipulate? As for the flat tax, yes, I agree.
JP| 10.3.12 @ 11:02AM
"The double tax issue is a ruse. Dividend income is new income to a shareholder just as the wages earned by the grocery store clerk are new income to that person notwithstanding that everyone who shops at the grocery store pays with previously taxed dollars."
So, if a person earns $125,000 a year and keeps $65,000 of it (paying $60,000 in total taxes), somehow that money doesn't belong to him. Some government will lay claim to the $65000 remaining. That isn't a ruse; that's called unust taxation. He already paid taxes on that income. If he invests a small portion what's left over, that money is his. The government doesn't have a moral claim to it. For he invests $1000 of what's left over and loses all of it, the government isn't there to share in the loses
And you wonder why there is over $4 trillion in cash sitting in useless accounts. Better to allow inflation to eat away at your cash than to let the government steal it, again.
elsdallas| 10.6.12 @ 10:52AM
You shouldn't be paying $60,000 in taxes on $125,000 in income for one. Second, income taxes tax income. So if you earn income on your investment then you should pay taxes on it. Capital gains should be treated no differently than wages. But the tax rate on wages should come way down. Personally I don't see why the rate should be higher than 11% on anyone.
mike 3/505| 10.3.12 @ 11:50AM
"The double tax issue is a ruse. Dividend income is new income to a shareholder just as the wages earned by the grocery store clerk are new income to that person notwithstanding that everyone who shops at the grocery store pays with previously taxed dollars."
Absolutely untrue. The Profit the company makes is partially owned by the shareholder. Therefore, when the company pays taxes on the profits before handing out the dividends, it is paying those taxes on behalf of said shareholder(s). When the shareholder pays taxes on his dividends has is paying taxes for the second time on the same dollars, now decremented by previous payments to the feds. There is no other way to look at this.
JD| 10.3.12 @ 1:35PM
I agree that taxing increase in share value is not a double tax, as some will claim, but dividends are for the simple reason that if the company were not public, there would be no tax corresponding to the tax on dividends.
If a group of people owns a company privately, they pay income taxes on their shares of the profit. If that same group owns all the shares of a public company, those same income taxes are paid, and then what's left is distributed to the group as dividends, where it is taxed again.
It is true that any earnings reinvested in the company are not subject to the double-tax, but those taken out for the owner's personal use are. That's enough to be worthy of complaint.
BenZacharia| 10.3.12 @ 5:16PM
Sir, are you arguing that when I take my wages and plant fruit and nut trees, buy a feeder steer, and etc. that the gummint needs to come in and TAX me for the gain that I recieve on my INVESTMENT? I have received a capital gain, have I not?
Von Mises Jr| 10.3.12 @ 8:37AM
The long-term logical outcome is that virtually all Democrats and some RINO Republicans in DC figure that it is irrelevant once the fascist, statist regime is complete.
There will be no entrepreneurs except like the guys at Solyndra and Solar Trust who have the government back their projects. They get half-billion to a couple billion spending money, and the government picks the investments.
This is what happened with the Chevy Volt. It was losing $50K per car, so they put production on hold until after the election. Once the hullaballoo is over, then government will go back to producing golf carts at the cost of Mercedes.
The Avenger| 10.3.12 @ 9:22AM
I have heard it said that Wall Street wants to privatize the rewards and socialize the risks. In regard to capital gains the government wishes to privatize the risks and socialize the rewards.
Pecos Pete| 10.3.12 @ 9:41AM
The end result of our fed government tax policies will be government ownership of everything. No more capital gain taxes, or any other form of taxation. Fairness will require that we all live in equal housing, eat our veggies, and use only 2 squares of toilet tissue a day.
Pecos Pete| 10.3.12 @ 9:42AM
Lock and load.
Denver Todd| 10.3.12 @ 10:04AM
I learned in college that taxes are the way that the government encourages or discourages certain activities. Why not apply this to capital gains? Maybe encouraging investment is the reason that capital gains taxes are lower.
Taxguy| 10.3.12 @ 10:15AM
That is called a subsidy. What else should the government be subsidizing? Hint: nothing.
elias| 10.3.12 @ 2:30PM
Todd is right:
capital gains tax rate = personal income tax rate = no McDonalds, no Apple computers or iphones, etc., nor any of the millions of jobs these private entities have created.
Why take the risk if the reward is being penalized by the government as much or more than you are now? btw, that's a rhetorical question, taxguy.
JD| 10.3.12 @ 2:57PM
Obama has answered that question. It's about "fairness".
If the private sector is hurt, so what? We don't need it. All we need is for Republicans to get out of the way so government can grow sufficiently to make up for private sector losses!
markinla| 10.4.12 @ 8:34PM
You really believe this drivel that nobody would start a company or do anything on their own without special capital gains treatment. Well if everybody was just an employee, then who for? People built companies and businesses long before special treatment for capital gains and will do so long after. How else would people turn their ideas into wealth and make a lot more than some employee?
JD| 10.3.12 @ 12:30PM
The government does these things, then complains that negative outcomes were purely the result of an under-regulated "free" market.
pomdter| 10.3.12 @ 12:32PM
On my list of what defects in thinking make a person a liberal is the complete lack of understanding of the word "risk". In every argument on taxes, regulation, employment, etc, I find the consistent logical flaw of the liberal is the lack of accounting for the risk that current actions will not produce predicted results in the future.
JD| 10.3.12 @ 12:58PM
Liberals don't understand cause and effect, so how could they understand risk?
JD| 10.3.12 @ 1:04PM
Leftists hate those who earn capital gains, complaining that they did nothing but sit on their butts while money accumulated. But woe be unto any bank that holds the Leftist's deposits and doesn't pay him a healthy interest rate!
The Leftist will always complain that the bank was allowed to use his money, to lend it out, to profit from it, and yet it paid him little or nothing for it. This even though the Leftist's deposit was guaranteed! No risk! Yet when someone else makes a RISKY investment and it pays off, the Leftist complains that the whole of his gain is undeserved, and demands punitive, redistributive taxation!
The Leftist has a similar double standard regarding investment losses. A Leftist who suffers any hardship, no matter how directly self-inflicted, demands social welfare to support him after his failure. Yet he cheers the failure of the investments of others, and complains bitterly should his fellow Leftists grant them bailouts that need to be repaid. Did the first Leftist's handout need to be repaid?
Leftism is ultimately the short-sighted self-centeredness of the small child, who cannot comprehend the idea that those he interacts with are people just as he is. That is why it is rife with double-standards. Even when they claim to be charitable, they make the assumption that they possess a wisdom that others don't, and should thus have the authority to delegate all wealth.
elsdallas| 10.6.12 @ 12:29PM
The leftist's deposit was guaranteed by the US taxpayer through the FDIC. Abolish the F DIC and the Federal Reserve which suppresses interest rates then your point will have meaning. If you ate going to be against welfare then be against all welfare including corporate welfare.
wolf| 10.3.12 @ 2:21PM
when you say "capital gains" you've lost most of the general public...same with the words deficit and trillion dollar debt..it has no direct impact on their lives that they can control..
europe has a different method of dealing with government that costs them directly in words they understand..in turn the population takes to the streets and shuts the country down..not that it helps much these days..as they are out of money..and so is the US we just dont realize it yet..its the old chestnut: how can I be out of money..i still have checks..
elsdallas| 10.6.12 @ 11:05AM
Normally I agree with you, but you went off the deep end on this one. The government shouldn't be picking winners and losers. Capital gains should be treated no differently than wages. Now the tax rate should definitely come down on wages. A flat tax that taxed all income, including capital gains, at the same rate would be best.