Why we do it – II

(See previous post)

There were a number of reasons why I started and promoted my businesses, and why I will start another. Tax planning was not among them.

One of my businesses had outside investors, of the “friends and family” sort. Their reasons for investing were undoubtedly complex. I’m sure they were all aware of the capital gains tax treatment, but only one even thought to ask me what kind of corporation he was investing in, C or S. The rest were clearly not thinking too hard about taxes.

If you look for a rationale behind the special tax treatment of capital gains, one argument that crops up is that it addresses the unfairness of taxing a paper gain that is really nothing more than a change in dollar value due to inflation. But this doesn’t hold water.

As a simple example, my house is probably worth no more today than it was when I bought it, in the sense that the price I could sell it for would purchase no more than it would have twenty years ago. Yet the dollar price is higher today, thanks to inflation, and if I sold and pocketed the difference I could be taxed on that phantom profit. Yes, as a capital gain, the tax rate would be just 15%, but it would be much more sensible to adjust the purchase price for inflation when I figure my tax return, and treat the result as the actual profit or loss.

The other rationale that crops up is that it encourages economic growth when you use the tax code to incentivize people to invest for the long term.

Well, does it?

Here is a graph comparing the top capital gains tax rate with economic growth since 1950:

[This was taken from public testimony given by Leonard Burman to the House Ways and Means Committee earlier this year (pdf).]

I can see two correlations. First, a big change in the tax rate is sometimes accompanied by a temporary, but not lasting, change in the rate of growth. Second, both the tax rate and the growth rate have trended downward together, especially in the last twenty years.

Whatever you might read into this chart, concerning economic growth it doesn’t seem to me much more enlightening than a pig’s entrails. It doesn’t offer any justification for a government policy of deliberately distorting the capital markets by penalizing one form of investment over another.

In other words, certain classes of financial players have convinced Congress that their activities are especially valuable to the nation, and deserve special nurturing. But from my perspective, well outside the lobbyist ecosystem, I can see no compelling reason why all income should not be treated alike for tax purposes, and let the markets sort out whether day-traders should reap a larger or smaller reward than hedge-fund managers.

Can you?

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