Capital Gains Followup

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.

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35 Responses to “Capital Gains Followup”


  1. 1 1 improbable

    This is also a nice example. But I thought you were perhaps going to follow up on another comment made there: you wrote:

    “As Morten and Neil have pointed out, it is possible to disguise earned income as capital income and thereby avoid taxes. My argument does not apply to cases of skullduggery”

    Since the real world is full of people willing in engage in skullduggery, and taxing wages at 50% but (real and fake) capital gains at 0% would produce a pretty big incentive to do so.

    I would love to hear ideas about ways to close this loophole, without the distortions of taxing capital gains.

  2. 2 2 John

    Only problem is that the example neglects compound interest. As the number of periods goes to infinity the effective tax rate difference goes to the single period tax difference. Of course, this then is the difference (in the example) between 15 and 50.
    Now in real life the number of period is not infinity but the number of years in which interest compounds. I’m ignoring the inheritance tax of course but that can be merely treated as a different type of income tax.

  3. 3 3 Pyramid Head

    Steve, your math is flawless. I can’t argue with that. But you’ve ignored the point that CEOs incomes are not taxed in the first place: they receive most of their compensation is stock options and the like. So there was never a prior wage tax.

    e.g. Steve Jobs has a salary of $1.

  4. 4 4 Harold

    This is the problem. If we did away with tax on capital income and left everythinbg else the same, then people would find more ways to disguise compensation for labor as capital income. The best solution would be to make it impossible to do this, but I cannot see how. Niel’s example of the house asset was a good illustration. Bob increased the value through labor, which should be taxed as wages. The value may also increase through general price rises, or through the neighborhood improving, which should be taxed at the capital income rate (arguably zero). How could you separate the two?

    These are practical arguments in favor of taxing interest or other capital income, and you may or may not agree with their importance. Steve’s point is that the argument that people are paying a lower rate of tax on their capital income is erroneous.

  5. 5 5 Martin

    How does the tax code treat someone who starts a business, never takes a salary, and sells the business for $1 million?

  6. 6 6 Coupon_Clipper

    Pyramid Head: Since when aren’t stock options taxed as income? Actually, in the old days (pre-2005) I think it was even worse than that due to a bizarre twist in the AMT.

  7. 7 7 Harold

    Expressing this objection in terms of Steve’s example, it is like saying that some women can avoid paying the 20% tax on March 15, and only pay the 10% tax on April 15. Instead of 2 groups (men and women) we have 3 groups, men, women and women avoiding the March tax. Call them A, B and C. If we state our objective of making tax as equal as possible.
    With both taxes as stated we have A:20%, B:30% and C:10%

    If we get rid of the 10% April tax on women we have A:20%. B:20% and C:0%

    If we cannot get rid of group C, then it is impossible to tax everyone equally. Which is the best outcome?

  8. 8 8 Bob Knaus

    Steve’s point is an old one — capital can only be formed from labor. Since we tax labor, all capital has been taxed before it was formed, so any capital gains or dividend taxes are in reality sutaxes. This point is mathematical and unarguable.

    A subtle point (and he says this in his addendum) is that labor may not have been taxed in the distant past… so we may have old capital lying about which has never felt the taxman’s bite.

    A much more important point is that the tax on labor is highly variable, and for a large segment of society the average labor tax rate is NEGATIVE. Thanks to the magic of EIC, unemployment benefits, welfare, social security, Medicare/Medicaid, and other cash-equivalent transfers, a large fraction of households get more in benefits than they pay in taxes.

    Often when analyzing taxes it is the marginal rate which is of concern, but to calculate how much tax has been “prepaid” on capital you need to use the average tax rate… which is (benefits – taxes)/income for any particular household.

    Because enterprises vary in their customer demographics, the average tax “prepaid” on their receipts will vary. For instance, if I buy stock in Tiffanys, my investment income will be derived from the labor of the highly taxed. Whereas, if I buy stock in Dollar Store, my investment income will be derived from people who pay a negative income tax.

    Now, to make things more fair, my investment in Dollar Store ought to be more highly taxed than my investment in Tiffanys. Do you think that will fly?

    Think of the capital gains and dividend taxes as a crude measure to make up for the distortionary tax effects of government redistribution. Or, if you like, think of them as a subsidy for businesses that sell to lower income people.

  9. 9 9 Pat

    Pyramid, the present value of the stock that the CEO either sells for capital gains or holds onto for the dividends reflects the effect of the corporate tax.

    People who worry about Buffett’s secretary paying lower taxes than Buffett are getting the tax incidence wrong. Buffett bears the cost of the corporate tax, it’s just that the corporations write the checks for him.

    People think you can get a tax break by getting more of your income from stock, but that company’s stock is already taxed at a high rate.

  10. 10 10 Tal F

    Prof. Landsburg,

    I generally agree with you regarding the wrongheadedness of certain people’s complaints about capital gains taxes. However, I believe there is an exception where it makes sense to tax capital gains. Although the tax code could possibly be amended to reflect this, I’m not sure it would be so easy.

    Suppose you have saved some large amount from previous work (which was taxed at the appropriate rate) and that now you spend your days living off of the income from investing this money. You could invest it passively, perhaps in long-term Treasurys, or in a stock market mutual fund if you can stomach the risk. Alternatively, you could spend your days diligently looking for higher-yielding investments with minimal risk, perhaps investing in real estate or making private investments in worthy companies (angel investing) or whatever you’re good at. The fact is, much of the additional return you will earn with this strategy is a form of wage compensation for your efforts, but according to the tax code it is all capital gains (at least if you hold for over a year). Some will claim it is even possible to earn additional return through smart investments in the Treasurys or the stock markets themselves, but that is debatable. How is one to distinguish active investing in which one earns a fair return for one’s efforts to passive investing/saving?

    After writing this, I noticed Harold had already mentioned a similar complaint about a person improving the value of his house via labor. This could possibly be remedied in the tax code more easily (e.g. by comparing your capital gains to the change in an index, and surtaxing profits much greater than the index), although it hasn’t. The example I give is nearly impossible to remedy. I also think the case of the business that is sold for more than the purchase price (or zero if start-up) but whose value has increased due to labor may be remedied by taxing capital gains from the sale of sole proprietorships and small partnerships at a different rate from large corporations.

    In light of the above, perhaps the best argument in favor of the current capital gains tax is simplicity of the tax code!

  11. 11 11 Neil

    If we’d simply tax consumption rather than trying to tax income, we can make the problems go away and have more simplicity in the tax code. The late, great Princeton economist David Bradford showed how this could be done, even maintaining progressivity, in the 1970s (Blueprint for Basic Tax Reform.)

  12. 12 12 Jon Shea

    I’ll second Neil’s motion for the Bradford X Tax. The Wikipedia page is a little sparse, but I still lose an hour to wiki-walking every time I visit it: http://en.wikipedia.org/wiki/X_tax

  13. 13 13 Paul

    Steve:
    Your above example was in response to my comment on your last post that the income tax is economically equivalent to a combination of a wage tax and a wealth tax, wherein I pointed out that it only makes sense to judge the burden of the tax on the wage portion of the income tax through the lens of its effect on consumption. You responded with this supposedly analogous distinction between an income tax in April and an income tax in March and further stated that “nobody with a serious interest in the consequences of tax policy would find this observation terribly interesting.” Obviously the distinction between the same sort of tax in April and then in May is not terribly interesting, nor is the distinction between a tax levied on men versus women. But it is difficult for me to believe that you seriously believe that the distinction between wage taxes and wealth taxes is of no interest to those interested in tax policy. Your past posts seem to belie this conclusion.
    My central criticism of your post is that you immediately and without justification judge the rate of taxation as the effect that tax has one’s ability to consume. My point is that there are types of taxes in which the rate of taxation cannot sensibly be measured by its effect on one’s ability to consume, and I content that an income tax is such a tax. People seem to miss this point only because an income tax appears so similar to a wage tax. But of course the income tax is not just a wage tax but is also a wealth tax, a tax on windfalls, a tax on gifts, etc.
    One can especially see how nonsensical it is to apply the consumption measure to a wealth tax by looking at another type of wealth tax such as a property tax, and I gave such an example in my earlier comment. Here’s another one: Al, Betty and Clark live in a county where the local property tax is 1% let’s assume for simplicity that they each consume all of their income each year. The value of Al’s property and his income are such that the property tax reduces his consumption by 15%. The value of Betty’s property and income is such that her consumption is reduced by 10%. Clark rents so he doesn’t pay the tax, and his consumption is not reduced at all. Does it make any sense to say that Al is taxed at a higher rate than Betty, or that both of them are taxed at a higher rate than Clark. No they are all taxed at the same rate of 1%.
    Your second response to me was then to suggest that what I am really saying is that those who pay taxes on capital returns (the women in today’s example) are “really being taxed twice which is not the same thing at all.” Of course in your example this is true where income is being taxed in March and then it is being taxed again in April. But my point is precisely the opposite one, that an income tax taxes two DIFFERENT things and not the same thing twice. If you want to argue that a wealth tax is double tax because it also reduces the ability to consume, then on this basis then so are all property taxes, all sales taxes, all surtaxes, all fees, and really all taxes of any kind other than a wage tax. If this is your position than why don’t you just say that instead of playing some game in claiming that those who pay tax on capital returns are paying a higher tax RATE.

  14. 14 14 jambarama

    Even outside of the skulduggery argument, capital gains is treating income earned from work and from income earned from investing differently. You need to have money to make money investing, yes, so any income invested has already been taxed. But that your income isn’t being taxed as capital gains, only your gains on that income is taxed as capital gains.

    Income tax only affected the initial chunk of money invested, whereas capital gains only affects the proceeds of that chunk of money. If the chunk of money was invested in something else – say a business – you’d pay income tax on the proceeds. Capital gains tax is funneling spare money into capital and away from other non-security investments.

    This provision obviously benefits those with enough disposable income to have meaningful investments. This may give rise to an equity argument, but I’d rather see a separate, parallel, & progressive capital gains tax than our current flat 15%.

  15. 15 15 improbable

    @jambarama “income earned from investing differently” [to income from work]

    Perhaps it’s helpful to clearly separate three things, since I’m not quite sure which of these you are referring to. All of these increase your bank balance, but they are very different:

    1. There is income from work, which may include the managing of a fund, which may be your own.

    2. There is interest on invested money, which is what our host is arguing most strenuously about having taxed as income, since the money being invested has already been taxed when earned for the first time, and so this represents double taxation.

    3. There are gambling profits, from pure luck.

    4. Finally there is the moment of inheriting money, which *you* did not earn. Your family may have paid tax on this money, when someone earned it, but *you* just happened to be born in the right place. If you believe that the family is the rightful economic unit, you may discard this, but I do not.

    “Skulduggery” refers, I think, to counting 1 as if it were 2 or 3, so as to take advantage of the lower tax rate (capital gains tax instead of income tax). I think a sensible debate to have is whether this loophole can be closed.

    2 is not “income”, even though it involves an increase in the number of dollars. Another toy model to show this is to imagine a country in which the rate of inflation is much higher, say 41% annually. Then anything you own appreciates very rapidly, and is subject to capital gains tax. It’s pretty clear owning a house in this country, which quadruples in value every 4 years, does not constitute income. It’s still the same house, with the same tenants in it. But you have to pay tax (after 4 years) on 3/4 of its value.

  16. 16 16 jambarama

    Maybe this will be clearer. I have $1000, post-tax, I don’t need now. I’d like to use it to make more money. I have two options – I can start a part-time internet business and make $1200 or invest in an existing internet business and make $1200. The rate of return is the same, but the proceeds of my new business will be taxed at the higher income tax rate, whereas the proceeds of my investment will be taxed at the lower capital gains rate.

    This is my complaint, that lower capital gains tax rates encourage investment in stocks and bonds, and away from other income producing activities.

  17. 17 17 Pyramid Head

    @Coupon_Cliper:

    My bad. If stock options are taxed then my objection is moot.

    Pat:

    Indeed, the corporation already paid taxes over its earnings, but what is the tax rate compared to the income tax?

  18. 18 18 Tal F

    jambaramba:

    The difference between your two options is that option #1 will require some added labor on your part. You may end up with the same amount in the 2 cases by coincidence, but the _expected_ returns differ due to the additional compensation due for the efforts of your labor.

    Also, if you choose not to withdraw your $200 profit from the business but reinvest it, you can then sell the business, after which you will pay capital gains. The same applies to stocks, which you may also reinvest without paying any tax (i.e. by not selling the stock).

    Sorry, but actually there is no disincentive here. In fact, there may be an incentive towards starting the business, since the true alternative to starting a business is not buying a stock but going to work for an existing business. I believe tax rates overall are a bit lower for self-employed vs. employees, not least because you get to deduct things like your rent and energy bills, which many self-employed would have anyway since they work out of a spare bedroom.

  19. 19 19 Scott H

    Two observations after reading the nice posts from fellow readers:

    1.) I’m not sure to what extent its useful to decide that effort matters when it comes to investing income. I don’t know that it really ends ups mattering anywhere else income is involved. Does the guy that makes $75,000 per year put in more effort than the guy that makes $50,000? In many of your eyes if the answer isn’t yes, then the tax code needs to come to the rescue. That mental fixation can cloud your ability to see what Steve is talking about (in my opinion).

    2.) This next observation might be an indirect siding with Paul. However, Steve, wouldn’t my calculated compound rate of taxation actually be variable? The amount of money I could have invested were it not for income taxes is not linearly correlated with the tax rate. An anology would be profits and revenue. Revenue growth of 10% could make profits soar 100%. Lets say I make 100 and am taxed 50. My living expenses are 49. I have just one to invest. However, for every percent the taxes were decreased I would have had one extra to invest. Therefore my (previously)taxed away capital gains aren’t 50% of the total. They would be over 98% of the total! (51 versus 1). I guess, on the bright side, I could say that the effective rate of both taxes would never be lower than the single, initial 50% rate. However, is there a flaw in the variability reasoning?

  20. 20 20 Steve Landsburg

    Scott H: Your point 2) is right. Alice spends all her income right away and pays a 50% tax. Bob saves all his income, spends it after it’s doubled, and effectively pays a 52.5% tax. If you spend some and save some, then you’re a sort of part-Alice-part-Bob and your effective tax rate is somewhere between Alice’s 50% and Bob’s 52.5%.

  21. 21 21 Pat

    Pyramid, the corp tax matches the top brackets for any company that makes substantial money. Toss in the dividend and capital gains taxes, and it’s taxed higher than any income tax. Rich people get no break for getting less of their money from wages and the rest of us pay higher taxes for any money made from investing.

  22. 22 22 Harold

    Pat, Are you saying that the money to pay top execs is taxed because of corporatuion tax? This may be so, but the tax is not paid by the exec. The corporation pays this, and the cost is spread over that whole organisation. The exec. gets rewarded for labor, but pays personally only capital tax. I may be completely wrong here, I do not quite follow all this tax business.

  23. 23 23 Pat

    Harold, it doesn’t matter who writes the check. The corporation’s after tax profit is reduced by the amount of the tax.

    Hard worker earns 100k pre tax. Pays 35% tax. Has 65k after tax

    Lazy passive investor owns company that makes 100k pre tax. Pays 35% tax. Has 65k after tax dividends. Oh wait, we tax those too, knock 15% off that. Left with 55k.

    Forget who writes checks. I don’t write checks to the IRS, my employer does for me. Am I richer? No.

    And it doesn’t matter whether it’s capital gains or dividends, the stock price reflects the cost of the corporate tax.

  24. 24 24 Harold

    Pat, I was thinking of an employee of the corporation, who is paid in dividends rather than a salary, rather than an investor.

  25. 25 25 Pyramid Head

    @Pat: Point taken. Teaches me to do some research before posting :)

  26. 26 26 Benkyou Burito

    Would this be a fair restatement of your message?

    “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.

    In cases where the (S)avers earned the money they are saving or have been given it by a person who earned it under the same taxation scheme as the (S)penders, That’s exactly what’s going on with capital taxation.”

    But what about the wealth held three or four generations after it was received in exchange for work, goods, or service?

    It is not an accident, nor a statistically natural distribution, that as Edward Wolff puts it, “In terms of types of financial wealth, the top one percent of households have 38.3% of all privately held stock, 60.6% of financial securities, and 62.4% of business equity. The top 10% have 80% to 90% of stocks, bonds, trust funds, and business equity, and over 75% of non-home real estate”.

    That would be a tremendous amount of power and influence to be held by such a small number of people even if those people aquired that wealth themselves through their own hard work, innovation, genius, even deviousness. But to have that amount of privileged and influence, essentially handed down along each family’s successive line of princes, dukes and barons is un-American.

  27. 27 27 philip meguire

    I invite all of you to take the Hall-Rabushka Flat Tax more seriously.
    As it stands in the 1995 3rd edition of their book, it will not fly because it increases the tax burden on a fair slice of the middle class. The way forward is to raise the flat rate to 27-30%, then credit FICA tax payments against flat tax liabilities.

    The simplest way to make the average tax rate progressive is to give every legal resident of a country a flat “demogrant,” and the Flat Tax should do just that. The result is a flat tax on value added, levied only on employers. This tax ignores all capital gains, except realized capital gains on business real assets not reinvested in other real assets within the same accounting period.

    A short post describing my ideas in more detail:

    http://www.facebook.com/home.php?#!/notes/philip-meguire/a-simple-sweeping-reform-of-the-american-tax-system/133890303320234

  28. 28 28 philip meguire

    @Burito:

    The only alternatives to inherited wealth are gifting wealth to nonprofits, empowering the state to seize wealth at death, or simply letting wealth run down in old age because “you can’t take it with you.” The latter two alternatives are unpallatable because they will leave us all poorer.

    Nobody much thinks about the gift tax anymore. I bet the reason is that it is unenforceable in practice. If that is the case, then estate taxation is essentially pointless.

    You want to make the size distribution of wealth holdings more egalitarian? Then change the taxation of capital income as follows. Purchases of financial and real assets are tax-deductible. Reinvested capital income is untaxed. Withdrawals from investment accounts are fully taxable. In other words, treat all investments as if they were held in IRAs with no annual contribution limits. I submit that in such a world and within 50-80 years, most families whose adult members are employed most of the time would retire worth 1-2 million dollars.

  29. 29 29 Tal F

    Scott:

    Does the guy who puts in 1 days’ effort to fix up his $1MM home and sells for $1.1MM put in more effort than the guy that puts in a year’s effort to fix up a $100k home and sells for $150k? What does the amount of effort have to do with anything? The point is only to distinguish between capital gains that come from zero effort (e.g. a broad stock market mutual fund) and capital gains that come from some sort of effort (e.g. real estate investments, private equity, venture capital). Of course it is impossible to judge the amount of effort from the amount earned. More important will be the capital base from which the investor starts, whether that be financial or human capital.

    So to answer your question about the guys making $50k vs $75k, the guy making $75k may have higher human capital but is putting in less effort. You should not be taxed for effort, but for the product of effort and capital. In the case of passive capital gains, the effort is zero, and so should not be taxed.

  30. 30 30 Benkyou Burito

    phillip– You mention “empowering the state to seize wealth at death, or simply letting wealth run down in old age because” as being unpalatable.

    For the first part, who is the wealth being seized from? The dead guy? Let him stand up and fight for it. Let him vote too. I’m with Adam Smith on this one when he said, “there is no point more difficult to account for than the right we conceive men to have to dispose of their goods after death”.

    As for your second point, I’m not sure what you mean by letting the wealth “run down in old age”. You mean that the extremely wealthy will, after years of living in luxury, stop doing so? Or that because the only tax they will have to pay on investment income will be paid after they are too dead to spend the income anyway that they will not make investments? I’m not trying to put words in your mouth, but the words you put down are vague.

    Do you mean that because, for the few % of the population affected, because they may only pass on enough money to make their children millionaires they will not strive to produce at their maximum potential? How does it make us all poorer?

    Consider Landsburg’s premise from M-S-i-S-S, that more people is a good thing because the true drivers of an economy are ideas (technology and innovations in things like finance). But right now we have a football team (to borrow his metephor) made up of players chosen only from 10% of our class size. By taxing estates as I mentioned we could fund scholarship endowments (or to avoid the tax, motivate private donations to scholarship endowments) enough to ensure that the most capable and motivated get the education they need to produce those innovations; and not just the ones motivated, capable, and willing to saddle themselves with a lifetime of debt. Increasing the number of PHDs this country produces by a factor of 10 might allow us to keep up with the Chinese, who now have a Phd population about the size of the total US population.

    The same can be said for healthcare. There are millions of people with great ideas for a business who do not dare because they would lose the federally subsidized insurance that their corporate firm employer provides. Some of that will change in the next few years, but the heavily watered down healthcare reform that was passed still favors corporate distribution and still subsidizes corporate firm employment. I think that’s one reason why there are so much fewer “big-box” restaurant and stores in Korea and Japan (and likely other places), I could get lunch at a different Ramen-ya every day for a year in the same city and never eat at the same place twice. And never at an Applebee’s.

    How would removing the tax on all investment related income and at the same time lowering the tax on all wages harm investment?

  31. 31 31 afan

    “By taxing estates as I mentioned we could fund scholarship endowments (or to avoid the tax, motivate private donations to scholarship endowments) enough to ensure that the most capable and motivated get the education they need to produce those innovations”

    This is the problem with the current estate tax. The state adopts a simplistic set of heuristics that determine which bequests are taxed and which are not. It assumes that any money left to a university provides important enough value to society that it should avoid taxation, while bequest to, say, a for profit corporation, do not. One can certainly debate whether this is true. The problem is that the estate tax does not leave room for this debate. To avoid the tax here are the set of acceptable beneficiaries. If they structure their businesses to qualify, then they can receive money without it subject to taxation. You make a case that this at least might be true for universities, but it would be stronger if you specified the degrees. Lot’s more engineers might help us compete with China. It is not so clear how PhD’s in English literature do so. Yet a university that turns out exclusively unemployed would be English professors is equally qualified to receive untaxed bequests as is a place that turns out exclusively entrepreneurial engineers. If you consider that donations to your church also qualify, with no attempt to demonstrate their economic value, it is hard to accept the claim that the estate tax benefits society. If it does, it does so very inefficiently.

    One could avoid recreation of a hereditary landed gentry with a confiscatory tax only applied to very large estates. One hundred percent of the amount in excess of $100 million would do this job. At the same time eliminate the charitable exclusion. Or require a demonstration that the charity would use the funds to stimulate economic productivity. If a church spent half its money on feeding the poor and training engineers (economically productive) and half saving souls and turning out unemployed English majors (economically unproductive), then 50% of the bequest would escape the tax.

  32. 32 32 Benkyou Burito

    Afan– I think we’re on the same page. I would have no problem allowing gifts to private companies to escape estate tax if they are willing to follow the same accounting rules and verify that it is being put into capital investment and not just being directed into the salary of a few people.

    I would argue that a Phd in English is as likely to be valuable as a Phd in Engineering and where there is a difference the simplicity of a smaller set of criteria would more than make up for it.

  33. 33 33 jambarama

    @Tal F

    You’re speaking out both sides of your mouth. In one post you’re saying “the _expected_ returns differ due to the additional compensation due for the efforts of your labor” whereas in another you’re saying “what does the amount of effort have to do with anything?” Labor has expected returns or it doesn’t. I posit labor has no expected returns.

    Back to capital gains, I have only two points, and hopefully this is clear. First, the previously taxed investment in the asset is basis, which is recovered tax-free. Capital gains only covers amount realized in excess of the basis – there is no double tax on the same money. Second, earnings on capital are taxed even if they are not capital gains, e.g. interest income, rental income, etc. Those investments are taxed at ordinary income rates. So the capital gains rate, which caps the rate which can apply, is preferential in comparison.

  34. 34 34 afan

    Burrito,

    That is why I was careful to specify “unemployed” English PhD’s vs entrepreneurial engineers. If we have decided that competing on technology with China is so important that things contributing to that should escape taxation, then the exclusion should be so targetted. If a university could make a case for why their English majors are helping beat out the Chinese for manufacturing solar panels, then the share of donations that go to this effort should be tax free. A policy that says all charities, of any kind, with any objective, leads to lots of inefficient allocation of resources.

  35. 35 35 Benkyou Burrito

    But we are not competing with China only for engineering jobs. I think “competing” is probably the wrong word to use as well but neither here nor there. China is producing Phds in English Literature too. Just as well, there is a case to be made that even if a person receives a “useless” degree in something like philosophy or English Lit, it still increases the likelihood of their producing one of these innovative ideas or perhaps it helps them to draft a more well-rounded business plan or grant application.

    My goal, in addressing cumulative wealth is to limit the consolidation of power and opportunity. I use education as an example because in a world where the drivers of economic growth really are innovation (in ideas, technology, politics, finance, etc) there is an external benefit from educating a person that is reaped by society as a whole. I’m not sold on the “competing with a country for jobs” approach but it exemplifies a popular mindset. Nationalism plays into this narrative but is not necessary for it.

    As Landsburg illustrates in the book of his which I referenced (more sex is safer sex) increasing the number of people in the world relative to 1850 has resulted in less hunger not more because of the larger pool of idea-producers from which a statistically rare event like coming up with a better way to irrigate a farm or a better way to insure the risk of starting up a new airline. I extend his premise that increasing the quantity of human capital results in more of the necessary innovations and therefore benefit society as a whole to include investments into upgrading the existing human capital to achieve the same end.

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