The Treasury Stops by Freakonomics

I love the way that Michael Mundaca, the assistant Treasury secretary for tax policy, has taken to the blogs to help up some of the perennial confusion surrounding taxes. And yes, he tackles the biggest question of all, about those 1099s:

While businesses do not need to start filing information returns on the expanded set of payments until January of 2013, some groups have already raised concerns about the burden that this new provision may impose. As the President has said, it is important to look at whether this burden is too great for businesses to manage. Treasury and IRS are sensitive to these concerns and will look for opportunities to minimize burden and avoid duplicative reporting… Already, we have used our administrative authority to exempt from this new requirement business transactions conducted using payment cards such as credit and debit cards. So, whenever a business uses a credit or debit card, no information report will need to be filed, and there will thus be no new burden under the new law.

This is a start, even if it’s clearly insufficient; the good news, at least, is that there does seem to be a bit of time to fix things. If we can’t reach bipartisan consensus on this, then we’re never going to be able to pass anything in the next two years.

More interesting is the way that Mundaca defends the way in which dividend and capital-gains tax rates are lower than income-tax rates. I’ve never understood it, but Mundaca gives the best explanation I’ve yet seen:

The arguments in favor of taxing capital gains at a rate lower than that for ordinary income include offsetting the taxation of purely inflationary gains; reducing the tax on risky investment that would otherwise be disadvantaged by the tax system, especially because of the limits on deducting capital losses; and offsetting the “lock-in” effect where high capital gains rates can impede economically desirable asset and portfolio reallocations by imposing a tax on the sale of capital assets that can be deferred to the extent that the assets are not sold. With the exception of a few years following the Tax Reform Act of 1986, long-term capital gains generally have been taxed at preferential rates since 1921.

I’m not convinced, and I’d still love to see the tax rates brought into line with each other, if only because financial engineering makes it pretty easy to take income and convert it into capital gains, if you’re rich enough. (Don’t get paid yourself, just set up a company, then sell the company.) That’s what the private-equity honchos all did, and their low tax rates are unconscionable.

Still, the inflation argument is a good one: inflation is bad enough without having to pay taxes on it. The next argument, about encouraging risky investment, is weak—capital’s always going to flow to where it gets the best return. And as for “lock-ins”, I have some sympathy, but suspect that if it was really a problem then total return swaps would simply become a lot more popular.

In any event, let’s have more of these forums where Treasury technocrats talk directly to the public. Anything which disintermediates journalists has to be a good thing, right?

Update: Jimmy P reckons that far from raising capital gains taxes so that they’re the same as income taxes, they should instead be lowered to zero!

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Felix Salmon is an Audit contributor. He's also the finance blogger for Reuters; this post can also be found at Tags: , , ,