Wednesday, September 5, 2012

Responses to the Capital Gains Tax Question

In a follow-up to my prior post, three of the other Energion roundtable participants have posted answers regarding capital gains and whether they should be raised or lowered or perhaps eliminated entirely.

Elgin Hushbeck posted Roundtable Question 3: Capital GainsTaxes and took a very similar position to mine and no surprise I didn't find much to quibble about. Elgin writes:

From my perspective, this is pretty easy. It should be at a minimum lowered significantly, with serious consideration being given to eliminating it all together.   This is because economic growth requires investment, and investment, as the legalese of many financial commercials make clear, involves risk and the past performance is not indicative of future results.  It is the threat of loss that makes capital gains income different than regular wages and salary income. 

Elgin is correct that taxing investment discourages investing and risk taking, the very sort of activities that are necessary for job growth and a healthy economy. He also raises the question, what is the purpose of taxation and how does that fit into our general culture?

In a pretty radically different persepctive, Bob Cornwall responds with his post Is the Capital Gains Tax Fair and Just? -- EnergionPolitical Roundable. Bob looks at the issue of taxes in general as a necessary function of government, something none of us would argue with but then gets more specific about the capital gains tax question...

So, what about the Capital Gains tax?   Since it applies largely to the profits made on the sale of stocks, mutual funds, or property, this tax likely will not hit the poorer among us as hard.  It places a greater burden on those most able to pay.  It should be noted that many of the wealthiest among us derive much of their income from the sale of stock and stock options, which is unearned income. This is why Mitt Romney’s effective tax rate is lower than most people who earn their living with a job – and with capital gains taxes, you’re able to balance gains with losses – selling enough stock at a loss to reduce tax liability.      

Can we make this particular tax fairer than it currently is?  Could a compromise be reached so that the tax is eliminated for those making under $200,000, while we raise it for those above a certain rate?   Such an idea might remove the burden from the many seniors who live off their savings, stocks, and property.

Bob clearly looks at the tax system quite differently than I do. Issues of "justice" and "fairness" creep into the conversation and that makes our tax system a means for more than simply raises revenue and into a system to rectify perceived social injustice by taxing the "rich" more highly for the benefit of the poor. Bob's idea of further skewing the capital gains tax by increasing it on those earning above a certain threshold and lowering or eliminating it certainly would be great political fodder but again is targeting those who invest and produce.

A third entry comes from Joel Watts Energion Roundtable:Capital Gains Tax. I am not really sure what he is advocating for to be honest. He was quite clear about his disdain for "Reaganomics" and Republicans in general but I am unclear as to his position on capital gains taxation:

So, now… for the question of capital gains. First, I think “work” should not be taxed. No income tax. No corporation tax. I believe in a progressive flat tax. In other words, no tax on food and the bare necessities of life, at least on the Federal and higher State level. Capital gains, the tax you pay when you sell imaginary pieces of paper, seems just as imaginary, but without a flat tax, one must tax things otherwise not worth taxing. I guess I view capital gains taxes like taking a census for imaginary friends. Our economy is too tied to Wall Street (imaginary capital) and not Main Street (production). I also do not believe in double taxation, something capital gains does.

But, what about selling real estate? Or actual product. Without a flat tax, you have to secure a method of raising money, and the people who have the most taxable money are those with product to sell. We need to shift capital gains out of Wall Street, limit the money traded on Wall Street (can of worms there), and tax actual product. If we could, I would limit all capital gained from Wall Street and other stocks to refocus the money into actual production.

I would take umbrage at the idea that these are imaginary transactions. Someone who owns a share of General Motors is a partial owner of a company that owns and operates hundreds of facilities, that moves untold millions in inventory and employs tens of thousands of people. That is not "imaginary", that is real life. Without villainous Wall Street brokers it would be impossible to raise the capital needed to invest in companies that make the products we use. To be blunt I don't think Joel really understands what capital gains are. He does recognize that they are a form of double taxation but given his desire to eliminate income taxes, consumption taxes on "bare necessities" and apparently also capital gains taxes, I am not sure where the tax revenue to run the government is supposed to come from.

The capital gains tax issue is a complicated one and requires some fundamental understanding of investments, capital markets and how corporate America functions. As I said in my original post taxing capital gains is easy political rhetoric because few people understand what they are other than something that only impacts "rich" people.

I was glad to see that the discussion has somewhat evolved beyond just capital gains taxes and into tax policy more broadly. There are two distinct positions here. One, is that capital gains taxes and taxes in general should be as simple and low as possible so they do as little as possible to hamper economic growth. The other is "Well the rich can afford to pay more and still be rich". That is true and entirely not the point. It doesn't follow that because someone can pay more that they should pay more. Imagine if you went into a store and at the check out they asked to see you tax returns. If you made $25,000 a year, a box of Cap'n Crunch is $0.75 but if you made $100,000 the prior year you would be expected to pay $7.56. That would be ridiculous but that is sort of what the mindset is regarding capital gains taxes.

The reason the Federal government has a taxing function is quite clear and limited in purpose. In Article I., section 8 of the Constitution we see the power of taxation.

The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;

It is hard to look at that paragraph without assuming our current tax system into it. The level of taxation we have today would be unthinkable to the Founders, as would the various government bureaucracies, the incredible volume of regulations, the enormous standing military and the state of perpetual indebtedness but those are questions for a different day. I for one am not content to simply tinker around the edges of the tax system and instead would rather burn it down and replace it with something that is simpler and more consistent. It is an untenable situation in a culture to have almost half of tax payers paying no Federal income tax and a tiny percentage of the top wage earners paying nearly half of all Federal income tax receipts. As Elgin wrote in his post: " of the greatest dangers in a democratic form of government is the ability of the majority to impose tax burdens on a minority, burdens that they do not share themselves." When a society devolves into two camps, payers and takers, we have a problem. Many people vote for candidates without having any skin the game but there comes a point where we will run out of money to take while never running out of people willing to receive.

The power to tax is intended to pay our debts (at this time incurred from borrowing to fund the Revolution, we had not yet started borrowing money to fund all of the other functions usurped by the Federal government) as well as to provide for the "common Defence" and "general Welfare". What exactly the "general Welfare" means is shown in the following lines of Article I section 8. Mostly we see issues having to do with the army and the navy, immigration laws, printing the common currency, patent laws, post offices and post roads for the carrying of mail and other very limited functions. Crop subsidies, food stamps, unemployment benefits, medical insurance, a standing military based overseas, etc. are nowhere in sight.

What does our tax system pay for today? First and foremost the behemoth of the Federal bureaucracy full of Dept of Ag employees who have never been on a farm and Dept of Education employees who have never taught in a classroom. The sheer number of Federal employees is incredible Second, it funds a standing military that is unmatched anywhere in the world. Sure other nations have more men in uniform but no one is a serious threat to the U.S. Our military is the finest in the world by a wide margin and we have the annual spending to show for it.

Our tax system was created to fund very basic functions of the Federal government that couldn't be effectively managed by the states. It was not intended to be a mechanism to take from the rich and give to the poor, a mechanism that has, rather than lifting people up, instead imprisoned millions into a system of multigenerational poverty. The weight of government spending, taxation and borrowing is an anchor on the economy and with the national debt at $16,000,000,000,000 and rising it is clear that neo-Keynesian deficit spending to fuel the economy has been a failure. What we need now is less government, government that taxes less, spend far less and regulates less. Rather than shuffling the deck, taking from some to give to others, we should be pursuing a tax policy that removes barriers to investment and risk taking (without the implicit promise of Federal intervention when something goes wrong). The key to a healthy, robust economy is the private sector, not the government, and we had better figure that out before it is too late.
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