Monday, February 27, 2012

A capital gains tax argument I've never quite gotten...

Ira Stoll brings it up, which is the impetus for this post. But I've never quite understood the "don't tax capital gains because it's double taxation" logic.

What's so special about financial assets? I've taken my money (which is taxed when I earn it) and spent it on graduate education (not AU, that's covered - but GW). I now own some human capital. I invested in that human capital because I expected a return on it. That return that I earn comes in the form of more wages, which get taxed at income tax rates. What's so special about financial assets that returns on those assets should get taxed at a lower rate? I don't get it. Why is it that everyone pretends capital gains are not part of your return on investment? When it comes to thinking about capital gains taxes. From an accounting perspective the "double taxation" point is really strange. What income isn't from other income?


  1. I am puzzled by this post.

    Do you want your human capital to be taxed? That would certainly even things out.

    Perhaps there is something about the US tax code I don't understand here.

    1. But the returns on human capital are taxed, and nobody fusses over double-taxing. A big chunk of the returns on investment are not only taxed at a lower rate, but then people complain that it's double-taxing. And maybe I'm misunderstanding here - I should add to the fact that I'm not a finance expert that I'm also not a tax expert. But the argument has always struck me as bizarre.

      What's even stranger is that when you sell your assets within a year, you ARE taxed at the same rate as income for precisely this reason. So why, when we come to assets sold after more than a year, is this "tax at the same rate as income" not valid?

      I'm not even saying we need to hike up the capital gains tax... I'm just saying this concern has always confused me.

  2. Daniel,

    Perhaps the tax laws are different in the US. In the UK and Ireland taxes are paid on income from capital such as shares and interest on bonds and bank accounts. That normally happens at a lower tax rate than the top rate (in Ireland it's 30% the top rate of tax is 41%). Capital gains are also taxed separately at 30%.

    I'd agree that the "double taxation" aspect of this is complex. To begin with there isn't double taxation beyond that on top-rate income tax if the sum of income tax and capital gains tax is less than the top rate. That's what happens with first houses which aren't subject to capital gains tax.

    Also, if a person can arrange for all their taxable gains to be capital gains then they can avoid the income tax aspect. The same goes for income tax if they can avoid all capital gain. Of course, that's not always possible.

    It's an interesting question if double-taxation is avoided overall. That is, how does the weight of these taxes fall?

  3. It's quite simple in fact. The idea is that capital gains are paid out of corporate profits and that you already own the profits when the corporation makes them. So really, the payment of dividends is just shuffling money around. It was already your money, you just moved it from your "stocks" account to your checking account. It would be quite absurd to tax your flow between your savings and checking accounts and so the same logic applies here.

    On the other hand, your salary wasn't yours until after it was paid to you.

    But I agree it's a weird argument. (And I just don't see how it applies outside of dividends) Why would it matter in how many steps the government takes its cut? The size of the cut it takes is the important bit. IMHO the good arguments (as in sound, not persuasive) in favor of reduced capital gains taxes are about encouraging capital formation. (Or an argument that the total rate is too high)


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