Saturday, May 06, 2006

Why Give Tax Breaks for Capital Gains and Dividend?

Using Waldo's aggregator, I wandered over to Vivian Page's website to read her post about the Republican Tax bill, in which among other things she said:

I have never understood the preferential treatment of capital gains and dividends, especially dividends. Back when the top tax bracket was 70% (and, yes, I'm old enough to remember) the capital gains rate was 20%. The wealthy have gotten significant cuts in the tax brackets - the top bracket is now 35%. I see no reason for capital gains to be a maximum of 15%. And if dividends are taxed at 15%, why not interest as well? Both are investment income. Doesn't it penalize conservative savers over risk-takers? Is that what we want to accomplish?

I wrote a lengthy comment, and decided to promote it up to my own blog as a separate entry because (at least at 12:45am) it seemed like a good idea:

The purpose of lower (or zero) tax rates for capital gains is well-known — to encourage investment in businesses, who can use that investment to grow, improving the economy and employing more americans.

If you buy that, including dividends is a rational and actually necessary move. By taxing dividend higher than capital gains, the tax code artificially inflated the value of stock price inflation over return of income via dividends. So rather than pay dividends, business would buy back stock or build up cash, both in an effort to raise the value of their stock. Since paying dividends is a better indication of REAL income (it’s hard to fake income when you have to send real checks), we needed to change the tax code to eliminate this artificial bias toward stock price inflation.

If you wanted to push a lower tax rate on interest, I’d be with you. The argument isn’t as clean, but you could still say we want to encourage savings, and lower taxes on interest would do so. As it is, SOME interest gets special treatment, others don’t — that is why we won’t see this, because it subsidises state and county borrowing (because they are allowed to issue tax-exempt bonds at a lower interest rate).

The tax code as it is makes people do odd things. For example, if you have both normal investment, AND an IRA, you should put all of your INTEREST investments in the IRA, and use your normal investment for risky stock purchases. The reason? Capital gains are taxed at a much lower rate than interest — but ALL earnings in IRAs are taxed as normal income at retirement. So your IRA should have all the non-favored investments.

From a theoretical perspective, a fair tax code would tax investments only on the inflation-adjusted increase. If I buy a stock, and 5 years later it has only increased at the rate of inflation, I haven’t really made ANY money - the sale gives me money that buys the same items I could have bought 5 years earlier. But I can’t imagine how complicate THAT sort of calculation could be.

The lower tax rates for capital gains is a quick-and-dirty way of mimicking the theoretical desire for taxing only REAL gains, while encouraging people to invest for the long term.

What I don’t like is that while gains are fully taxed in the year they occur, losses can only be taken against gains, with only $3,000 loss allowed each year. People like myself, without a lot of money, and with large losses in the stock market, literally can take DECADES to write off all of our losses. If you earn $10,000 in one year, and lose 10,000 the next, it will be 4 years before you get your losses reflected in your taxes — but if you lose 10,000, and gain it the next year, all of the losses are taken care of in that year.

I like the teacher tax deduction — although it signals a problem with local schools providing the tools teachers need.


Michael Snook said...

I'll agree to taxing cap-gains after inflation if you'll let me tie minimum wage to inflation.

Fair trade?

Charles said...

I would like to abolish the minimum wage, and replace it with a "fair wage".

A fair wage is the wage at which a willing legal employee and a willing legal employer agree to an exchange of money for service.

That way, each citizen can decide what they can live on, and value their contribution based on their own feelings, rather than being forced to value themselves based on what government tells them.

Vivian J. Paige said...

Charles - there has to be a minimum; otherwise, unscrupulous employers will take advantage. Isn't that part of the reason we have an immigration problem right now?

Charles said...

What does it mean to "take advantage"?

I'm sitting in my house, and I decide I'd rather have money than free time. SO I run down to the local store and see if they have a job.

If they do, I sit down with the owner, and he tells me how much he is willing to pay.

I decide whether or not my time is worth the amount of money he has offered -- if it's too small, I decide I'd rather sit around at home.

If nobody is willing to work for that price, the owner will have to offer someone more. If jobs were traded on e-bay, each job would go to the person willing to do that job for the least amount.

I've never heard anybody say that on e-bay, the government has to set the maximum value for a bid, or else the seller will take advantage of someone.

The only way a worker can get taken "advantage of" is if the worker is too ignorant to know what he is worth. And I don't think government exists to protect us from our own stupidity.

If we lived 100 years ago, I may be swayed to your position, because the market was very segmented and quite opaque (meaning it was hard to find all the jobs that might be available).

In this day and age, anybody can get on the web and find out what jobs are worth all around the world. Almost every state and local government provides job training and search assistance.

The illegal immigrants are "taken advantage of" because they can be blackmailed, since they can be deported. On the other hand, most illegals don't think they are being taken advantage of -- they earn a princely sum for fairly simple (but backbreaking) work, and they support their families well because of the cost-of-living disparity.

Having said all that, raising the minimum wage isn't my biggest fear of the government. I don't think it would cause business irreparable harm to add a buck to the wage. At the moment, the job market is actually pretty tight, and most of those "minimum wage jobs" like working at McDonalds seem to be paying a bit more than the minimum.

Raising the minimum wage will mostly hurt people just trying to get into the job market who have little education and no job experience -- in other words, the poeple who aren't worth six bucks an hour.

There are jobs that aren't worth the minimum wage. Someone could make three bucks an hour shredding documents for a firm -- but hiring a new worker at 6 bucks is just too much, so the firm will just tell the employees to shred their own documents.

In other words, drop the minimum wage, and you will greatly increase the work available to the portion of the population that can't break in.

There are jobs that simply aren't worth the minimum wage.