Thoughts on Capital-Gains Taxation
The U.S. currently assesses taxes on capital gains, which are profits generated via productive investment. The tax structure is progressive, meaning that higher levels of income are taxed at progressively higher rates. For a single person, capital-gains income up to $39,375 is taxed at a zero-percent rate, income between $39,376 to $434,550 is assessed at 15%, and income over $434,550 is levied at a rate of 20%.
First and foremost, I would like to consider the morality of capital-gains taxation. Let me first assert that investment constitutes an individual putting his money on the line for a venture that may succeed or fail. There are plenty of ventures soliciting investment: private corporations, whether the investment occurs via purchases of publicly-listed stock or direct infusions of liquidity; the U.S. government, via Treasury bonds; hedge funds; gold brokerages; the average shyster; etc. I would also assert that without investment, few ventures would have the liquidity necessary to enter the marketplace (that is where the "capital" in capitalism comes from).
Some ventures are implicitly more likely to succeed than others. Investments in the U.S. Treasury via bonds, even though they may produce a negative rate of return, have a proven track record of stability. Even though you may lose a fraction of a cent on the dollar, you stand little chance of losing the large majority of the principal you have invested.
Restaurants are a different story. According to FSR, 60% go out of business within the first year and 80% of them shut their doors by year five. Someone who invests in a restaurant is legitimately "putting his money on the line for a venture that may succeed or fail," as I phrased it a few sentences ago. It is possible, if not probable, that an investor who writes a $50,000 check for a restaurant will never again see his principal -- let alone investment income. The government provides no subsidy for an investor who loses his shirt, and since corporate welfare distorts economic signals, nobody is complaining.
The inverse also holds true. Why should the government assess a tax on the investor whose $50,000 check generates a profit of $250,000? The investor, by fronting the equivalent of 500 Benjamin-Franklins, made himself eminently vulnerable and he also gave a fledgling business the chance to succeed. There should be no governmental penalty for virtuous behavior of this sort, and the current penalty -- which is shrouded by the term "capital-gains tax" -- is manifestly unfair.
One may concede that the private-equity investor should not be assessed by the government, but suggest that the investor in Treasury bonds -- who is purchasing AAA-rated securities -- should be taxed for his profits. I would be open to this line of reasoning. However, it is important to consider that the purchaser of Treasury bonds is doing everyone a service by pushing down bond yields and making other investment options -- e.g., fledgling restaurants -- more attractive. It must also be noted that the IRS may not have the capacity to accurately discern different classes of investment (at least without intruding into the affairs of each and every American investor, both large and small).
It is also important to observe that investors do not hoard money; they invest. For example, Warren Buffett has a sizable net worth, but that is because Berkshire Hathaway makes money on one investment and then redeploys the proceeds to another company in need of capital. That allows for the consistent augmentation of the investor’s principal.
Reducing or eliminating the capital gains tax would allow investors to take home more of the money they have generated. This would allow them to grace more and more ventures with the gift of liquidity, just as people like Warren Buffett have been doing for decades.
The second thing I would like to contemplate are proposals to index capital-gains taxation to inflation, which have been floating around for years.
Currently, capital-gains taxes assume that the dollar someone invested in, say, gold in 1985 is the same dollar that one can spend at Walmart today. If someone purchased 50 ounces of gold in 1985 at a cost of $327 an ounce, that would constitute an investment of $16,350. Under the current capital-gains schedule, someone who sold those 50 ounces at today's spot price -- $1,686 -- would receive a check for $84,300. The government would assess a 15% tax on $67,950 of those proceeds ($84,300 less $16,350).
Proposals to index capital gains to inflation would assume -- correctly -- that 1985 dollars are not the same dollars that we use today. According to USInflationCalculator.com, a dollar in 1985 had the purchasing power of $2.40 today (using the Consumer Price Index). Thus, 16,350 1985 dollars is actually 39,221 2020 dollars. The government, under current the tax schedule, would assess taxes on only $45,079 of the proceeds ($84,300 less $39,221). The tax bill would be roughly $6,800 instead of nearly $10,200.
While I would argue that capital-gains taxes are unfair, indexing them to inflation would make them fairer. This change would theoretically incentive investment in American ventures, as there would be a multitude of ventures to invest in and nothing dissuading investment (except for, of course, market forces such as risk). Furthermore, if indexing taxes to inflation proves economical, it could open the door for zero-percent capital-gains taxes for all investors, regardless of income.
More investment would mean more capital for American businesses. Corporate balance sheets would grow (they can be assessed at 21%, the U.S. corporate tax rate) and employees and executives would see bigger paychecks (they can be assessed at U.S. personal income tax rates). There could be a Laffer-curve type effect in which tax revenues actually increase as a result of capital-gains taxes being eliminated.
As one of the University of Chicago's essay prompts reads, "[T]he options, as you can tell, are endless."
First and foremost, I would like to consider the morality of capital-gains taxation. Let me first assert that investment constitutes an individual putting his money on the line for a venture that may succeed or fail. There are plenty of ventures soliciting investment: private corporations, whether the investment occurs via purchases of publicly-listed stock or direct infusions of liquidity; the U.S. government, via Treasury bonds; hedge funds; gold brokerages; the average shyster; etc. I would also assert that without investment, few ventures would have the liquidity necessary to enter the marketplace (that is where the "capital" in capitalism comes from).
Some ventures are implicitly more likely to succeed than others. Investments in the U.S. Treasury via bonds, even though they may produce a negative rate of return, have a proven track record of stability. Even though you may lose a fraction of a cent on the dollar, you stand little chance of losing the large majority of the principal you have invested.
Restaurants are a different story. According to FSR, 60% go out of business within the first year and 80% of them shut their doors by year five. Someone who invests in a restaurant is legitimately "putting his money on the line for a venture that may succeed or fail," as I phrased it a few sentences ago. It is possible, if not probable, that an investor who writes a $50,000 check for a restaurant will never again see his principal -- let alone investment income. The government provides no subsidy for an investor who loses his shirt, and since corporate welfare distorts economic signals, nobody is complaining.
The inverse also holds true. Why should the government assess a tax on the investor whose $50,000 check generates a profit of $250,000? The investor, by fronting the equivalent of 500 Benjamin-Franklins, made himself eminently vulnerable and he also gave a fledgling business the chance to succeed. There should be no governmental penalty for virtuous behavior of this sort, and the current penalty -- which is shrouded by the term "capital-gains tax" -- is manifestly unfair.
One may concede that the private-equity investor should not be assessed by the government, but suggest that the investor in Treasury bonds -- who is purchasing AAA-rated securities -- should be taxed for his profits. I would be open to this line of reasoning. However, it is important to consider that the purchaser of Treasury bonds is doing everyone a service by pushing down bond yields and making other investment options -- e.g., fledgling restaurants -- more attractive. It must also be noted that the IRS may not have the capacity to accurately discern different classes of investment (at least without intruding into the affairs of each and every American investor, both large and small).
It is also important to observe that investors do not hoard money; they invest. For example, Warren Buffett has a sizable net worth, but that is because Berkshire Hathaway makes money on one investment and then redeploys the proceeds to another company in need of capital. That allows for the consistent augmentation of the investor’s principal.
Reducing or eliminating the capital gains tax would allow investors to take home more of the money they have generated. This would allow them to grace more and more ventures with the gift of liquidity, just as people like Warren Buffett have been doing for decades.
The second thing I would like to contemplate are proposals to index capital-gains taxation to inflation, which have been floating around for years.
Currently, capital-gains taxes assume that the dollar someone invested in, say, gold in 1985 is the same dollar that one can spend at Walmart today. If someone purchased 50 ounces of gold in 1985 at a cost of $327 an ounce, that would constitute an investment of $16,350. Under the current capital-gains schedule, someone who sold those 50 ounces at today's spot price -- $1,686 -- would receive a check for $84,300. The government would assess a 15% tax on $67,950 of those proceeds ($84,300 less $16,350).
Proposals to index capital gains to inflation would assume -- correctly -- that 1985 dollars are not the same dollars that we use today. According to USInflationCalculator.com, a dollar in 1985 had the purchasing power of $2.40 today (using the Consumer Price Index). Thus, 16,350 1985 dollars is actually 39,221 2020 dollars. The government, under current the tax schedule, would assess taxes on only $45,079 of the proceeds ($84,300 less $39,221). The tax bill would be roughly $6,800 instead of nearly $10,200.
While I would argue that capital-gains taxes are unfair, indexing them to inflation would make them fairer. This change would theoretically incentive investment in American ventures, as there would be a multitude of ventures to invest in and nothing dissuading investment (except for, of course, market forces such as risk). Furthermore, if indexing taxes to inflation proves economical, it could open the door for zero-percent capital-gains taxes for all investors, regardless of income.
More investment would mean more capital for American businesses. Corporate balance sheets would grow (they can be assessed at 21%, the U.S. corporate tax rate) and employees and executives would see bigger paychecks (they can be assessed at U.S. personal income tax rates). There could be a Laffer-curve type effect in which tax revenues actually increase as a result of capital-gains taxes being eliminated.
As one of the University of Chicago's essay prompts reads, "[T]he options, as you can tell, are endless."
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