Former Fed vice chairman Alan Blinder doesn’t
get it, and neither, frankly, do I.
Why do we have a preference for capital gains in the first place? The main
argument is that lower taxes on capital gains boost investment. But the evidence
on that point is iffy at best, and there are better ways to spur investment,
like, say, the investment tax credit. Besides, lower taxes on capital gains
reduce the tax bills of the rich relative to the rest of us — after
all, they own most of the capital. But in this age of hyper-inequality, shouldn’t
we be making the tax code more progressive, not less?
A far more important objection is that the tax preference for capital gains
undermines capitalism — a system in which capitalists, not the state,
are supposed to make the investment decisions. When I discuss this issue with
my Economics 101 students, I show them an example of a proposed investment
that loses money before tax (and which, therefore, should be rejected) but
which actually turns a profit after tax because of the preferentially low
capital gains rate. (Accountants and tax lawyers live this example every day.)
The government thus induces people to make bad investments.
Justin Fox, on the other hand, says
that "In economic theory it’s pretty clear what a capital gain is and
why you would want to give favorable treatment to capital investment."
And Brad DeLong says
that he’s "’much more sympathetic to the capital gains tax preference
than Alan Blinder is".
The way I see it, when you’re rich enough, you can pretty much always structure
your income so that it turns into a capital gain. (In its simplest form, you
just found a company with a little bit of money, redirect your income into that
company, and then sell the company.) So having a capital gains tax rate much
lower than the income tax rate is tantamount to giving the rich a massive tax
break – even before accounting for the fact that it’s the rich who generally
have capital gains in the first place, and not the poor.
But I’m not an economist, so maybe one of them can explain to me how economic
theory, and/or economic practice, shows that capital gains should indeed be
taxed at a lower rate than income.