In an article I wrote last month, Is There A Just Tax? , I presented the case for basing government revenue on what is known as a Land Fee. In a better world, this would seem to be the singular tax that could be instituted fairly and without detrimental effect to a healthy economy. Income, sales and property improvement taxes all have substantial problems and instill negative effects on an economic system.
But let's face it, taxes of all shapes and colors have become a way of life and sadly are more likely to stick around than to go away. So practically speaking, anything we can do to existing taxes to reduce their negative impact and to impart a sense of justice and equity is a definite improvement. Bawling about government thievery and abolition of all taxes is well and good and arguably justified, but as the saying goes; big journeys start with little steps.
Capital gain is a profit received from the ownership and subsequent sale of a capital asset. A capital asset is an asset that is held in the course of doing business. Stocks, bonds buildings or income producing property could all be considered capital assets. The intent must be to earn income.
Apparently, it is bad to profit from fun as far as the IRS goes; hence, vacation homes and escort services are not usually recognized as capital assets by the IRS unless of course, the vacation home is a "corporate" meeting center and the escort service, is used in the course of doing business. Hmmm!!!!
The Government also differentiates between assets held for business and assets which are bought to be resold. It appears that buying an asset to resell for a higher price is a practice that should be taxed higher than buying the same asset for business purposes and selling it after a specified period for a higher price. Such is the need for the IRS to make simple matters as complicated as possible in order to obscure who is actually paying and what amount they may be paying or not paying, and to hide actual tax rates. Multitudes of accountants and lawyers are appreciative of this type of behavior.
The recent push seems to be to lower capital gains tax rates and the same reasons always crop up. The primary one is always a variation on keeping the capital investment flowing to stimulate the economy. What exactly would capital do if it wasn't flowing? Capital, which exists as a product of the economy, cannot stand on its own. Our present economic situation is recent proof. Its sole purpose and natural function is to perform work within the economy, to complete the cycle of resource, labor and capital. What do they think it would do, take a vacation?
As a matter of fact, yes. Our incessant policy makers fear capital would be used for personal satisfaction, luxury items, second homes or hedonistic expenditures that produce enjoyment rather than what is considered "productive" activity.
The simple ignored logic would be; is it possible to expend and not have an expenditure? If capital has no use other than utility, wouldn't any use be productive? In other words, an investment in pleasure is an investment none the less. The investor receives a return; usually a lot faster than with a "productive" investment and the capital has funded productive enterprises owned by others. Capital has been exchanged and the economy has been stimulated. Personal freedom has been enhanced as the investor made a personal decision based on his own wants and needs rather than a differential in tax rates.
The tax rate of capital does not stop the flow of capital, it simply adds to the cost of seeking the return. The "relative" tax rate is what is critical and this must be on an equal footing with labor and resource.
The other common reason for lowering capital gains tax is the argument that a percentage of capital gain is actually not realized profit but inflation. We must lower the rate to protect the investor from inflation. And where exactly is the wage earner's inflation tax break? His wage is possibly the only truly transparent account in our economy, taxed to the fullest extent and highest rate. Some protection!
The 1031 exchange is what protects the investor taxpayer from capital gains inflation. Basically a form of barter, your old investment can be sold, a new one obtained of equal or greater value and no taxes ensue. If you instead decide to sell and keep the earnings, you can rest easy in the knowledge your investment has compounded through it's lifespan with only a single discounted tax at the time you sell. The laborer or salaried employee has no such luxury. He is taxed almost faster than he earns.
If inflation is truly the concern does it make sense to depress capital gains rates which promotes increased trading of capital assets, subsequently stimulating upward price pressure? Wouldn't it be more beneficial to craft our monetary policy to discourage rather than encourage inflation?
Traditionally, interest is defined as what one receives for loaning out Capital. Interest is treated [as par for the course with many exceptions and complications!] as normal income. This practice seems a bit odd since a vast majority of the principle that earns interest at the local bank is promptly utilized for capital expenditures by whoever the bank deems worthy. And whoever the bank deems worthy, the government usually deems worthy of the lower tax rate. The source of the capital is punished by a higher tax rate while the receiver benefits twice; once receiving the funds and twice with a lower tax rate on profits from the funds. Even if the funds are not used directly for capital assets but instead for a personal asset such as a home, bountiful tax breaks await. Doesn't make a whole lot of sense!
What about double taxation? Hasn't the investor's capital already been taxed? Well, join the crowd, every citizen who has money in his pocket that has not been deposited there illegally, has money that has already been nixed by Uncle Sam! The return or interest is taxed the second time, not the principle which forms the basis. Very similar to the wage earners pocket change which is spent at the local grocery store that pays taxes on the profit they make off the "investor's" original funds.
In the case of the Corporation, what income the Corporate Veil allows the government to see is subject to double taxation. But it is not as simple as that. This is a complicated tangent and deserves to have a dedicated article. If you have a moment and are interested in a look at the legitimacy or illegitimacy of corporations within a free market, you can link to my article, Corporations and the Free Market
The economy has three principle building blocks, Resource, Labor and Capital. Everything else is a combination or variation of the three. Capital exists only as a result of Labor and Resource; it is the egg of the chicken! As we noted, its only purpose is to be utilized in the economy. In a way, it becomes a "magnifier" of labor and resource. More work can be accomplished in a more efficient way when it is added.
We can only draw taxes to maintain government revenue from one of these three fundamentals. As it stands, we subsidize Resource, Tax the begeebees out of Labor and sporadically and inconsistently tax Capital at a lower, constantly changing the rate. Hence, we use the begeebees out of the Resource, we avoid Labor like the plague and we find creative ways to use Capital following the direction of the tax codes. What follows is resource shortage, outsourcing or avoidance of labor and protected use of capital.
The Revenue Act of 1921 was the first tax legislation that differentiated Capital Gains from Income and bestowed upon it a preferential tax rate of 12.5%. Since then, much time, effort and money has been consumed attempting to influence lawmakers to act in one direction or the other. The tax code has grown to where it could fill a small library.
Taxes are taxing, no doubt about it. Any tax constricts and changes the natural course of an economy. Income tax is particularly effective in depressing activity as it punishes people for taking part in the economy.
But let's face it; our chances of reforming income tax are much greater than our chances of abolishing it, so let's play the odds.
Income is Income, pure and simple. If we are going to institute a tax fairly, it must be applied evenly to all. Singling out one form of income over another is giving advantage to one over another. The closest scenario to zero tax on income is taxing all income, whether it is gain or wage or salary or interest, at the same rate. Any tax will inhibit the economy somewhat, but an evenly applied tax will not favor or benefit one segment over the other.
Current events are unveiling the obvious top heavy effect of too much capital, real or created. Preferential tax rates, exemptions and generous direct subsidies through our monetary policy have bloated the financial segment and corresponding excessive tax rates have constricted the labor segment. We are producing on paper rather than in the fields, factories and shops. This is not some Socialist labor cry but an effort to instill equity into a Capitalistic system. Taxing all income equally will generate the same revenue level at lower overall rates. Business decisions can be made with economic concerns foremost and tax concerns secondary. It would be a step in the right direction.
©2008 Gene DeNardo, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Tuesday, December 16, 2008
Last modified: Tuesday, December 16, 2008
The views expressed in this article are those of Gene DeNardo only and do not represent the views of Nolan Chart, LLC or its affiliates. Gene DeNardo is solely responsible for the contents of this article and is not an employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
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Reader Comments:
Posted By: sommers
Date: 2008-12-17 06:10:39
My view on the subject of taxes, whether they be wage earnings (work income) or capital gains (investing) is a flat tax approach to both. Minimum earnings amounts would be needed for the lower earning workers.
(arbitrary numbers) No ones earnings would be taxed for the first $30,000. All earnings taxed at 20% over that amount. The lower scale workers would pay little or no income tax. The pure 20% with no deductions would be quite fair on the very rich. Soc. Sec. and medicare taxes might need some attention.
Capital gains would be similar, with a minimum of say $50,000 once a decade, to be allowed without taxes. This enables the moderate earners to participate in the capitalist system and not be punished for some nice investing, while not being a vehicle for the super rich.
Of course politicians would not allow this as they would lose much of their power over their constituancy, as they couldn't use tax codes to favor one group over another.
Other opponents, as you mentioned, would also fight this simple system. Lawyers, accountants, real estate interests. ("Americans love their mortgage interest deductions") Average Americans would love a fair simple system I believe. I do not believe we will see it in our lifetime.