Forbes, as Joe Nocera points out this morning, thinks that its list of the 400 richest US billionaires “instills confidence that the American dream is still very much alive.”
That’s because, Forbes says, “Seventy percent of the Forbes 400 members made their fortunes entirely from scratch.” I’m sure none of them had pops fork over some startup capital, but let’s leave that aside.. If the American dream is the ability for a handful of people to grab virtually all of the economic gains of the country and to get so rich you can pay lower tax rates than your maids, then the dream is surely still alive.
Nocera uses the 400, who on average added half a billion in wealth last year, and news on Mitt Romney’s super-low tax rate as pegs to examine why our tax system favors the very wealthiest people. The reason is the long-term capital gains tax, which at 15 percent is less than half the 35 percent top tax rate on labor. Should wealth be taxed less than work? Since most people would say no, the framing has become: Do taxes on wealth discourage investment more than taxes on labor discourage work?
Over at Ezra Klein’s Washington Post Wonkblog, Dylan Matthews argues that “Romney’s tax rate should be low”:
The rationale economists—even liberal ones—give is quite different. Take Emmanuel Saez and Peter Diamond. Saez is best known for the work he’s done with Thomas Piketty detailing the rise in inequality over the last century. Diamond is best known for winning a Nobel prize even as congressional Republicans blocked his appointment to the Federal Reserve’s Board of Governors. All three have advocated marginal tax rates far above those being considered by either Democrats or Republicans right now. And yet, even they think savings and investment income should be taxes at a lower rate.
The basic idea here is that you investing is a form of savings. And economists don’t really want to tax savings, in part because the effects of taxing savings can be a little weird. Saez and Diamond imagine that there’s a 30 percent tax on income, whether or not it’s saved. They then imagine you save that money for 40 years, and earn 5 percent interest every year. If savings weren’t taxed at all, then you could take that money out after 40 years and pay the 30 percent rate. But if the savings were taxed before it was saved and after it’s pulled out, the total rate comes to a staggering 60.6 percent. So there is, in effect, a massive incentive to spend money now rather than save it and spend it later on.
But Matthews is wrong here. First, most of Romney’s income came from capital gains. Those are only taxed on realization, not every year like interest and dividend income are. Saez and Diamond specifically exclude capital gains from the formula in their report (they also exclude 401(k)s and IRAs, the latter of which has shielded much of Romney’s wealth from taxation.
Second, interest income (which was 22 percent of Romney’s 2011 haul) is taxed at the same rate as regular income, not at the lower rate afforded dividends and capital gains.
Third, principal isn’t taxed (at least until you die, and only if your fortune is more than $5 million). What’s taxed is in the income from the principal or the increase in its value. In other words, if I put $1,000 in Widget Corp. shares and I sell them in five years for $1,500, I’m only taxed on the $500 increase. In other words, investors get the benefit of their investment compounding (assuming it goes up) tax-free until they sell it, at which point they pay 15 percent of the gain. It’s true that if your investment goes up at the rate of inflation, you get taxed on that inflation and ultimately lose money, but that’s a separate question.
Finally, most of Romney’s capital gains come from the carried interest loophole (something Matthews doesn’t mention) which lets FIRE partners magically turn their labor income into capital gains for the purposes of slashing their taxes.
It is an axiom of tax policy that you tax more that which you wish to discourage, and less that which you would encourage.
Taxing labor more than capital is a perfect manifestation of favored policy, both by GOP and Dems. Work is smelly and icky. People who work are uncouth and, thankfully, absent from our parties, so we don't have to listen to their boorish whining. I've seen a couple of workers but would not like to spend any time with them--and certainly would not like to encourage that sort of lifestyle.
So, of course, tax that.
DON'T tax dividends and capital gains and carried interest: we want much more of that sort of thing. Isn't that what the "opportunity society" is all about?
#1 Posted by Edward Ericson Jr., CJR on Wed 26 Sep 2012 at 06:10 PM
Ignored in all this capital gains discussion is the fact that capital gains from a retirement account is not taxed at the capital gains rate but as ordinary income. If you have a pre-tax retirement account, your withdrawals, all withdrawals, are taxed at the rates of ordinary income. If you invest in after-tax retirement accounts, the gains are taxed at ordinary income levels.
Sure, the rubes are assured that your income will be lower after retirement when you start withdrawing, and that is true. So if you are one of the lucky duckies whose retirement income is less than $8,700 per annum(single), your retirement nest egg gets taxed at the 10% rate, and you make out like a bandit. If your retirement income is less than $35,350 any income over $8,700 is taxed at 15% the same rate as capital gains, more than Mitt Romney. Then if you have a decent retirement income, anything over $35,350 is taxed at ordinary income rates.
(Of course, if you are in the 10 and 15% bracket, you are not liable for actual capital gains tax on your private investments, but you *are* for your retirement account investments.)
I get a rationale that your pretax contributions is taxed at ordinary income levels, but why are the capital gains on your retirement investments taxed at ordinary income levels? Because, I imagine, that the rubes don't have lobbyists working in Washington, and plus, you don't really *get* the difference until it becomes important, i.e., after you retire.
It's a big racket foisted upon the rubes, with fund managers making out like the bandits that they are. Why don't retirement funds accrue as much capital gains as other investment funds? They generally don't even track index funds. But you are kind of stuck, because defined benefit is pretty much a thing of the past, and with defined contribution, the boss and the fund managers pretty much have you by the short hairs. But you don't know what a dupe you are until after you retire.
(note: I may have some of these details wrong, IANATA, but I think I have the basics right.)
#2 Posted by James, CJR on Wed 26 Sep 2012 at 10:11 PM
The argument behind the argument is that capital is a limiting resource. This has not been the case for a long, long time.
If you pick up the Wall St. Journal and read the news columns, you will immediately see what the editors don'tm-- that there is way more capital out there than anybody can think what to do with.
Another benefit of the New Deal, by the way,
#3 Posted by Harry Eagar, CJR on Fri 28 Sep 2012 at 04:07 PM