James Maule is on the lie-exposing warpath once again, but this time, at least technically, he’s onto something.
Maule attacks issue 9.04 of Tax Bytes, released by the Institute for Policy Innovation, titled “Investing Earns You Additional – Not Lower – Taxes,” that argues that the capital gains tax is a double tax because the moneys originally used to purchase the capital asset were already taxed once.
First, let me illustrate why I agree with Maule that the double-taxation argument is inaccurate by positing the case of a hypothetical man known as Mitt Buffney.
Let’s assume the following:
- Buffney received $75,000 dollars in gross wages in 2011.
- After taxes, he received $50,000 dollars of these wages.
- He paid federal income taxes on these wages of $20,000
- He used the $50,000 of these after-tax dollars to buy a condominium which he rents out.
- In 2015, Buffney sells the condominium for $100,000 dollars.
- Buffney made no improvements to the property before he sold it
- He claimed on his tax returns $6,000 of depreciation.
Here are the tax consequences of Buffney’s sale of this capital asset in 2015:
Sales Price $100,000
Less: Basis in property sold 50,000
Long term capital gain $ 50,000
Depreciation Recapture* 6,000
For our purposes (ease of calculation) Buffney’s tax liability is calculated as follows:
Capital gain less recapture $ 44,000
Cap gain rate 15%
Cap gain tax 6,600
Recapture 6,000
Ordinary rate .35%
Tax on recapture 2,100
Total Tax (6,600 + 2,100) $8,700
Buffney has an effective tax rate of 17.4% calculated as follows:
8,700 / 50,000 = 17.4%
* Depreciation is deductible against ordinary income, therefore, when a capital asset is sold, the portion of the gain that is attributable to the depreciation allowed (or allowable) is taxed at ordinary rates.
James Maule says that there is no double taxation in this case even though Buffney was taxed once on his wages and then again on his capital gain. What Maule means, of course, is that Buffney’s receipt of wages in 2011 are one taxable event and his receipt of proceeds from the sale of a capital asset in 2015 are another taxable event.
Maule correctly points out that because the tax code permits Buffney to reduce his gain from the sale of his condominium by the amount of his investment (i.e. his basis) in the sold property he is only being taxed the second time on the additional income he received due to the appreciation of the condominium. There is no double taxation because it is different income that is being taxed the second time.
Of course, some of Buffney’s appreciation is due to inflation. How much inflation depends on a number of factors, not the least of which is the state of the economy. But if we assume an annual rate of inflation of 3%, then $4,500 (3% x 50,000 x 3) should be taxed at zero percent because it represents no gain at all. Consequently, when inflation is considered, Buffney’s real gain is $44,500 and the downward inflation adjustment bumps his effective tax rate up to 19.55% as follows:
$8,700 / 44,500 = 19.55%
Maule is correct that there is no double-taxation as that term is generally understood, but the fact that there is no double taxation does not undermine the rationale for lower capital gains rates.
Let me explain.
Had Buffney, instead of investing $50,000 in an appreciating capital asset, merely socked that money away in a savings account, even though his effective tax rate would have been higher, he would have paid less tax than he paid in the above hypothetical:
|
With Cap Gain |
Without Cap Gain |
|
| Ordinary Tax 2011 |
20,000 |
20,000 |
| Cap Gain 2015 |
8,700 |
0 |
| Total Tax |
28,700 |
20,000 |
The above table shows that Buffney’s risk pays off to the advantage of everyone. The economy is better off, Buffney is better off, and the government is $8,700 richer.
Now, you would think that this outcome would make big-government liberals happy, but, sadly, it doesn’t. And why doesn’t it? Because they are blinded by the part where Buffney is better off. These folks simply cannot abide a rich man getting richer, even if it is good for the economy… and the uber-bureaucracy they so passionately love.
In any event, I hope you can now better appreciate why capital gains are taxed at a lower rate than ordinary income. The goal is to give people who have money a sufficient enough incentive to take risks and invest it rather than hoard it.
Anti-rich progressives, instead of looking at the benefits of reduced capital gains rates, focus only on the symbolic negatives: The rich are getting a tax break that is unavailable to the poor. Because they are fixated on income and wealth inequality, they cannot see the forest for the trees. The preferred capital gains rate is designed to favor those with money for the simple and obvious fact that people who don’t have money cannot invest in capital assets.
We, as a nation, want to favor investments in capital assets because those investments mean more jobs and more money circulated in the economy. And remember, because the value of a capital asset might decline rather than increase, investors are taking a risk when they invest in capital assets. If investors stop taking these risks, our economy will tank.
Finally, the reduced capital gains rate isn’t free. In exchange for it, investors are only permitted to deduct their capital losses to the extent of their capital gains plus $3,000. The reason for this limtation is sound and consistent with the overall purpose of favoring capital gains: We want to reward investors for making sound, economically substantive investment decisions rather than ones that are motivated solely, or even primarily, by tax benefits.
To reiterate, isn’t it better for the economy and the government to have a Buffney who pays $20,000 + $8,700 in taxes than to have a Buffney who only pays $20,000 in taxes, even if the former Buffney’s effective tax rate is less than the latter Buffney’s?
Of course it is, but truth matters little to those who see the price of everything and the value of nothing.
13 responses so far ↓
1 Allan // Feb 10, 2012 at 4:45 pm
Bah.
While it is true that the government would be better with $8,700 than nothing, the argument is silly. I would agree that the investor gets screwed by inflation, but all investors and lenders do at some point or another. On the other hand, if there is deflation, the investors and lenders are better off.
First, Buffney would have had to put the money in a non-interest bearing savings account to get 0 ROI. That would not happen. Given your example, only if the interest paid was 25% (simple interest) would saving be better for Buffney.
Second, if Buffney put his money into an interest bearing savings account, it would do just as much for the economy as investing himself (as the bank would invest or loan to someone else to invest in his stead).
Third, Buffney is clearly better off with the extra $40,000 or so in his pocket, than if he had not invested at all.
Fourth, assuming that Buffney would invest or put the money into some sort of savings account (I don’t think he would hide it under his mattress), is the $50,000 that his MONEY earned any more valuable to the economy than $50,000 of SERVICES provided by the average Joe? I don’t think so. In fact, I would rather, in the long run, have Joe get the money because Joe is more likely to buy stuff from me than Mr. Billionare Buffney. And I can take that money and invest it in making more stuff.
In sum, no matter whether the capital gains tax is more or less, Buffney will invest in what he invests in, so long as he makes more investing that he would not investing. And, unless the tax is 100%, that will always be the case.
2 Peter // Feb 10, 2012 at 6:08 pm
Allan,
The greater the risk the greater the potential return. Had Buffney done something conservative with the money (like putting into a bank account and earning 3, 4 or even 10%) there would have been less of a return to be taxed.
Also, as I pointed out, the downside risk of capital investments does not come with any tax benefits (i.e. its limited to 3k per year unless you have cap gains).
And it’s not the 50k that Buffney earned that is valuable, its how he earned it that is valuable. And yes, capital investment, is more valuable than socking the money away in a bank account. We give incentives to people with money because we want them to take calculated risks. This is how the economy grows and is one of the reasons why most of the great advancements in science, technology and medicine have happened right here in America. We value risk taking.
Finally, I am not sure you understand basic economics and risk/reward analysis. If a thing costs more to do, a person is less likely to do it, all other things being equal. This is Econ 101. The cost of capital investment is higher if the tax rate is higher, therefore, fewer people will choose to make capital investments.
3 allan // Feb 10, 2012 at 7:35 pm
Of course I understand the risk/reward analysis.
I agree that the greater the reward and the less the risk, the more likely one is to invest. Taxes have to be computed into the equation, for the lower the tax, the greater the potential reward if there is a gain.
But that is neither here nor there. If the cost of the condo investment is $50,000 with a tax rate of X%, the cost will go up or down depending on whether X goes up or down.
My question to you is: if Buffney does not invest his money, what will he do with it? Even putting it in the bank is ok by me.
I do not think that the investment is worth more to society than the labor. They should be taxed at the same rate. Income is income is income.
The bottom line is that Buffney will invest in prudent products whether capital gains are taxed less than labor or not. The rates just affect the risks that the investor will take.
My original point still stands: if Buffney has money, the government and Buffney will benefit, unless he hides it under his mattress.
4 Peter // Feb 11, 2012 at 9:35 am
Allan,
And don’t forget, the other reason we give tax preferences to capital investment is because money invested in capital assets is more likely to expand the economy and increase employment than money that is merely hoarded or saved. Some even think we should make the cap gain rate zero on this account.
5 allan // Feb 11, 2012 at 11:20 am
Peter,
Your last comment makes the argument for lower taxes in general. The same theory applies to labor as to capital investment. At least that is what Ayn Rand wrote about… But, people can go Galt, money cannot.
I believe that you should look at the Laffer curve. I think we are to the left on the x-axis of the curve from the peak. If that is the case, we should raise taxes. Do you think we are on the right of the peak? Or do you think we are to the left of the peak and we should go even further left because government is spending too much?
In any case, nothing you say or have said has convince me that having capital gains tax rates lower than tax rates for other income is good policy. The only thing I hear from you is that low capital gains tax rates are good. You never touch the other half of the equation. But without doing that, you only have half an argument.
The bottom line is that tax rates as a whole are too low. We know that, because we have a deficit. Trying to get tax rates right without figuring out how much tax revenues we need is like saying “I am giving you X gallons of gas and a car, get from LA to NYC”. You arguments do not address the number of gallons or the gas mileage. Instead, you want to change the distance. Good luck with that.
6 Peter // Feb 12, 2012 at 11:06 am
Allan.
You say:
“We know that [tax rates are too low] because we have a deficit.”
I say:
“We know that spending is too high because we have a deficit.”
Also, it is possible to lower tax rates, expand the economy and thereby increase tax revenue.
7 allan // Feb 12, 2012 at 12:08 pm
Ok. I will go with what you say, “spending is too high”.
Your platform, therefore, should be “reduce spending.” It is not, it is “reduce taxes.” I find your platform unpersuasive.
8 Peter // Feb 12, 2012 at 9:28 pm
Allan,
No, it’s reduce spending and don’t raise taxes.
9 allan // Feb 13, 2012 at 1:34 am
Fine.
How would you reduce spending so we don’t raise taxes? And, by the way, you have to persuade 50% +1 to do it, otherwise, it won’t work. Neither George Bush could not do it. Obama could not do it. Reagan could not do it. Carter could not do it. Nixon, Johnson, and Kennedy could not do it. Neither could Eisenhower, Truman, or Roosevelt. And Hoover, well….
That leaves Clinton. You must have liked that guy.
Once we get to the point that we have spending less than revenues, I look forward to hearing how best to lower taxes.
10 Peter // Feb 13, 2012 at 11:41 am
Allan,
Naturally, people favor higher taxes when they themselves don’t have to pay them. So it’s hardly surprsing that the 99% would like to see 1% pay more taxes. The left knows that fanning the flames of class-warfare is effective. Chavez did it. Castro did it. Stalin did it. Mao did it. And it may very well “work” here.
This is the reason the left always attacks and belittles the notion of the American Dream. As long as the poor and the middle class believe that they, too, can succeed and become rich, the left will have a hard time convincing them that the rich are gaming the system and cheating them out of what is rightfully theirs.
In short, the left must convince people that they are helpless and cannot succeed because middle-aged, rich white men are keeping them down.
11 Allan // Feb 13, 2012 at 12:31 pm
I do not favor higher taxes because I will not pay them. I am in or very close to the 1%.
What I favor is fiscal solvency.
You seem to be in favor of having the poor and middle class “believe” they, too, can succeed. Even if it is not true. That, my friend is propaganda.
I do support policies that tax high earners more and lower earners less. I do not do this because I want to provide more wealth transfer (although that may be the case). I do that because our economy is driven by the demand of the middle class. The stronger the middle class, the stronger the country. If that means taxing the wealthiest among us more, so be it.
Give me a policy that will strengthen the middle class AND lower the tax rates for the 1% and I will likely support it.
12 Peter // Feb 13, 2012 at 2:40 pm
Allan,
It is true that the poor and the middle class can succeed, but only if they stop blaming others for their bad choices. That they can’t succeed unless rich white people stop screwing them over is, my friends, propaganda.
13 Gabriel // Feb 16, 2012 at 7:54 pm
Consider the example of my employer, for example. Is it not true that employees who receive bonus checks from their employers are also being double taxed? I worked in a physician’s office for 2 years and receive bonus checks at the end of both years. The federal government technically shouldn’t be taxing that income because it came from his profits.
Secondly, your argument for spending cuts is weak. There is no confusion where the majority of the budget goes. A good 70-75% of our current budget is spent on three line items. These things are here to stay, and nobody is going to alter those benefits. The rest of the budget is spent on EVERYTHING else. How in the world are you going to put a serious dent in the budget by cutting anything? Personally, I think the solution is to lower corporate taxes or eliminate them altogether and tax capital gains and dividends as regular income, and increase the top rate to 40% or even 50%. Dude, the rate used to be 70% as late as 1980 and even higher during previous years? Was the federal government made up of morons to tax rich people at so high a rate? Even Ronald Reagan realized his mistake in 1986 and decided to tax gains as income. Its the only solution for real growth.
Leave a Comment