16 August 2011


The economic justification for having a separate and lower tax rate for capital is the sensitivity of capital inputs to tax relative to labour inputs.

However, the effect of lower taxation on capital rates is to generally subsidize the following
1) Home ownership and housing prices. Especially at the upper middle price point (the capital gains exclusion on housing ends around a half million, or 250k for an individual rather than a married couple). I already don't see the need for a home mortgage interest deduction, but I certainly don't see a need to further encourage home ownership and housing price inflation beyond that already distorting subsidy. We have plenty of incentives even without these for property ownership relative to renting shelter (price stability is higher, inflation protection on fixed interest mortgages, privacy, individual control over renovations or additions, school district placements for children, etc).
2) Financial sector growth. I suppose it's nice that banks and mutual funds can expand. But do we need a national industrial policy to encourage it further?
3) Corporations. It would seem to me the best subsidy to offer corporations is to abolish their income taxes and tax income where it reaches people instead. We have very high corporate income taxes in this country and this is a problem for global investment (Even the supposedly socialist Europeans have much lower corporate taxes than we do). What doesn't seem necessary is to push capital flows toward large cap companies in favor of small businesses or entrepreneurs or even smaller competing corporations in the same industries. Corporations already have favorable regulatory structures (barriers to entry) and abolishing their income taxes allows a considerable market advantage for global investment. Further benefits in the form of huge capital accumulations seem unnecessary.
4) Wealthy individuals. Large portions of individual wealth are accumulated in stocks and bonds and housing. For the average person, capital gains taxation is a dream world. Indeed, the average person's "investments", in the form of stock especially, are locked up in 401ks and IRAs, and unless these are ROTH accounts, are already taxed at income tax rates regardless of the devices used to invest for retirement. Essentially this is a highly regressive income tax device as a result. (this does not even include the disparity between people who make money by trading money and people who make money by trading their labour, who then must have their employers pay payroll taxes, further diminishing their post-tax income).

So I'm not quite sure why we still preserve this distinction of "income" from "income". The purported economic argument that still makes sense is to avoid, or at least lower, double taxation because of the existing corporate income taxes and then to tax also their dividends and capital gains. But if you sweep out the income taxes at the corporate side, then the gains and dividends no longer double taxed. And you could just as well tax them at regular individual marginal tax rates. This would have the effect of encouraging lower and middle income investment, for example when people are younger and tax brackets are likely lower, or older retirees who are living off of retirement savings, and provide a diminishing return to large capital accumulations. Progressives and pragmatists would win under this logic because the tax code would become more progressive. The tax base would also increase, potentially increasing government revenues. Conservatives would then also win because they could probably decrease marginal tax rates and get to sell a tax cut to the public. Small businesses and competing corporations would win against incumbent large caps gobbling up investment capital at subsidized rates. Corporations could win by not having to game the income tax system and their profits could be untempered, investors could receive larger dividends, etc. Renters and lower-to lower middle class people would win by not having inflated housing prices in dense urban areas. And so on down the line.

The only people who lose out are the aforementioned parties who benefit from the status quo.

So I would bet that a policy shift like this would never happen.
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