A short followup to yesterday’s post on capital gains. This came up in the comments, and I think it’s worth highlighting:
Suppose we rewrite the tax code as follows: Every March 15, women pay 20% of their incomes and men pay nothing. Every April 15th, women pay 10% and men pay 20%.
Now someone writes a letter to the New Yorker complaining that the April tax is unfair to men, who pay twice as much as women do. I think it would be fair to dismiss this complaint as silly. Yes, it’s true that if you look at the April tax in isolation, men pay more than women. But there is no sensible reason to look at the April tax in isolation. If you look at the combined effect of the March and April taxes, women pay 30% and men pay 20%. By any sensible reckoning, women are taxed at a higher rate than men.
That’s exactly what’s going on with capital taxation. Some people (the savers) are taxed twice — once when they earn their income and again when they withdraw it from their savings accounts. Others (the spenders) are taxed once. It is true that the second tax on the saver is lower than the first tax on the spender. But there’s no sensible reason to look at those taxes in isolation. If you look at the combined effect of the wage and capital income taxes, savers pay a higher percentage than spenders do.
A tax on wages is (among other things) a tax on capital gains, because your capital gains are proportional to your savings and a tax on wages reduces your savings. Capital gains, therefore, are taxed in advance at exactly the same rate as earned income. The capital gains tax (along with any other tax on capital income) sits on top of that. And it’s only the total that matters.
If that’s not crystal clear, then I encourage you to work through yesterday’s numerical examples. That’s always the only way to be sure you know what’s going on.