Capital Gains tax and tax on investment interest

[toxigal]

can someone (preferably politely) explain to me the logic behind not paying them? i'm being completely sincere in my bewilderment. if i have to pay taxes on money i work for, why shouldn't i also pay taxes on money that i get without doing work?

[raider.adam]

I think the idea is to encourage investment. Personally, I don't think that matters much. Now in case you don't know, the reason they have capital gains at a separate rate is because of "double taxation". The money is taxed at the corporate level and then taxed again when people receive it as investment income.

If I had my way, what I would do would be to eliminate the corporate tax and then treat all capital gains and investment income as normal income (the higher tax rates). Throw in Romney's deduction cap and that is a nice progressive, and rather fair, shift of tax liabilities to the wealthier tax payers while at the same time simplifying the tax code.

[rjj]

first start by gaining the understanding that investing is work. having the right portfolio isnt luck, its research.

[PASnow]

first start by gaining the understanding that investing is work. having the right portfolio isnt luck, its research.

Most people probably just by Mutual Funds in their 401k or IRA, where the company lays it out what they're going after (agressive, overseas, tech, safe). Most wealthy people probably have Financial Advisors.

[eldondre]

can someone (preferably politely) explain to me the logic behind not paying them? i'm being completely sincere in my bewilderment. if i have to pay taxes on money i work for, why shouldn't i also pay taxes on money that i get without doing work?

a very good question. I don't agree with adam on the reasons why, dividends are taxed twice as income...additionally, capital gains were originally taxed as income and separate rates weren't created until tax rates got insanely high. The reality is it satisfies an unholy alliance of rich people, bankers, and supply siders who genuinely believe that it causes investment which, in turn, they believe causes job growth. the only thing it really does is help shelter money from taxes and create perverse incentives. this differential was behind the rise of corporate diversification since it was easier to earn money investing and paying 25% than dealing with regulations to produce a good or service and pay 52%. today these incentives still exist (35% for production and 15% for capital gains). if I'm not mistaken, job growth is actually associated with the narrowing of the gap between income and capital gains (regardless of rates). low capital gains rates simply cause more market distortions which lead to bubbles and things of the sort. today we seemed trapped between two failed systems (the new deal and supply side). adam's proposal to eliminate corp taxes and tax everything as income is great, it eliminates perverse incentives, simplifies the tax code, and would result in accountants being repurposes to something other than tax manipulation. decisions between stock buybacks and dividends would be more rational, depreciation might once again match useful life, etc.

[BarryG]

a very good question. I don't agree with adam on the reasons why, dividends are taxed twice as income...additionally, capital gains were originally taxed as income and separate rates weren't created until tax rates got insanely high. The reality is it satisfies an unholy alliance of rich people, bankers, and supply siders who genuinely believe that it causes investment which, in turn, they believe causes job growth. the only thing it really does is help shelter money from taxes and create perverse incentives. this differential was behind the rise of corporate diversification since it was easier to earn money investing and paying 25% than dealing with regulations to produce a good or service and pay 52%. today these incentives still exist (35% for production and 15% for capital gains). if I'm not mistaken, job growth is actually associated with the narrowing of the gap between income and capital gains (regardless of rates). low capital gains rates simply cause more market distortions which lead to bubbles and things of the sort. today we seemed trapped between two failed systems (the new deal and supply side). adam's proposal to eliminate corp taxes and tax everything as income is great, it eliminates perverse incentives, simplifies the tax code, and would result in accountants being repurposes to something other than tax manipulation. decisions between stock buybacks and dividends would be more rational, depreciation might once again match useful life, etc.

You might be right but capital gains are taxed different from wage income worldwide, the belief that it spurs in investment and that the double-taxation is unfair is a widespread belief by economists and not a conspiracy. Of course the US has one of the lowest rates.

[robot]

You might be right but capital gains are taxed different from wage income worldwide, the belief that it spurs in investment and that the double-taxation is unfair is a widespread belief by economists and not a conspiracy. Of course the US has one of the lowest rates.

A big difference to me between capital gains and income is risk. There is a risk with any investment that you normally don't think of with respect to income from a job. While I don't think a higher tax on capital gains would discourage the very rich from investing I do think it would have a negative effect on middle class investors who don't have much money to invest. I would probably just put more money into my house than the stock market if the capital gains rates were the same as income. Plus, capital gains are only taxed when they are realized, so I imagine the very rich would figure out ways to delay the realization indefinitely.

[raider.adam]

a very good question. I don't agree with adam on the reasons why, dividends are taxed twice as income...additionally, capital gains were originally taxed as income and separate rates weren't created until tax rates got insanely high. The reality is it satisfies an unholy alliance of rich people, bankers, and supply siders who genuinely believe that it causes investment which, in turn, they believe causes job growth. the only thing it really does is help shelter money from taxes and create perverse incentives. this differential was behind the rise of corporate diversification since it was easier to earn money investing and paying 25% than dealing with regulations to produce a good or service and pay 52%. today these incentives still exist (35% for production and 15% for capital gains). if I'm not mistaken, job growth is actually associated with the narrowing of the gap between income and capital gains (regardless of rates). low capital gains rates simply cause more market distortions which lead to bubbles and things of the sort. today we seemed trapped between two failed systems (the new deal and supply side). adam's proposal to eliminate corp taxes and tax everything as income is great, it eliminates perverse incentives, simplifies the tax code, and would result in accountants being repurposes to something other than tax manipulation. decisions between stock buybacks and dividends would be more rational, depreciation might once again match useful life, etc.

Actually, dividends have been moved to the capital gains tax also. Also, much of the time when the capital gains rate was higher, there were also a base level of exclusions, so the top rate wasn't actually the effective rate.

[raider.adam]

A big difference to me between capital gains and income is risk. There is a risk with any investment that you normally don't think of with respect to income from a job. While I don't think a higher tax on capital gains would discourage the very rich from investing I do think it would have a negative effect on middle class investors who don't have much money to invest. I would probably just put more money into my house than the stock market if the capital gains rates were the same as income. Plus, capital gains are only taxed when they are realized, so I imagine the very rich would figure out ways to delay the realization indefinitely.

Except the majority of middle class who are investing, they are doing it through IRAs and 401Ks, so there are no capital gain tax considerations.

As for delaying the realization indefinitely, that's fine and all, but it also means they are delaying liquidating assets indefinitely too.

[annie]

A Tax Plan That Economists Love (And Politicians Hate) : Planet Money : NPR

This doesn't talk about capital gains tax but I did think it was interesting (listen to the story, they cover it in an amusing way).

Except the majority of middle class who are investing, they are doing it through IRAs and 401Ks, so there are no capital gain tax considerations.

I was wondering if that was supposed to appeal to middle class people who have no idea what capital gains are and that they don't apply to their investments.

[jdhill]

A big difference to me between capital gains and income is risk. There is a risk with any investment that you normally don't think of with respect to income from a job.

This is an excellent point that's rarely considered when people talk about the fairness/unfairness of the capital gain tax rate. Investment income can only result from investment, and with investment there is the risk of loss, sometimes even total loss. Not too many of us go to work and at the end of the year are asked for all of our wages back, but this can happen with investments.

Next, some will claim that losses create a "tax write-off", but this isn't true either. From a tax reduction perspective, capital losses are primarily applied to capital gains, and offsets against ordinary income are capped at 3K annually. While you can carry it forward (indefinitely i believe), it's hardly a great option if it takes you 10 years simply to retrieve what was effectively an overpayment of taxes during the period of your investment.

[robot]

Except the majority of middle class who are investing, they are doing it through IRAs and 401Ks, so there are no capital gain tax considerations.

As for delaying the realization indefinitely, that's fine and all, but it also means they are delaying liquidating assets indefinitely too.

Right, I mean people who invest outside of their 401ks, IRAs, etc. They may not be the majority, but I know plenty of middle class "savers" who even after maxing out their 401k and IRA limits have money that they invest in the market directly or through mutual funds. You pretty much have to if you plan on retiring at a decent age. If you keep your savings in money market accounts or worse a savings account you are basically losing money to inflation.

[raider.adam]

This is an excellent point that's rarely considered when people talk about the fairness/unfairness of the capital gain tax rate. Investment income can only result from investment, and with investment there is the risk of loss, sometimes even total loss. Not too many of us go to work and at the end of the year are asked for all of our wages back, but this can happen with investments.

Next, some will claim that losses create a "tax write-off", but this isn't true either. From a tax reduction perspective, capital losses are primarily applied to capital gains, and offsets against ordinary income are capped at 3K annually. While you can carry it forward (indefinitely i believe), it's hardly a great option if it takes you 10 years simply to retrieve what was effectively an overpayment of taxes during the period of your investment.

I think the risk point for tax purposes is a red herring.

[raider.adam]

Right, I mean people who invest outside of their 401ks, IRAs, etc. They may not be the majority, but I know plenty of middle class "savers" who even after maxing out their 401k and IRA limits have money that they invest in the market directly or through mutual funds. You pretty much have to if you plan on retiring at a decent age. If you keep your savings in money market accounts or worse a savings account you are basically losing money to inflation.

I think we are over analyzing the risk in these scenarios. On average over time, investing in the US Stock market with diversified portfolios has been one of the most reliable and profitable avenues there is.

The Capital Gains issue with risk si pretty much when we are talking about large movers. People who are dumping tons of money into a company or a stock or investment real estate.

[torts]

I think the government should tax capital gains at at least 50%. That's extra money people make. The government should take that extra money and give it to those who did not invest OR people who lost money in the stock market. Personally, I think the same applies to casinos. If someone is "the big winner" at the blackjack table, let's take his money and share it amongst the people who lost. That way EVERYONE wins and EVERYONE spends the money. You see, the same sum of money actually INCREASES when you share it. It's a NET BENEFIT. That's called the multiplier effect. Thank you. And have a blessed day.

[toxigal]

I think the idea is to encourage investment. Personally, I don't think that matters much. Now in case you don't know, the reason they have capital gains at a separate rate is because of "double taxation". The money is taxed at the corporate level and then taxed again when people receive it as investment income.

but can't the corporation right off the investment income that pass on to the investors as an expense?

also, is it really double taxation if two different entities are taxed (the corporation then the individual)?

[jdhill]

I think the risk point for tax purposes is a red herring.

Well, the element of risk is what makes capital gain income incomparable to ordinary (wage) income when it comes to tax rates. And the IRS seemingly agrees as it does not allow one to offset capital losses against ordinary income to more than a nominal degree.

[jdhill]

I think the idea is to encourage investment. Personally, I don't think that matters much. Now in case you don't know, the reason they have capital gains at a separate rate is because of "double taxation". The money is taxed at the corporate level and then taxed again when people receive it as investment income.

It sounds as if you're conflating dividends with gains from the sale of stock. The former is subject to double-taxation, but the latter really is not. Most capital gains are from the sale of stock, in which the company is rarely a party to the transaction. If you buy then sell 100 shares of GE, you're neither buying it from nor selling it to GE. The gain you may realize is provided by a private buyer and at most is connected to the underlying company by the buyer's anticipation of the future after-tax cash flow that his "share" of ownership will provide (in dividends and ultimately stock appreciation).

[jdhill]

but can't the corporation right off the investment income that pass on to the investors as an expense?

also, is it really double taxation if two different entities are taxed (the corporation then the individual)?

You're tangling things up. The capital gain is not a result of any money passed from the company to the individual. There's no cost to the company when stock price appreciates and the holder of stock sells, realizing a gain.

[toxigal]

You're tangling things up. The capital gain is not a result of any money passed from the company to the individual. There's no cost to the company when stock price appreciates and the holder of stock sells, realizing a gain.

okay. so it is not double taxation (at least with respect to stock profits). so why shouldn't the individual have to pay taxes on that income?

and for dividend income (where the company did pay taxes, correct?), is it really "double taxation" if it involves taxing two different individuals (going with the "corporations are people line of thinking"?