Orthodox thinking argues that a low capital gains tax is justified by three reasons: 1) it encourages investment in us markets by foreigners and us citizens 2) since corporations are already taxed, a high capital gains tax would be double taxation, and 3) It encourages long term holdings of financial assets and discourages short term speculation. However, while each of these justifications have some validity, they also fail to consider significant exceptions. 1) Foreigners invest in us markets because of the high level of liquify and transparency of our markets. A higher capital gains tax would not change this. Furthermore, with a higher capital gains tax, the income tax or national debt could be lowered, placing the us economy on a firming foundation, which would serve to encourage investment far more than the free money being given to those who are already wealthy and capital rich. In addition, lower domestic income tax, or a lower expectation of future taxation would free up additional capital which would likely be reinvested into the capital markets, more than making up for the loss in investment that would occur days to a higher tax. 2) while the argument that capital gains taxes are a double taxation since corporations are already taxed on their profits, most capital gains occur from asset appreciation, or increase in the paper value of the financial asset. The increase in paper values are based upon expectation of future earnings and not present profits which have already been taxed. Thus, when a investor sells their stocks for a profit, those profits have not been taxed yet since the future earnings which produced the capital gains also have not been taxed, making the double taxation argument spurious except the case of a dividend distribution of current profits. 3) a higher capital gains tax, which is still lower than the short term capital gains tax, would encourage investors to hold their investments even longer, since taxes are not assessed until these investments are sold. It is better to hold an investment for 20 years than 10 years if taxes are higher, assuming asset prices increase for every given year (perhaps an unsound assumption, but one made by policy makers and investment professionals like). Unfortunately neither party seems willing to raise the capital gains tax for political, rather than social or economic reasons.
Before discussing the politics of the capital gains tax, and some potential fiscal and social solutions a higher capital gains tax might offer, consider the primary forms of taxation exercised by the public sector, both explicit and implicit. The most obvious form of taxation is the so-called progressive income tax, first implemented in the dawn of the twentieth century, when industrialist were amassing fortunes by borrowing foreign capital to build monopolies of every which way. The progressive income tax is so named because it supposedly achieves the aims of so called progressives in maintaining social equity. It may also be so named because the tax get progressively higher as a workers salary increases. The key word here is a worker's salary, since those who are already wealthy can easily avoid the progressive tax by reporting the vast majority of their income as a capital gain, which is only taxed at a maximum of 15%. Thus, for a person of meager means and no accumulated capital, the progressive tax only serves to make it more difficult for the enterprising, but still capital poor individual from making it big. Every time they want to reinvest their earnings, they get hit with a tax up to 35% of every additional dollar they make. Contrast this with the wealthy individual who simply puts the capital he or she has already accumulated into investments: stocks, bonds, etfs, gold, oil, soybeans. These already wealthy individuals only pay a maximum of 15% of their earnings. furthermore, considering the majority of wealth creation in the last 10 years has been redistribute rather than accumulating, based on the ratio of net worth of the lowest quartile of the population to the highest quartile of the population, and that the majority of this redistributed wealth was created by the financial industry, which has fought tooth and nail to preserve the carried interest method of accounting for their labor, the already wealthy have not been paying any progressive taxes, while the middle class, yet again have been gutted by the public tax policies. A wealthy hedge fund owner and operator is only liable for 15% capital gains no matter how much money they make, whether hundreds of thousands of hundreds of millions. However, a hardworking and enterprising individual who starts a small to medium size business is liable for both a tax on their business at the progressive rates, as well as a personal income tax. This is neither progressive (socially), nor economically efficient, since the hedge fund owners are neither conducting any economically productive activities which contribute to the real economy, though they accumulate and lock away more capital out of general circulation in the economy, except for luxury goods and high end real estate, while the enterprising entrepreneur who actually creates real economic activity and jobs which increase the level of innovative human capital and physical capital in the economy faces 35% barriers in reinvesting his or her profits. Further, though he bears a higher relative proportion of taxes than his financially innovative brethren, the financial innovator (good gambler) get the majority of government support when their business models fail, which they have failed, time and time again, the latest being the bailouts which have been continuing worldwide for over two years now. How is it progressive to make it more difficult for those who start with nothing but their human capital to deploy the financial capital they earn through hard labor, while protecting those who already have accumulated vast amounts of wealth and continue to do so simply by pressing buttons on a keyboard wagering on the next big thing created by the small entrepreneur, with the full knowledge that they will be bailed out if their bets go horribly wrong,and that they get to keep all the money they made from other peoples savings even if they lose more than they made anyhow? This is not a free market, but a welfare state for the wealthy. How does this contribute to growth in the real economy?
Add on top of this the social security tax, the most regressive of all taxes which achieves progressive aims where workers must pay 12.5% of their wages to pay for the retired population easy lifestyles? To add insult to injury, a cap on this tax occurs at a relatively low dollar amount so that the wealthy do no have to worry about this tax, despite the significant benefits they accrue from the social safety net provided to their workers. Without this safety net, most industrialist would find themselves faced with greater labor demands, higher pension costs, and possibly a even more poorly educated work force, since many progressive researches have linked higher expenditures on education to higher expenditures of social security.
Next, the sales tax, which is so obviously regressive, it does not need too much explanation, since lower and middle class individuals spend a higher amount of their income and wealth on consumables than wealthy individuals who put most of their money into stocks and bonds, and other financial products, which may face a .1% transaction tax at most. Income from this product,as previously expounded upon is taxed as if these individuals were barely above the poverty line.
So does the tea party and republican party tax policies make any more sense than the progressive democrats policies? Stupid questions need not be answered, but let us explore the implicit taxation which republican tax policies force upon the society. Republicans generally agree with the capital gains scheme since lower taxes are always better. Furthermore, they want to lower income taxes on everyone, but mainly those who have high incomes. So in these respects, the only difference in current tax policy between republicans and democrats is who gets to have lower income taxes. Yet they both operate within the same taxation scheme and neither provide any innovative solutions, though there is the so called flat tax, which will never be adopted. So republicans espouse fiscal responsibility, except when it comes to keep the welfare state for large and wealthy organizations and individuals. To maintain this system while also lowering taxes, the only solution is deficit spending, a la Reganomics. The result of this is that more government debt has to be issued, which theoretically will Be paid off by the wealth which their policies create. Republicans frequently point to the success of the 80s despite the fact the wealth of the eighties was largely a result of the severe policies implement by Paul volkere, chairman of the federal reserve board, as well as the collapse of the soviet union which opened vast markets for American capital while also reducing the need for military expenditures. The massive debt piled on by the replublicans in the eighties and the republicans in the new millennium has exceeded all previous accumulation of debt, when compared to the past, except during ww2. Some might say that the current democratic administration has piled on more debt than all the republicans combined, though the republicans bear at least half the responsibility for this since the financial crash developed and occurred on their watch, which necessitated the massive increase in debt over the last two years. However, no one seriously expects that this debt will ever be paid off through taxing future generations. In fact it is already being paid off by the quantitative easing (ie inflation) created by the federal reserve. Inflation hits those without inflation adjusted income, such as social security, real estate, and to lesser degree, financial assets. Those who pay the most for inflation, again, are those who are just getting started in life, who spend the majority of their income on serving loans such as student loans, whose rates are now over 5%, and consuming food and energy, which has risen steadily despite the so called deflation of recent years. It hits those who want to buy a house since home prices increase with inflation. So again, this tax is regressive in that it takes money away from the middle class, to the benefit of the entitled poor and rich. Locking out those who might achieve the american dream with even greater financial burdens than the progressive scheme of taxation would while simultaneously burdening future generations with greater uncertainty about interest and tax rates.
An increase in the capital gains tax would be the only truly progressive scheme of taxation since it does not enact barriers to the middle class from achieving financial freedom, does not increase the burden of taxation on the poor, and does not discourage hard work which contributes to the development of the real economy and the concomitant improvement in human capital. Furthermore, it preserves the sanctity of private property which is one of the pillars of our constitutional democracy, while also promoting social equity without gutting those in the middle class who hope to achieve the American dream.
The theme being developed in this essay thus far is that both parties have enacted tax schemes which punish hard working, middle class individuals while protecting the already wealthy and the entitled poor. Hence the pervasive theme of the gutting of the middle class , which everyone seems to talk about as their primary concern, but no one actually addresses. Republicans give the middle class more money in their pockets by lowering taxes, only to take it away with inflation, while democrats make it more difficult for the middle class to achieve financial freedom, while refusing to change policies which makes it easy for their already wealthy old money supporter to make even more money and secure even more political influence by locking out aspirants except those whose interests are already aligned with their: the captains of American finance and the publicly traded entities they own.
Both parties have no interest in increasing the capital gains tax. A brief survey of the political economy of both parties serve to show why the cards are stacked against the middle class, and why voters have shunned democrats, who supposedly represent the common man for republicans, who supposedly espouse fiscal responsibility. The majority of big donors to the democratic party are individuals who have already made their money or old money, while democratic partisans typically come from upper middle class backgrounds with little exposure to the free market and little understanding of economics beyond the college level courses they took since most have taken jobs in public service or non profit sectors or with the command style bureaucracies ofmso called private profit seeking corporations. Republicans are often upstart business people who chase after wealth and emphasize family and individuals over society. However the big donors are more likely new money, and thus, they find the progressive tax laws onerous since it impeded them from getting as rich as the old money. They also resent paying for those who did not struggle upwards as they believe they did, despite the fact that their success rested on the foundation of a well educated and socially secure workforce upon whom they depended. Neither party can alienate their big donors or their partisans and so economic, social and political stagnation occurs.
I focus my criticism on democrats and progressives in the hope that the democratic party is more reasonable and responsible than the republican party, though thus far my biased view has been proven unfounded. With both parties beholden to the captains of finance, an increase in the capital gains tax and a repeal of the carried interest loophole seems unlikely. I will not even bother to try to convince the republicans for now, but I hope they will also consider my critique, as without major reform of one or both parties, a third party will undoubtably emerge which will sweep away the extremist on both left and right. After all 50% of the electorate do not vote, not because they are lazy or uneducated, but because they have seen the policies of both parties represent mainly the interest of the parties rather than the general welfare.
While some may cheer a revolution of sorts, the real danger exists that the instability brought on by an overturning of the political order may bring more losses as a whole than gains. History is the surest indicator of this likely outcome. The historians of both parties, should surely take note and encourage their leaders to reform before it is too late to avoid an imminent political collapse.
- Some Quotes from "An inquiry Into the Permanent Cause of the Decline and Fall of Powerful and Wealthy Nations" (1814)
- Debt And Revolution: Fed Save Us All
- The Audacity of Economists
- Economic Theory: Tax Rate Mythologies
- RAND Survey Shows That Voters See Little Difference Between Candidates On Ideology