TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, March 5, 2015

WSJ: Is It Fair to Tax Capital Gains at Lower Rates Than Earned Income?

Wall Street Journal, Is It Fair to Tax Capital Gains at Lower Rates Than Earned Income?:

Capital gains—and how big a bite the government should take out of them—have become a major point of contention in the past couple of months.

In January, President Obama proposed tax changes designed to raise some $320 billion over 10 years, largely through higher levies on high-income Americans. The revenue would be used to cover $235 billion in tax breaks, mostly for moderate-income workers, along with other initiatives.

Among the changes he proposed: boosting the capital-gains rate to 28% for the top 1% of taxpayers, up from the current 23.8%, as well as a new capital-gains tax on many inheritances.

The GOP fired back that taxing investment income would harm economic growth by discouraging business investment and thereby hurt workers’ incomes.

All of which points to a broader question that divides experts: Are capital gains so different from earned income that they should be taxed at a different rate?

Below, two experts tackle that question.

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What's not fair is taxing "gains" from inflation. Hold an asset 20 years and inflation creates a gain even if none exists in real terms. Taxing that "gain" confiscates principal.

The rate of tax is less important than properly defining what is taxed.

Posted by: AMT buff | Mar 5, 2015 12:02:20 PM

On balance, I think Dr. Sumner has the better argument re cap gains. The arguments in favor of a lower rate are (i) phony inflation gains and (ii) double taxation given that corporate taxes are already reducing shareholder returns. Then again, the recognition requirement introduces a substantial deferral benefit (along with the concomitant risk that the tax consequence will deter recognition). Not easy stuff, but certainly substantially lower ordinary rates would render the case for a disparate rate far less compelling – we had that for a brief shining moment after the 86 Act because ordinary rates were capped at an acceptable 28%.

In any case I have long thought that taxes on consumption need not be regressive. How’s this for a thought:

Start with our current income tax. Repeal all deductions for retirement contributions except individual IRAs. Expand the IRA concept so that there are no limits on contributions and withdrawals can occur in any year without penalty. Upon death everything left is deemed withdrawn and taxed. Basically, this is a classic expenditure tax (ala Kaldor, William Andrews, and Sam Nunn) that ensures a tax upon one’s deemed final withdrawal, and as such lifetime income is taxed as spent. No more need for an estate and gift tax. Progressivity via graduated rates are preserved, and neutrality as between the decision to save and consume is achieved (i.e., no more discrimination against saving/investing). And no need to start over with a new tax that no one knows how to administer (e.g., Fair Tax). Not perfect -- since still no corporate/personal income tax integration, and the vexing problem of cap gain/ordinary income disparity remains unresolved (as might be appropriate), but better?

Posted by: Mike Petrik | Mar 5, 2015 1:29:57 PM