Taxing Capital Gains As Ordinary Income

-Submitted by David Drumm (Nal), Guest Blogger

When politicians frame the debate on taxes, higher income taxes on the wealthy are always preceded by the descriptor “job-crushing” and lower capital gains taxes “encourage investment.” Investment is often used as the justification for a tax rate of 15% on capital gains, monies from the sale of stock, and dividends, which are now included in the 15% bracket. For the wealthy, those making $379,150 and above, ordinary income is taxed at 35%.

Is this “investment” justification backed by the data?

The above graph shows the capital gains tax rate in red. Real business investment is plotted in blue. The figure shows a lack of correlation between the bouncing red line and the steadily increasing blue line. High capital gains tax rates don’t discourage investment and low capital gains tax rates don’t encourage investment. As Warren Buffett said:

I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off.

Another argument used for low capital gains tax rates is that many middle-class investors are benefited by the lower rates.  However, figures show that 70% of the benefits of capital gains tax cuts go the richest 1%. The poorest 60% of Americans get only 2% of the benefits. In reality most of the middle-class investment in stocks is in the form of 401 (k) plans that are tax deferred until retirement. At retirement, they are taxed as “ordinary income,” and don’t benefit from the tax cuts for capital gains and dividends.

But, wait. Aren’t corporate profits taxed twice, once as corporate income and then again as dividends? It’s hard enough to get corporations to pay tax once let alone twice. Two-thirds of all dividends are paid out to tax-free entities such as pension plans and other retirement vehicles. The logic of the “double tax” argument should also apply ordinary income that is taxed again when purchases are subject to sales taxes. Ordinary wage earners get taxed twice when their wages are taxed for FICA and the same wages are taxed as federal income.

It’s time to tax the non-workers the same as the workers.

H/T: Kevin Drum, Jared Bernstein, Citizens for Tax Justice, The Seattle Times.

40 thoughts on “Taxing Capital Gains As Ordinary Income”

  1. puzzling:

    if you are a paid troll, how can I get in touch with your employer? I am doing this for free right now and would love to get paid to promote economic and political freedom.

    It is a poverty of argument when someone such as yourself, a person with a long history of promoting political and economic freedom on this blog, is called a paid troll. If that is the opponents of freedom only retort I guess things are moving along in the right direction.

  2. Frankly,

    Global competition for capital isn’t static. The US doesn’t write the tax code throughout Asia. This isn’t 1995.

  3. so P, you are saying that the obscene tax rates of the 90s killed all economic growth while the great rates Boy Blunder instituted resulted in unprecedented growth? You really want to try to sell that smelly line of bullshit to people over age 12 who have a brain & can remember further back than last month?

    Please try again, but next time try to incorporate the real world into your masturbatory fantasies.

  4. So let me get this right: It’s 1991 and I invest $10,000 in a stock, only to sell 20 years later in 2011 for $20,000, a 100% gain subject to ordinary income tax.

    In this scenario I am taxed on $10K at ordinary income rates, say 33% or $3300.

    Although it looks like I have a $6700 gain, I actually lose on this transaction. The $10K adjusted for inflation into 2012 is the equivalent of $16,700, and I haven’t included state or local taxes in the calculus. In purchasing power I come out behind.

    Not only will increases in capital gains taxes push investment overseas, it will encourage even more domestic consumption rather than savings thereby also reducing capital available for growth. Instead we should be talking about elimination of the capital gains tax to encourage growth and entrepreneurship, eliminating double and triple taxation and restoring some level of global parity for the US tax code.

  5. Raising capital gains taxes will simply shift capital investment overseas to friendlier tax venues. Higher taxes will slow corporate growth in the US, reduce overall government revenues, and continue the trend of jobs moving overseas.

  6. Has anyone noticed the apparent lack of trolls over the weekend? I fully expected an extended lecture from Klownderosa and GiGi on this topic. I looked back & they disappear over weekends.

    I half way joke that they are paid trolls from the RNC or similar radical anti-American league but this makes me think it is not a joke & they just punch a time clock.

  7. For all the talk about “builders”, “productive people”, etc., entrepreneurial activity increasingly is all about buying and selling stuff rather than creating capital. just look at Romney. he bought and sold companies and they tended to just go bankrupt. the strategies used to “unlock value” tend to involve forcing out experienced (expensive) people with little thought to the functional efficiency and productivity of the organizations involved. In guarantees that once the short-term economies are wrung-out that a business becomes vulnerable to failure. Even a great satan like Bill Gates creates something of value, even if it’s often a highly flawed product or lacking in real innovation. The argument that tax breaks should go to “builders” should be turned around to raise taxes on people who are mere wheeler dealers.

  8. Interesting presentation and a valid point that capital gains should be taxed as ordinary income. However, in an unstable monetary environment (usually inflation) what should be taxed is the capital gain in ***real dollars***. So adjust the basis of a long-term asset by the ratio of CPI at sale to CPI at purchase, compute adjusted gains, and tax at the appropriate progressive ordinary income rate. Net out all short-term gains and losses, including “carried interest”, and tax as ordinary income.

  9. Great article David. The facts never get in the way of the Right as they continue to rape the poor and middle class. When will the people who are not in the top 5% realize that these policies are not doing anything for them or for the country?

  10. If the wealthy don’t want to pay higher taxes then they must convince the government to stop waging war.

  11. “During the negotiations regarding raising the nation’s debt ceiling, congressional Republicans have gone to the mat to defend all manner of unwarranted tax breaks, including those for oil companies and corporate jet owners. Despite the drain on the Treasury caused by these tax breaks — and the negligible benefit they provide — Republicans have threatened to allow the nation to default on its obligations rather than abandon them.”

    And the working Man/Woman they want to take this,and no kiss.

    GOP takes unusual tack, rips tax cut as wasteful

    WASHINGTON • In a turning of the tax policy tables, Democrats are increasingly hammering Republicans who oppose President Barack Obama’s proposal to extend for a year a payroll tax cut passed last year with bipartisan support.

    Read more:

  12. it is just further devaluation of labor. People who ‘work for a living’ are just not as useful or valued as those who move money around to no good end. Heaven forefend you get your hand dirty. Todays so-called ‘makers’ make nothing but markets, they are not Ford or Edison or Carnegie. Instead they really are takers, using the labor of others (often investing the money their grandfathers or fathers made) to fund bullshit like credit default swaps that add value to nothing but their bottom line. They suck money out of the system.

    While I do believe there should be a tax rate that recognizes the risk of long-term investing it has gotten to be just another give away for the top couple of percent and an indication that actual work is not as valued.

  13. How about taxing the managers of hedge funds at the same rate as regular folks?

    Closing The Hedge Fund Manager Tax Loophole Would Raise $4 Billion Annually From The 25 Richest Managers
    By Pat Garofalo on Jul 6, 2011

    During the negotiations regarding raising the nation’s debt ceiling, congressional Republicans have gone to the mat to defend all manner of unwarranted tax breaks, including those for oil companies and corporate jet owners. Despite the drain on the Treasury caused by these tax breaks — and the negligible benefit they provide — Republicans have threatened to allow the nation to default on its obligations rather than abandon them.

    One of the tax breaks upon which President Obama has focused is a provision that allows hedge fund managers — who make billions annually — to receive a substantial tax break. This particular tax break, known as the carried-interest loophole, allows hedge fund managers to treat the money they receive from investors as capital gains, subject to a 15 percent tax rate. Though this money is a paycheck received for services, just like a movie star receiving a bonus if her movie does well, it’s treated as investment income.

    Since hedge fund managers are some of the richest people in the country, this tax break actually causes a significant loss of revenue. In fact, according to calculation by RJ Eskow, closing this loophole would raise more than $4 billion per year just from the 25 richest hedge fund managers:

    The top 25 hedge fund managers in the United States collectively earned $22 billion last year, and yet they have their own cushy set of tax rules. If they operated under the same rules that apply to other people — police officers, for example, or teachers — the country could cut its national deficit by as much as $44 billion in the next ten years.

    That may seem like a lot of revenue to raise from just a few people, but it’s simply what would happen if the income hedge fund managers receive to manage other people’s money was treated the same as income earned by other workers. It would take the combined income of 441,000 middle-class families to equal the income made by just the 25 richest hedge fund managers. The top hedge fund manager at the moment, John Paulson, makes more hourly than most Americans will earn in a lifetime, while paying a lower tax rate. This is an egregious loophole, but the GOP refuses to consider it as part of a deal to avoid default and an economic catastrophe.

  14. I seem to recall that years ago, capital gains were taxed as ordinary income unless they were “long term” investments — over a year.

    Now, with computer trading, a stock may be held for only a fraction of a second. This is not investing, it’s simply churning the pot. How could someone get any information on the value of a company in such cases.

    I would accept a very small tax incentive to hold stocks, bonds, etc. for over a year. This would require investors to committing to the growth of a company.

    Also, a small transaction tax would slow the computer-driven trading.

  15. Warren Buffet has apparently made a lot of investment decisions in his course of life…I bet he has better experience in this field than the rest…Ok, so he has a fortune..So, why not listen to sage advice….Thanks nal…

Comments are closed.