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Tilting at Windmills

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June 26, 2007
By: Kevin Drum

KEEPING IT REAL....Matt Yglesias endorses Ron Wyden's tax plan today, and I might join in if I had the slightest idea what Wyden was proposing here. Unfortunately, "All Americans should be able to complete their taxes in an hour or less" isn't a proposal, it's populist nonsense. The modern world has lots of complex ways of making money, and if you choose to earn your money in one of those complex ways there's really no alternative to having a complex tax code to handle it.

Furthermore, although I hate to do it, I have to take issue with Matt's suggestion that "all income should be taxed according to a single rate schedule. Right now, capital income is taxed much more lightly than labor income, which is great if you're rich, but otherwise not such a hot idea." I agree, but I think this requires a caveat.

The problem with investment income is that it gets eroded by inflation. Suppose, for example, that you have $100, the inflation rate is 5%, your return is 8% (3 points higher than inflation), and the tax rate is 30%. Here's what happens.

At the end of the year you have $108, which makes your total income $8. At a 30% tax rate you have to pay $2.40. However, your inflation-adjusted income was only $3, which means that your effective tax rate is 80%. That's a bit steep, no?

Taxing capital income at the same rate as labor income seems like basic fairness to me. But that needs to be a real rate, which means including an inflation adjustment of some kind. Of course, that also means adding some complexity to the tax code. Sorry, Ron. Alternatively, you can do a quick and dirty adjustment by taxing capital gains at a lower rate and figuring that that's close enough. But you really have to do something.

Kevin Drum 5:52 PM Permalink | Trackbacks | Comments (81)

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Comments

"The problem with investment income is that it gets eroded by inflation."

Damn. And I always thought it was a problem that wage income was eroded by inflation. Silly me.

Posted by: tedb on June 26, 2007 at 6:01 PM | PERMALINK

Are you saying inflation is considered in wages? Especially low wages which have not changed in ten years. Do we get to pay less taxes on wages in high inflation? Does inflation calculation even begin to reflect the real world.

Inflation can erode the income for the wealthy enough to have investments as it does low wage earners who have nothing now much less the future.

Posted by: Yoduuuh on June 26, 2007 at 6:03 PM | PERMALINK

Kevin can you explain to a person that made $8 mowing a lawn, why they shouldn't get the same benefit? Say you only made $8,000 in a year. You were impacted by inflation just as much as the person with investments, and you had to work for that $8,000. This is Cato/Heritage B.S. and you should know it...

Posted by: mdana on June 26, 2007 at 6:04 PM | PERMALINK

I agree that the idea that *all* Americans should be able to complete their taxes in an hour or less is silliness.

Heinlein did propose that all laws, including and especially tax laws, should be understandable to anyone with a twelfth-grade education. I think that might be a better goal.

Posted by: Wapiti on June 26, 2007 at 6:05 PM | PERMALINK

I don't buy the idea that income from investments hsould be adjusted for inflation. Income from wages isn't adjust for inflation before being taxes. I think investment income should be taxed no differently from wage income. The rich shouldn't get a better deal on taxes.

Posted by: beb on June 26, 2007 at 6:08 PM | PERMALINK

Why can't 90% of Americans complete their tax return in less than 20 minutes?

Can't the IRS prepare the tax return of most Americans?

Look at my tax return.

I have a W-2
I have some 1099's for investments.
I pay property tax and I pay mortgage interest.
I give money to charity and the few big donations I make have a tax receipt with it.

All of that paper is with the government.

Why can't we simplfy the return?
1) Increase the standard deduction so fewer people even have to worry about itemizing.
2) Fix the insanity around capital gains. Tax long term gains at one rate and short term gains at another. It shouldn't be 5% as difficult as it is.
3) Get rid of all of the insane phase outs. Why should I have to lose a portion of my personal exemption if I make more than a certain amount? Raise the marginal rate if you want me to pay more taxes; don't make the tax code more complex.
4) Raise the AMT threshold to $100,000 so most people don't even have to think about it.

Then if these ideas cost too much revenue then raise the rates by 1% or 2% to make up for it.

90% of Americans SHOULD be able to do their return in less than an hour.

BTW, the flat tax doesn't make anything any easier.

The problem is calculating 'TAXABLE INCOME'. I defy anyone to define 'taxable income' in less than 100,000 words.

It is easy to define taxable income for most people but cetain people want to play games and we need complicated rules to stop the people from playing those games.

Believe me, I know what I am talking about. My job is creative finance that creates tax losses for corporations.

Posted by: neil wilson on June 26, 2007 at 6:11 PM | PERMALINK

Heinlein:

Great Storyteller? Yes.
Great Political Thinker? No.

Posted by: thersites on June 26, 2007 at 6:14 PM | PERMALINK

coming fresh off Matts blog and a comment in support of taxing capital gains at the regular income rate, I must agree with your point about inflation.
If I invested 100$ 10 years ago and I cash out now for 200$ thats not 100 dollars in profits but 200 minus 10 years inflation adjusted 100$ or considerably less.
The solution: raise the cost basis (the 100$) by the inflation rate (which is historically lower then 5% btway) at the published inflation rate chart printed by the IRS.

I also want to agree with the idea that you should be able to do your taxes in an hour. You should. Instead of relying on private parties to make tax software, the IRS should have a taxpayer website, and you should be able to use their software to do your taxes on an ongoing basis. Complicated? Multiple options? sure, the tax software should handle it. They have a new way of computing "this or that" treatment? then go back and recompute at the new better treatment. If it lowers your taxes then you get a refund in the mail.
It should also allow quick and easy treatment of employee taxes by employers.
And if there are confusing questions with multiple options- then explain it and give options.
It should also allow you to experiment without penalty....

Posted by: Aaron on June 26, 2007 at 6:15 PM | PERMALINK

mdana: If you make $8 moving a lawn, you get paid right now. Your income is $8.

If you invest your money, you get $8 a year from now. In reality you've only gotten $3.

This ain't Cato BS. It's real. If you tax investment income at an effective rate of 80%, pretty soon you have no investment. The technical word for that is "bad."

Posted by: Kevin Drum on June 26, 2007 at 6:21 PM | PERMALINK

The problem with investment income is that it gets eroded by inflation. Suppose, for example, that you have $100, the inflation rate is 5%, your return is 8% (3 points higher than inflation), and the..

zzzzzzz...PARIS HILTON IS FREE!!!

Posted by: haha on June 26, 2007 at 6:22 PM | PERMALINK

If you consider indexing for inflation, you also have to make allowance for the very real benefit of tax-deferred compounding. Wage slaves only get that benefit for a couple thousand dollars in an IRA, but capital gains are only payable on final sale (and investments can be structured to delay that almost indefinitely)

Posted by: ToonArmy on June 26, 2007 at 6:37 PM | PERMALINK

pretty soon you have no investment.

What are they going to do with it instead? Put it in their mattress and lose 5 dollars or spend it on something that is bound to depreciate at an even higher rate?

Just saying. Maybe making money via investments shouldn't be an automatic proposition. Maybe you should have to expend some brain power and time. At least till the gap between the working class and investment class starts stabilizing.

Posted by: B on June 26, 2007 at 6:41 PM | PERMALINK

Kevin's example in the original posting is quite poor and confusing. He's right though. The issue is this: imagine buying a a stock 10 years ago for $100. Let's say that you have to sell it now for $110. That's $10 in capital gains that you will pay taxes on. Of course, given inflation over that 10 year period, you actually lost money, and just to pour salt in the wounds you're going to lose more because of the tax on that $10. THAT'S what Kevin is getting at. Wages don't have this problem unless there is hyperinflation.

Posted by: Noogs on June 26, 2007 at 6:43 PM | PERMALINK

Noogs,

You invested in the wrong stock. You aren't goint to make money no matter what the tax rate is. It happens all the time.

Posted by: B on June 26, 2007 at 6:50 PM | PERMALINK

This ain't Cato BS. It's real. If you tax investment income at an effective rate of 80%, pretty soon you have no investment. The technical word for that is "bad."
Posted by: Kevin Drum on June 26, 2007 at 6:21 PM | PERMALINK

Depends on if they have a choice to invest somewhere else where it's more worth their while. Investors go for the highest yeild with the best risk ratio. Right now, the USA has the lowest risk, because our nation hasn't been bombed into oblivion or taken over in the past 100 years, and spends a huge % of GDP on Defense (and bills the peons the bulk of this money by borrowing it; as opposed to taxing the investors, like everyplace else).

You can't really say that about any other nation. That's why investors, given a choice between investing somewhere else, and investing in US securities, will invest here. It's secure; and it's high yield, compared to anyplace else. For now, anyway.

Posted by: osama_been_forgotten on June 26, 2007 at 6:58 PM | PERMALINK

Here's how you solve that problem, Kevin. You don't tax gains on investments unless the proceeds are used for income. For example, if I have $10,000 in an investment account, and it grows to $20,000, I don't pay taxes on that. If I withdraw $5,000 from my account to spend on food, cars, living expenses, etc., that would be taxed.

This would have several benefits:
1) Make the stock market more efficient. Currently many investors are afraid to sell a stock or mutual fund that's done well because of the capital gains they would owe. This means that people hold on to bad or overvalued companies longer than they should.

2) Treat stock investment gain the same as real estate investment gain. In real estate, you can use the 1031 exchange to flip properties without paying capital gains.

3) Reduce the prevalence of annuities, which by and large, are more expensive and more abused than mutual funds or individual stocks.

4) Eliminate the major tax differences between dividend income and capital gains.

5) Encourage people to save more.

This is a much better deal and would make our tax system fairer and simpler.

Kilroy

Posted by: Kilroy Was Here on June 26, 2007 at 7:04 PM | PERMALINK
Furthermore, although I hate to do it, I have to take issue with Matt's suggestion that "all income should be taxed according to a single rate schedule. Right now, capital income is taxed much more lightly than labor income, which is great if you're rich, but otherwise not such a hot idea." I agree, but I think this requires a caveat.

The problem with investment income is that it gets eroded by inflation.

No, it doesn't.

The income is worth just as much when realized as labor income of the same amount realized at the same time. The only thing inflation arguably affects is the basis value of the investment you needed to make in the past to realize the capital income, but since many investments in the hope of future labor income aren't deductible at all, and those that are tend to be deductible only at the time of the expense, not at the time of the later income (when presumably you would be making more money, paying a higher marginal rate, and therefore, even if not indexed for inflation, the deduction would be worth more), I hardly see why capital gains, favorably treated compared to labor income by the fact that the amount of the initial investment is fully deductible from the realized income in the first place, need any further special treatment, whether it is indexing the initial investment for inflation, or getting favorable capital gains tax rates.

But, in any case, its simply factually wrong to say investment income is "eroded" by inflation as a disadvantage compared to labor income.

Posted by: cmdicely on June 26, 2007 at 7:07 PM | PERMALINK

Good God almight Kevin Drum is a fucking idiot.

Kevin. A Tax is something levied by a govenment on income. There is an actual transfer of money from the income earner to the government.

Kevin. Inflation is not a tax. There is no fucking transfer of money from the income earner to the government by means of inflation.

Kevin. Inflation is inflation. A tax is a tax.


There is an explanation of how and why treating all income the same removes one of the factors driving inflation higher. But for someone like Kevin Drum, who doesn't know the difference between taxes and inflation, it is useless to give the explanation.

Posted by: ken on June 26, 2007 at 7:07 PM | PERMALINK

If your 100 dollar investment earns 8 percent and inflation is 8 percent, after one year you have made zero income. If you get paid 8 dollars for mowing a lawn and the inflation rate is 8 percent, you still made 7 dollars and 41 cents when corrected for inflation.

Posted by: fafner1 on June 26, 2007 at 7:09 PM | PERMALINK

In addition to the inflation issue, there is the problem that investers who buy and hold (particularly small investors with modest regular incomes) would be penalized disproportionately when they do finally cash out.

Taxing $100,000 of capital gains at the marginal rate for earned income, when those gains represent the profit on an investment of a year's duration or less, is quite fair, and likely to have distributional consequences all progressives would approve of.

But what if such a payout represents 25 years of patient waiting? Even if inflation had not eroded the value of these gains, would we really want to tax what is an annualized average of $4,000 of income at the same rate as we do the one-year take of $100,000? I doubt it.

In practice, this patient-investor penalty is often obviated entirely by the homeowner exemption, since a primary residence is the most common sizable instrument for the small investor. But there is no reason to disfavor other instruments (if you want to rent, and build retirement income in equities, rather than owning your primary residence, you ought to be able to do that without a big tax penalty).

A simple solution would be to first annualize any capital gains, and then use the marginal rate for earned income against that annualized number. Even the crudest version of this calculation -- simply dividing the gains by the number of years held -- would be better (certainly fairer and probably more efficient) than both an arbitrarily-lower capital gains rate (as we have now) and an undifferentiated rate for short- and long-term investments.

Posted by: Amileoj on June 26, 2007 at 7:09 PM | PERMALINK

damn there are some people here that need a basic math education.

Posted by: Nathan on June 26, 2007 at 7:13 PM | PERMALINK

How, though, Kevin, do you determine the proper inflation rate?

People work, they get paid that week, next week, two weks, half a month, or next month... People invest... The capitalization is at which point for the taxes?

For Options, the date of the option is given and the date the option is vested is the capitalization that is taxes - not the day you sell the option, which may be before or after that point.

It gets kinda hazy, ya know.

Posted by: Crissa on June 26, 2007 at 7:16 PM | PERMALINK
Taxing $100,000 of capital gains at the marginal rate for earned income, when those gains represent the profit on an investment of a year's duration or less, is quite fair, and likely to have distributional consequences all progressives would approve of.

But what if such a payout represents 25 years of patient waiting? Even if inflation had not eroded the value of these gains, would we really want to tax what is an annualized average of $4,000 of income at the same rate as we do the one-year take of $100,000? I doubt it.

The simple way to handle this is to allow people to voluntary recognize income for tax purpose in advance of its realization, building up a pool of deductions that can be used later to offset windfall income.

This is easier than annualizing capital gains, and allows people whose labor income may be more sporadic because of market fluctuations to smooth their taxes out as well as dealing with the issue of long-term capital gains.

Posted by: cmdicely on June 26, 2007 at 7:21 PM | PERMALINK

So Kevin, would you increase the capital gains tax in deflationary times?
People who invest can do the arithmetic. What's it going to yield in real terms in X years? Worth investing or not? What are the alternatives? And so on. If inflation is rampant, investments can have higher nominal yields.

Posted by: focus on June 26, 2007 at 7:32 PM | PERMALINK
If your 100 dollar investment earns 8 percent and inflation is 8 percent, after one year you have made zero income.

No, you've made $108 income. You've made $8 in profit, and maybe $0 is increased purchasing power, presuming the things you wish to purchase exactly match the basket of goods and services used for the inflation index you are looking at.

But, if I sacrifice something in the hope of future labor income, I don't get to deduct the value of that sacrifice, much less adjust it for inflation, when computing my tax liability for the labor income. So why should I for capital income, other than the fact that those living off their capital income tend to have more political pull, per capita, than those living off their labor income?

Posted by: cmdicely on June 26, 2007 at 7:33 PM | PERMALINK

Being able to complete income taxes in an hour may not be a reasonable goal. But requiring each Senator and Rep to do their own taxes with no more than a calculator or spreadsheet would result in a great deal of worthy simplification.

Posted by: m on June 26, 2007 at 7:35 PM | PERMALINK

Wrong Kevin

Capital gains avoid the tax rate every year until realized ...

Therefore investors are using deferred taxes at no expence ...

Compounded , these deffered taxes multiply gains at the current
15% , whereas inflation only compounds at the current rate , say 5% ...

If one has depreciation it gets even better ...

Sorry Kevin , your economic assumptions are wrong , very wrong !

mckinl

.

Posted by: mckinl on June 26, 2007 at 7:38 PM | PERMALINK

Wrong Kevin

Capital gains avoid the tax rate every year until realized ...

Therefore investors are using deferred taxes at no expence ...

Compounded , these deffered taxes multiply gains at the current
15% , whereas inflation only compounds at the current rate , say 5% ...

If one has depreciation it gets even better ...

Sorry Kevin , your economic assumptions are wrong , very wrong !

mckinl

.

Posted by: mckinl on June 26, 2007 at 7:38 PM | PERMALINK

Kevin,

You are confused, as others have correctly pointed out. Income is income whenever it is received and is never "eroded" by inflation. Cash -- and other assets, too -- may (or may not) be eroded by inflation. If they are, that's tough. Why should taxpayers subsidize a decline in the value of any asset? Erosion of the value of cash may even inspire the wealthy to support fiscal measures to keep inflation under control. Which wouldn't be a bad thing at all.

Posted by: thug on June 26, 2007 at 7:42 PM | PERMALINK

"mdana: If you make $8 moving a lawn, you get paid right now. Your income is $8.

If you invest your money, you get $8 a year from now. In reality you've only gotten $3.

This ain't Cato BS. It's real. If you tax investment income at an effective rate of 80%, pretty soon you have no investment. The technical word for that is "bad.""

If the economy undergoes 3% inflation it's not like your house stays the same- it goes up 3% in value (assuming the housing market tracks the overall economy). If anything income investment is the form LEAST subject to inflation problems because what is pegged to is a the very system that is inflating. Whereas the poor slob getting paid a wage just eats the inflation cost outright, unless they are either wealthy enough to put a fair portion of their income into investments or they are lucky enough to get a cost of living raise every year.

I'm sorry Kevin but you seem to be wrong on this one.

Posted by: Tlaloc on June 26, 2007 at 7:42 PM | PERMALINK

The inflation problem is real, but it's already offset by the fact that you don't realize a gain until you sell. Assume you have an investment that increases by 3% this year, and inflation is 3%, unless you sell, you aren't paying taxes on inflation because you aren't paying taxes at all. I've had years in which I've earned hundreds of thousands of dollars for which I paid no taxes at all. Deferring a tax to the future has a significant value, which offsets the tax on inflation.

Posted by: pj on June 26, 2007 at 7:58 PM | PERMALINK

tax plan for 90% of americans:

declare to your employer # of dependents and also provide social security # of spouse.

bank electronically sends irs your mortgage info payment.

irs sends your employer updated withholding information to reflect mortgage payments and other job info.

at end of year, you get a paper to sign, confirming that the listed income and mortgage deduction they have received is correct. If nothing weird happened, you owe $0 and get a refund of $0.

Posted by: Chris Green on June 26, 2007 at 8:00 PM | PERMALINK

Erosion of the value of cash may even inspire the wealthy to support fiscal measures to keep inflation under control.

They already do -- it's called high unemployment.

Posted by: Disputo on June 26, 2007 at 8:30 PM | PERMALINK

Fine, Kevin, just so long as you allow people to adjust the taxes paid on their monthly paychecks and annual bonuses to account for the erosion of purchasing power due to inflation (perhaps I'm the only one, but my bank account doesn't slowly accrue funds as I work throughout the day), as well as start to treat donations of labor and donations of cash equally when calculating deductions.

However, I have to admit that I am partial to cmd's suggestion of treating labor income as a cap gain on prior investments in education.

Posted by: Disputo on June 26, 2007 at 8:47 PM | PERMALINK

I'd be willing to go along with lower taxes for long term investment income (but not dividend income) if it were for truly long term investments. It is ridiculous to me that holding an investment for one year is considered long term. How about 3 years or 5 years even?

Lew

Posted by: Lew on June 26, 2007 at 9:18 PM | PERMALINK

If I put $10,000 in my mattress and inflation is 5%, do I get a deduction of $500 for the money I lost? No, because I didn't lose money, I lost buying power.

By Kevin's logic, someone with $100 million in (poor) investments who's only making 5% (if that's the inflation rate) and withdrawing the gains to live on should pay nothing on what certainly looks to the average schmuck like $5 million a year in income. According to Kevin, they're making no money at all, though somehow the "no money" is plenty to support a lavish lifestyle.

Posted by: KCinDC on June 26, 2007 at 9:36 PM | PERMALINK

Using this logic, interest income should also be taxed at a discounted rate. This makes sense in theory, but using this logic, any increase in salary I get this year that is not over the rate of inflation should not be taxed. Or, if I take a new job at a lower rate of pay, I should be able to offset this differential against previous years income. It pretty much falls apart at this point. I say tax all form of income equally.

Posted by: sublime33 on June 26, 2007 at 9:40 PM | PERMALINK

Kevin, you are all wet.

As everyone else has already stated, income is income. Period. Doesn't matter if it came from working the fry machine, a gift from your mommy, or from your "investments". You just want a special tax deduction because you don't think your "investments" have a high enough return. Guess what, none of us likes paying taxes, either.

How about having taxes based on more on assets than income? The single biggest outlay of the federal government is the military, which is protecting assets, not income.

Posted by: TT on June 26, 2007 at 9:41 PM | PERMALINK

While I basically agree with Kevin's point about indexing income for inflation, I believe as a basic policy, any gains realized in less than one year should not be indexed. My reasoning is that this will discourage the accelerating churning of capital and encourage investors to look at least six to twelve months ahead and less at the quarter.

If you suffer 80% taxation, perhaps buying a house to flip it in three months doesn't appeal as much as buying and improving and earning income from a property.

Posted by: OKDem on June 26, 2007 at 10:05 PM | PERMALINK

That's a bizarre kind of inflation.

If you passively watched your portfolio appreciate, your eight bucks is unfairly eroded to three. But if you earned your wages by working for it, your eight bucks is still worth the full ammount????

If you're going to multiply and subtract inapproprately, you can come up with all sorts of "unfair" sounding reults.

Posted by: Jalmari on June 26, 2007 at 10:18 PM | PERMALINK

Wait a second, Kevin - Your inflation-adjusted income after one year is not $3. It is $8 times .95 or $7.60. Also, your theoretical example also neglects to take into account "compounding", which means in Year 2 you will earn interest on the Year 1 interest. Further, you assume a fixed rate of return. If you assume that you have the ability to reinvest in a different debt instrument at the end of Year 1, the rate of return on that instrument is likely to be higher. Finally, if you take equity risk, you can earn a much higher rate of return than purchasing a fixed rate (i.e. debt) instrument.

The problem is that too many Americans (perhaps Kevin too) are innumerate as well as being illiterate.

P.S. Wyden's comment about making the income tax code is demagoguery, as 60% of Americans today could file their taxes on Form 1040-EZ, which is already one page. It isn't income that makes the tax code complex - it is the credits, deductions, carryforwards, carrybacks, Section 1031 exchanges, MACRS vs. ACRS depreciation, depletion allowances, etc., etc., etc. that have been written into the Code by and for wealthy individuals, corporations and special interest groups that make it complex. The average Joe/Josephine should be able to do his or her taxes in an hour.

Posted by: The Conservative Deflator on June 26, 2007 at 11:03 PM | PERMALINK

Conservative Deflator -- I think that Mr. Drum's point is somewhat different from yours. Mr. Drum is pointing out that the principal is also subject to inflation; so after 1 year, it takes $105 worth of cash to get the same purchase power that $100 worth of cash had at the start of the exercise. So in that sense, Kevin is right, the increase in purchasing power is only $3 (actually $2.60 in first-year dollars -- $108 * 0.95 - 100).

On the other hand, Deflator is also implicitly making a good point -- the investor has seen an increase in his/her purchasing power of $7.60 in first-year dollars, relative to what he/she would have gotten if he/she did nothing (put the $100 in a non-interest-bearing checking account, for example). So from that point of view, inflation is irrelevant: all of the money we have sitting around is losing its value at the same rate, so the mere existence of inflation shouldn't have any bearing on this issue.

Putting it another way: suppose we tax capital gains and earned income the same way, and the hypothetical investor decides that, with inflation and taxes factored in, he/she doesn't want to invest that money. So he/she keeps it in a non-interest-bearing checking account. After a year, he/she is even further behind, because even though there was no income to tax at 30%, the principal was still eroded by the 5% inflation. So with or without inflation, investing is better than not investing, and higher rates are better than lower rates -- regardless of whether some of the options for investing have a rate of return which is lower than inflation.

And to put it numerically: in the absence of inflation, the investor winds up $5.60 ahead of the non-investor at the end of 1 year. Including the inflation, the investor winds up $5.32 ahead of the non-investor in first-year-dollar purchasing power. Not a huge spread when you look at it that way.

Posted by: PT on June 27, 2007 at 12:21 AM | PERMALINK

Mr. Drum-I don't get your point. What if I shoveled someone's walkway for snow in January and you cash out the same date? Wouldn't I still have lost the purchasing power due to inflation? I don't understand why someone who cashes out an investment at the same time I am getting paid that $8 gets an inflation adjustment and the dumb shmoe breaking his/her back doesn't get the same adjustment.

I shovel someone's driveway for $8 on Dec. 31, you cash out an investment that gives you an $8 return the same date. We both made $8 on the same date, but you get a rebate. I don't understand the logic. I understand the point you are trying to make, but it is an assault on common sense and fairness. Also, as someone mentioned the fact of deflation. Are you proposing investors pay more in those circumstances?

Posted by: mdana on June 27, 2007 at 12:23 AM | PERMALINK

"I don't buy the idea that income from investments hsould be adjusted for inflation. Income from wages isn't adjust for inflation before being taxes. I think investment income should be taxed no differently from wage income. The rich shouldn't get a better deal on taxes."

Kevin did not explain this very well.
The theory is this.
I invest $100 in some asset.
One year passes with 5% inflation.
I sell my asset for $108.
What is my capital gains.

One theory is to say $108 -$100=$8.
The alternative (and this is not unreasonable) is to say that the equivalent of $100 then is $105 is, so the REAL capital gains is only $108-$105=$3.
There is no real equivalent to this wrt wages. The issue of whether wages did or did not rise tracking inflation is an important point, but it is not the same as this point.

You can argue "screw capitalists, let the suffer" but that is not a useful answer. Different types of assets will track inflation in different ways, and if you don't privilege capital gains to allow for inflation, money will be deployed into assets not based on efficiency but rather on tax implications. (Of course that happens now but we are trying to create a system that is less retarded, not one that is simply retarded in a different fashion.)

At first blush Kevin's conceptual idea of providing the basic idea that everyone gets to use real prices as the basis for everything seems like a fine idea that's not too complex, but there's probably some way to exploit it to go against the spirit of what it is trying to do. The issue, of course, is how large is that compared to the epxloitations of the current scheme.

Posted by: Maynard Handley on June 27, 2007 at 12:44 AM | PERMALINK

Let me put it slightly differently.
The issue is not the relative moral status of salary income vs investment income. The issue is what counts as a capital gain.
The system we have right now
* taxes income and
* considers capital gains to be income.

I have already described why the capital gains part of the equation results in the behavior Kevin described.

If you want to strip out the effects of inflation, like so many posters above, then what you are switching to is a tax system based not on INCOME but on WEALTH. Now if you want to do that, go right ahead, but be aware of what the hell it is you are doing. And be aware of the consequences thereof.

If the effective results of inflation on taxes become onerous, the system WILL change so as to result in very little inflation, or better yet, deflation. At all times and in all places it is the WEALTHY classes who want hard money (ie no inflation). It is the poor who have agitated for policies that, explicitly or not, will result in inflation.

Kevin (and I) are not raging plutocrats. We are people who actually understand how and why the current system works, and what the likely consequences will be if it is changed in stupid ways.

Posted by: Maynard Handley on June 27, 2007 at 12:54 AM | PERMALINK

Smith and Jones each has $100 in his mattress. Smith takes his $100 out of the mattress and invests it in some stock. At year's end he cashes out and nets $8. He returns the $100 plus the $8 to his mattress. Jones on the other hand leaves his $100 in the mattress and goes out and mows a lawn one day and earns $8. He puts the money in his mattress. Each now has $108 in his mattress. Why should one man be taxed at a different rate than the other?

Posted by: Dave Howard on June 27, 2007 at 1:14 AM | PERMALINK

The most important tax law change we need is a requirement that all lawmakers fill out their own taxes without professional help.

All else will follow.

Posted by: joel hanes on June 27, 2007 at 2:32 AM | PERMALINK

Now that I think about it, it seems that Kevin must be assuming that over the long haul wages increase (albeit lagging somewhat) with inflation, so that each year's lawn mowing job that Jones does brings him incrementally more than the $8 he made the first year, while Smith's investment continues to earn the same rate of return. (To ensure ceteris paribus Smith must remove each year's $8 at year's end -- otherwise the compounding of interest would distort the analysis.)

Two things become relevant here:

  • the period under consideration must be long enough to outrun the lag time between inflation and average wage increase
  • The amount of wage increase must be comparable to the rate of inflation.

It is easy to see that the shorter the period of time that an investment is held the more like wages its earnings are, and the longer the investment is held the more of a hit it gets from inflation, vis a vis real wages.

This is what Kevin is getting at here:
mdana: If you make $8 moving a lawn, you get paid right now. Your income is $8.
If you invest your money, you get $8 a year from now. In reality you've only gotten $3.

But I gotta say, it could easily take a year to move a lawn, particularly if it's a good sized one and it had to be moved very far. ;)

Posted by: Dave Howard on June 27, 2007 at 2:58 AM | PERMALINK

Ok, how does Kevin's hypothetical situation get around the fact it is still a regressive tax on the worker. The worker is still getting $8 at the end of the year and getting taxed the full amount. There would have to be some sort of sliding scale perhaps a tax on post inflation profits that only allowed half of the inflation rate to be deducted. As many comments have shown there are different ways to measure the "wealth".

I am all for taxing wealth. Wealth is in many ways inefficient. I think that is the reason Democratic policies trump Republican ones in moving the economy. Democratic policies get the money into the hands of the worker who then spends it as quickly and efficiently as possible. Republican policies work to solidify wealth in the hands of the few.

For example, my dad had $200,000 from some stock from a public company that was bought out to revert back to a privately owned company. He sat on it for a few months, deciding if he wanted to buy Summer home or do something else with the windfall. He finally plowed it back into more stocks that he researched. However, for months it was kind of sitting there not really doing anything (I assume he had it in something gaining interest). Yet, if that money had been spread out to 1000 workers with $200 they would have bought lawnmowers, other products and services that would have moved the economy more than his money market or cd would have.

Now, when you get to billionaires like Bill Gates and Oprah (I realize there is a huge discrepancy in their wealth), they have to sit around for months and years deciding how to spend their wealth. They may fund great causes and charities, but that time spent deciding on how to spend that money is inefficient in some ways for the economy.

Posted by: mdana on June 27, 2007 at 3:51 AM | PERMALINK

[IP check reveals banned commenter]

Posted by: Manco on June 27, 2007 at 4:31 AM | PERMALINK

[IP check reveals banned commenter]

Posted by: Manco on June 27, 2007 at 4:37 AM | PERMALINK

Kevin - While I agree with your underlying point that investment income (let's call it what is is - passive income) should be taxed at the same marginal rates as earned income, your example is flawed. No, it is WRONG.

The effective income tax rate, given the assumptions you note, is NOT 80%. It is 31.6% or $2.40/7.60.

It doesn't help the liberal cause to present flawed arguments. The right can just say that liberals don't know what the fuck they are talking about. And in this case, they would be right. How about a retraction or clarification?

Posted by: The Conservative Deflator on June 27, 2007 at 6:48 AM | PERMALINK

I still can't tell if Kevin was talking about the income earned on the capital or about the capital gain secured on the sale of the capital at the end of the period. Also, do we really want to get into a discussion about total return on an asset, which muddies the water even further.

Mr. Drum also forgets that the labor represents a capital input as well - the investment in education and training that a person receives. How do we account for that? The laborer doesn't spring full-blown from the ground through sown dragon's teeth like one's of Cadmus's Spartes.

Posted by: PrahaPartizan on June 27, 2007 at 7:06 AM | PERMALINK

Actually the reformer is calling for a reform that already exists. About three-quarters of all taxpayers use the Short Form, which consists of a few lines, 11 last time I looked, some of which, like "name" and "address" are generally not considered brainteasers.

The rest requires the taxpayer to enter the info on the W2 and do some grade school artithmetic. Even with extreme standards of care, including triple-checking, it's a stretch to fill up half an hour with this labor.

It may take longer to take the return to the Post Office than to fill it out.

Posted by: Edward Furey on June 27, 2007 at 9:10 AM | PERMALINK

Actually the reformer is calling for a reform that already exists. About three-quarters of all taxpayers use the Short Form, which consists of a few lines, 11 last time I looked, some of which, like "name" and "address" are generally not considered brainteasers.

The rest requires the taxpayer to enter the info on the W2 and do some grade school artithmetic. Even with extreme standards of care, including triple-checking, it's a stretch to fill up half an hour with this labor.

It may take longer to take the return to the Post Office than to fill it out.

Posted by: Edward Furey on June 27, 2007 at 9:10 AM | PERMALINK

And this doesn't happen to wage income?

If we're going to propose mandatory cost of living increases in pay for everyone, well ok then. Otherwise, I'm still having a hard time figuring out why this is important.

Posted by: IMU on June 27, 2007 at 9:41 AM | PERMALINK

I think Kevin's point is that investments are more impacted by inflation then are wages. Taxes aren't paid on capital gains until the investment is liquidated, while income is taxed as it is earned. I agree with that point, and would be fine with means testing to determine an inflation-adjusted rate. The "completing taxes in an hour" canard is so tired. There are so many softwareprograms out there that complex tax returns shouldn't be a problem.

Posted by: MeLoseBrain? on June 27, 2007 at 9:50 AM | PERMALINK

Kevin is just plain wrong here. The whole notion of "income" is being misdefined when Kevin factors in the original $100 asset invested in order to earn the income. That is not part of the "income" in any reasonable sense.

Effectively Kevin is advocating an income tax cut based on the inflation-related depreciation of the original $100 in assets invested in order to earn the income. But this is special treatment for capital income over labor income. No income - capital or labor - is earned without investment. It just so happens that it is easier to quantify the $100 amount invested to earn $8 in capital income in Kevin's example. But labor income requires investment too - of time and other valuable assets. When calculating labor income, we don't include the value of all those input assets and then see if they've depreciated to calculate some theoretical "real" income earned.

The income from the investment in Kevin's example was $8, plain and simple. Inflation is affecting the $100 asset as well as every laboring American's assets equally. It is a wash.

Posted by: Liberal Chris on June 27, 2007 at 10:04 AM | PERMALINK

Kevin did not explain this very well.

Yes, he did.

The theory is this. I invest $100 in some asset. One year passes with 5% inflation. I sell my asset for $108. What is my capital gains.

Well, no, the question Kevin was posing was "What is my income that ought to be subject to taxation?"

The question that you overlook that is underlying Kevin's argument (and Kevin mostly avoids it as well, though it is clearly implied) is whether or not "capital gains" are the right basis for taxing capital income in the first place; while that's certainly what we do now, that in itself is a favorable treatment for capital income compared to how labor income is treated, and one without a whole lot of justification besides the desire to treat holders of capital better than workers.

One theory is to say $108 -$100=$8.

Well, yeah. We call that "theory" basic arithmetic.

The alternative (and this is not unreasonable) is to say that the equivalent of $100 then is $105 is, so the REAL capital gains is only $108-$105=$3.

I would argue that it is, indeed, unreasonable. Had you not used the $100 to buy an asset, but kept it around as cash, it would still be $100, not $105. The gain realized by investing is clearly and unquestionably $8, whether you are looking at the nominal gain or the purchasing power gained by investing vs. holding cash.

It is also pretty clear that the income is $108, not $8 or $3, and that taxing based on something less because of the purchase price of the asset, whether indexed or not, is effectively giving a deduction to taxable income.

There is no real equivalent to this wrt wages.

Sure there is. People invest money in order to enable them to earn labor income as well capital. They do this by investing in schooling, paying to take certification exams, etc.

When they do this, quite often they receive no deduction of any kind for tax purposes. When there are deductions, they are generally taken at the time the money is spent, not against the higher income they enable later, and often have strict eligibility limits based on income and other factors.

They certainly don't get to deduct the full value of the investment against later income, and they even more certainly don't get to do that plus adjust it for inflation. There is an equivalent for labor, there just is no similar treatment in the tax system, because we tax labor income but capital gains.

But even if taxing capital gains is reasonable (I think it is, so long as you are taxing at the same rate as labor income), the right gains to tax are the nominal gains, since those are also the real gains in realization-year dollars when compared to holding cash.

You can argue "screw capitalists, let the suffer" but that is not a useful answer.

Treating capital fairly doesn't screw capitalist (well, it does in comparison to the existing system which is tilted heavily in their favor, but the mere existence of injustice is not an argument for its perpetuation.)

Different types of assets will track inflation in different ways, and if you don't privilege capital gains to allow for inflation, money will be deployed into assets not based on efficiency but rather on tax implications.

That doesn't make any sense. Taxing based on the nominal gains of gains vs. an inflation-adjusted base value doesn't change the relative value of investments.

At first blush Kevin's conceptual idea of providing the basic idea that everyone gets to use real prices as the basis for everything seems like a fine idea that's not too complex, but there's probably some way to exploit it to go against the spirit of what it is trying to do.

As with regular capital gains, its a subsidy to things that are treated as capital gains rather than other income, even if they are essentially equivalent. The difference is that the magnitude of the subsidy may be harder to estimate in advance, since instead of guessing future income tax policy changes, you have to guess future inflation rates.

The issue, of course, is how large is that compared to the epxloitations of the current scheme.

The bigger issue is why have a capital subsidy at all? People with sufficient wealth are going to invest even if capital gains are unsubsidized, and people without sufficient wealth are not going to invest significantly even if capital gains are tax free. Any subsidy to capital is, in practice, a burden on the less wealthy paid for, in the long-run, either by reduced services or increased taxes on non-capital income. There is no cause for such a subsidy.

Posted by: cmdicely on June 27, 2007 at 10:54 AM | PERMALINK

This is arguing about how many angels can dance on the point of a needle.

We have an outrageous system where capital gains taxed at a max of 15%, and labor income at 35%. Even a Gilded Age Robber Baron would blush at it. Numerous studies have shown that the argument that the capital gains rate encourages investment is bullshit.

Inflation, inshmation. Fine. Labor income at 35% and capital gains at 30%. I'll but it. When are they changing the tax laws?

Posted by: alex on June 27, 2007 at 11:02 AM | PERMALINK

The benchmark against which all investments are measured is risk free U.S. treasury bills. They yield 5% and inflation is 3% for a real return of 2% yet the nominal 5% is taxed. By Kevin's argument, "pretty soon you have no investment." Of course we know this is false because trillions of dollars are invested in treasury bills.

It is a completely arbitrary decision to compensate inflation for a certain class of investments. The markets are fully capable of adjusting for inflation as evidenced by the difference in yields for long and short bonds.

And as others have pointed out, the tax deferral of capital gains is a very real benefit to the investor and a major factor in favor of the buy and hold strategy. This offsets the inflation penalty to some extent. In fact, one could argue that this tax deferral is actually a negative market factor that leads to inefficient allocation of capital by hindering the buying and selling of investments.

Posted by: BillS on June 27, 2007 at 11:25 AM | PERMALINK

Why should the government tax my capital gains at a percentage equivalent to my wages when it does not partner with me when I lose? If I take a risk by investing $100 and lose it all, where's my subsidy? After all, wages are paid now and reasonably risk-free. If the government wants to tax my at-risk capital at the same rate as my near riskless wages, it should subsidize my losses.

Posted by: Henry on June 27, 2007 at 11:33 AM | PERMALINK

Another way of looking at it is that equity investments are preferable to U.S. treasuries only to the extent that there is a "equity risk premium". Treasuries are taxed at the full rate without inflation adjustment. On the other hand, Kevin is arguing that the equity risk premium is incapable of effectively compensating for inflation and that it is necessary for the government to step in to artificially manipulate the inflation risk factor for equities. This seems to be a major indictment of free market principles.

Posted by: BillS on June 27, 2007 at 11:38 AM | PERMALINK
Why should the government tax my capital gains at a percentage equivalent to my wages when it does not partner with me when I lose?

1) It does "partner with you when you lose", by providing you a capital loss deductible against capital gains and even, to an extent, against other income, even though that other income is taxed at a higher rate than capital gains.

2) It doesn't, OTOH, partner with you when you invest money in the hopes of greater labor income and that doesn't pan out. So, really, this "doesn't partner when I lose" argument is a better argument for not taxing labor income as heavily as capital income than it is for the reverse.

If I take a risk by investing $100 and lose it all, where's my subsidy?

Here.

After all, wages are paid now and reasonably risk-free.

So is capital income. Expenditures in the hopes of future capital or labor income are, however, risky in both cases, the difference is that if the expenditure is in the hope of future capital income, if it does pan out you get to deduct the expenditure from the realized income and get taxed at a preferential rate on the gains, and if it doesn't pan out, you get to deduct the loss from other capital income, or even from more heavily taxed non-capital income.

Whereas, with expenditures in the hopes of labor income, they are generally not deductible at all, though some are partially and conditionally deductible, subject to income and other eligibility limits, at the time of the expenditure.

If the government wants to tax my at-risk capital at the same rate as my near riskless wages, it should subsidize my losses.

The government does subsidize your capital losses, unlike investments in the hope of greater labor income that don't pan out.

Posted by: cmdicely on June 27, 2007 at 12:07 PM | PERMALINK

Henry, cmdicely,

In my opinion there is another factor here as well, a factor which makes the current treatment of labor income even less fair. For a very large number of possible investments, particularly large investments, a great deal of Federal assistance is needed for the investment to have much value, and to retain that value. Consider investing in anything where the value is tied to copyright or trademark. Remove the Federal protection of trademark and copyright and the value largely goes away. Likewise any investment in any large financial institution requires that the institution have the backup of the Justice Department, FBI and Federal penal system to insure that the officers of the financial institution handle the assets properly. Any investment overseas needs to have the security provided by the US State Department and the Military. These are certainly services of great value provided by the US Government that are needed to secure the value of capital investments. Many others could be listed. I can think of nothing similar that is provided directly to help insure the value of anyone's labor income. I would agree that labor income does not seem to need services of this type, and of this value, but that is irrelevant to my point. Capital investment needs these services and they are provided automatically by the government. So the further subsidy of capital investment is the provision of these services free of charge if your investment does not pan out.

Posted by: MSR on June 27, 2007 at 12:42 PM | PERMALINK

Henry

Don't drink so much before you post here, it's embarassing.

Posted by: tomeck on June 27, 2007 at 1:14 PM | PERMALINK

Yet one more refutation of Kevin's theory that taxing capital gains at ordinary rates will discourage investment. Your 401k and traditional IRAs are investments that may be held for very long periods, enduring 40 years or more of inflation, and are taxed at withdrawal at ordinary rates. Yet millions of people prefer to invest in these vehicles rather than taking advantage of the favorable capital gains treatments of taxable accounts. The advantage of tax deferral outweighs the advantage of a lower capital gains rate. Kevin's theory is clearly wrong.

Posted by: BillS on June 27, 2007 at 1:45 PM | PERMALINK

Smith and Jones each has $100 in his mattress. Smith takes his $100 out of the mattress and invests it in some stock. At year's end he cashes out and nets $8. He returns the $100 plus the $8 to his mattress. Jones on the other hand leaves his $100 in the mattress and goes out and mows a lawn one day and earns $8. He puts the money in his mattress. Each now has $108 in his mattress. Why should one man be taxed at a different rate than the other?

The two situations are not the same. Jones didn't have to shove his $100 into a mattress and let it sit there for a year. He could go out and buy goods that are worth $100 to him. Smith does not have that option, since he has invested the money. One year later, Jones has spent the year enjoying goods that would now be worth $105 to replace, so Smith is only better off than Jones by $3 when he collects his $108 (we can ignore the $8 wages income, which both Smith and Jones are free to earn over the year). It is therefore reasonable to argue that only this additional $3 should be taxed, especially if you don't want to discourage profitable investment.

Posted by: Nickyg on June 27, 2007 at 1:45 PM | PERMALINK

Even if captal gains should be inflation adjusted, a captal gains rate is not the way to do it. If that asset was some high-flying stock and you sold it for $150 instead of $108, the inflation-adjusted income should be $45. But paying a 15% rate on the $50 comes nowhere close to recognizing that proberly.

Inflation, you might argue, is still a factor, when the return is low (like the 8% example), and the holding period is long. But even that argument is misses the point. Consider another example:

What if you put the money into an 8% interest bearing bond or CD instead of a CG asset? Should you then be entitled to treat it as an inflation-adjusted 3% return or apply an artificially low tax rate? What if you left the interest to be reinvested and accumulated (like a capital asset)? Does that give it even more entitlement to special treatment?

Most reasonable people would say that's going too far, and really not necessary. Why? Because the tax rates themselves are implicitly inflation-adjusted -- by NOT being inflation-adjusted. We simply take inflation into account when we make investment decisions. The rates are what they are, inflation or not.

You see, the investor chooses to hold property assets versus ordinary income producing assets, implicitly taking tax effects and inflation into account. She does not wake up one day 20 years later and discover that she "wuz robbed by inflation". She knew it all along and if it were a problem she'd make other investment choices.

Only in the wet dreams of a capitalist is inflation on capital assets a problem requiring tax relief. But I would argue that it's the poor people, the wage earners, who are most hurt by inflation. Prices go up, but their wages don't.

That said, I am not insensitive to the issue. The problem of inflation erosion becomes most evident when the asset is personal -- not held for income or profit. That's where the tax code is unfair. The best example is your personal home. If every time you moved you had to lose a bedroom to the tax collector, that's unfair. It's unfair because you didn't intend to make a profit. But we already deal with that with the home re-investment rules and the homestead exemption.

Another place where it is a problem is at death, when a going business might be hit with estate taxes on the appreciation of its capital assets, forcing it to sell and go out of business. But that doesn't seem to be as much of a problem in real life. Statistics show that it rarely occurs. The problem, if any, might be better resolved in the estate-tax code, not the internal revenue code.

Posted by: bob on June 27, 2007 at 1:47 PM | PERMALINK

Good grief! I hope all of you use accountants.

Kevin is pointing out that inflation erodes the principle in an investment. When talking about capital gains, only the real gain should be counted as income. What is real gain? Real gain is that gain minus the increase in price of the asset caused by inflation. If you invest $100,000 and, at the end of the year, the asset is sold for $110,000, but inflation alone was 10%, your net worth has not changed- you have earned no real income, but at a 25% tax rate that does not account for this, you owe a $2500 in tax. You have suffered a net real loss in purchasing power of $2500.

Dividends should be treated the same as labor income as long as the dividend is not taxed twice.

Now, to address the effect of inflation on labor income. Let's us suppose a worker makes $100,000/yr and pays a 25% rate overall- in year 1 he pays $25,000 in taxes. In year two, he gets a 10% raise to $110,000, still pays at a 25% rate, so his tax burden is $27,500, giving him a net nominal raise of $7500 to $82,500. The question is, what has happened to his purchasing power? His purchasing power is unchanged if inflation was 10% for the time period. In other words, he had no real gain in income after taxes. This situation is different from the case of capital gains in which the owner of the asset had a negative real gain in income after taxes.

If you want a property tax on assets, then make it an explicit one.

Posted by: Yancey Ward on June 27, 2007 at 3:11 PM | PERMALINK

I'll tell you what's still bothering me about this. If the argument is that capital gains loses due to inlfation, doesn't normal savings account interest as well? And often times, savings account interest for the year will actually be lower than inflation. And we still have to count it as part of standard income.

Posted by: James G on June 27, 2007 at 6:00 PM | PERMALINK

It doesn't matter to me. Nearly all of my capital gains are offset by losses that occur through depreciation. I recently sold all my 1990's era collector video games at a loss -- and when roto-rooter pumped my septic tank they actually charged me for the fertilizer they removed. Several thousand dollars a year in food and alcohol costs that were not recouped.

Posted by: B on June 27, 2007 at 7:06 PM | PERMALINK
Your 401k and traditional IRAs are investments that may be held for very long periods, enduring 40 years or more of inflation, and are taxed at withdrawal at ordinary rates. Yet millions of people prefer to invest in these vehicles rather than taking advantage of the favorable capital gains treatments of taxable accounts. The advantage of tax deferral outweighs the advantage of a lower capital gains rate.

While this is true for retirement accounts, they are something of a special case that makes deferment particularly valuable: retirement accounts are vehicles for investment during high-labor-income years that are liquidated during low-labor-income years ("retirement"), and thus deferment often allows you to reduce the portion of your income taxed at a high marginal rate.

Posted by: cmdicely on June 27, 2007 at 9:15 PM | PERMALINK
If you invest $100,000 and, at the end of the year, the asset is sold for $110,000, but inflation alone was 10%, your net worth has not changed

If we aren't giving tax deductions for people holding savings accounts, cash, etc., then we shouldn't be inflation-adjusting basis values of stocks, real estate, and other artificially-designated "capital" assets (not that they aren't capital assets, just that lots of things that don't get special tax treatment are too) that are liquidated for gains.

Posted by: cmdicely on June 27, 2007 at 9:21 PM | PERMALINK

Those who criticize Kevin's correct reasoning on using inflation to calculate capital gain income: Your mistake is to consider "the dollar" as a proper unit of measure from one year to another, as if it were the "meter" in physics. But dollars are not equivalent from one time to another. If I buy some shares for what is called "100,000" dollars in 1987, then resell the shares for what is called "120,000 dollars" in 2007, the effective meaning of "dollar" has changed between those times. It is as if "the meter" had shrunk during those twenty years. Why not properly adjust for the changing magnitude of *the unit of measure*? The kicker is, just imagine renaming dollars in that period of the past according to the same purchasing power they have today (and the "dollar" has no meaning except as a medium of exchange.) We should even, for thinking about it, rename them dollars(1987) and dollars(2007), with a conversion factor that strips away the illusion of identity caused by name and convention. Then, we would say I spent maybe around 200,000 dollars(2007) and sold for 120,000 dollars(2007), and so had a loss of 80,000 dollars(2007).

Again, suppose there had been no inflation, all else being equal. Then the numbers used to track the difference in "dollars" between those twenty years would be 100,000 and 60,000, which is a loss of 40,000 we would all agree. But that is the same loss already calculated in the inflated later dollars - proving the point. You should get this.

Posted by: Neil B. on June 27, 2007 at 10:23 PM | PERMALINK

Neil,

I think we get capital gains and inflation and the fact that changing the tax status of investment vehicles will affect investment choices.

What's not obvious is what a fair tax structure is, what the macroeconomic effects of proposed changes are, how quickly we might be able to transition safely, etc.

Posted by: toast on June 27, 2007 at 11:09 PM | PERMALINK

One problem with Kevin's simplistic model is that people who invest in capital goods during times of inflation can easily leverage that inflation to make even more money.

Typically, in a 100 dollar investment (for example a very cheap apartment building) the investor puts up only 10 dollars. He actually makes money on inflation of real estate because after a time period, the value of the property is 105 dollars...which is mostly inflation. But since his investment was 10 dollars, his profit is 50%.

The investor knows that the property is going to inflate and so he uses leveraging to make money on that information. There is no particular reason to say that the 5 dollars that he earns is somehow not five dollars (ok $4.75) in profit.

Of course I am not taking into consideration his probable postive cash flow and the fake depreciation (his asset is probably appreciating, not depreciating) that the tax code gives him.

Posted by: RobbL on June 27, 2007 at 11:18 PM | PERMALINK

cmdicely,

So what? Step up the basis for those other asset classes that entail taxable gains. I was not limiting the step up to stocks or real estate.

As for people losing purchasing power from holding cash during inflation, then do something about the inflation, or at least advocate doing something. We could try giving people a tax credit for the lost value, but this is almost the equivalent of stopping inflation at its source, so why not start there?

But an income tax should be a tax on income. If you want to tax capital, then advocate an explicit asset tax, don't do it through underhanded methods like taxing inflationary gains, especially when inflation is completely controlled by the government itself.

Posted by: Yancey Ward on June 28, 2007 at 9:31 AM | PERMALINK

If you want to tax capital, then advocate an explicit asset tax, don't do it through underhanded methods like taxing inflationary gains

Last time I sold some of my Dad's old cars it occurred to me that we already tax capital. If you hold an asset for 50 years you're far better off dying and letting your relatives recalculate the basis.

That said, I think some sort of independent truth in naming commission would be useful. I'd make it apply to Bush's environmental proposals, military campaigns in Iraq, and California ballot measures.

Posted by: B on June 28, 2007 at 11:11 AM | PERMALINK
So what? Step up the basis for those other asset classes that entail taxable gains.

Plenty of assets that are clearly capital assets do not involve taxable capital gains, they are instead taxed as income when their value increases (i.e., interest-bearing accounts) and while there are assets that are clearly capital assets.

As for people losing purchasing power from holding cash during inflation, then do something about the inflation, or at least advocate doing something. We could try giving people a tax credit for the lost value, but this is almost the equivalent of stopping inflation at its source, so why not start there?

I agree. Of course, this also applies to non-cash assets, equally. If the problem is people losing value to inflation, deal with inflation. Inflation-adjusting basis value for capital gains tax purpose is simply an unwarranted subsidy to capital, on top of the subsidy that arises from taxing capital gains rather than capital income, in which the purchase value of investments in hope of future capital income is deductible from that income when realized, a fact that is not true of many investments in hope of future labor income.

Posted by: cmdicely on June 28, 2007 at 11:12 AM | PERMALINK

cmdicely,

The expensing of capital costs also benefits wages and salary, so it is not subsidy to capital owners alone, and wages and salary are also deducted from revenue, thus benefitting those directly as well.

You won't get much of an argument from me that certain costs should be deductible for labor wages. For example, transportation to and from work, educational expenses, etc.

So, I can put you down as a supporter for stable money? For some reason, I doubt it.

Posted by: Yancey Ward on June 29, 2007 at 1:28 PM | PERMALINK




 

 

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