The Capital Gains Tax Rate is too Low

I will never be one to “punish” people for becoming wealthy. I don’t believe that obtaining wealth is some type of sin. But when Warren Buffet speaks, I tend to listen. In 2010, Warren Buffet paid $6,938,744 in taxes, which was a 17.4% effective tax rate. His tax rate was lower than any of the 20 other people in his office. In his op-ed, Buffet claims that he and his friends “have been coddled long enough by a “billionaire-fiendly Congress” and calls to a tax increase on those making more than $1 million, and an additional increase on those making more than $10 million. This increases would affect 250,000 households.

If you’ve been following the presidential campaign of 2012, then you have probably seen capital gains being discussed. A lot of this stems from the tax rates that President Obama, and particularly Presidential Candidate Romney have been paying. In 2011 Obama paid a 23.37% tax rate ($184k in taxes on an AGI of $789k). While not as low as many super wealthy, it’s still considerably less than someone earning $150,000 working a normal daily job with no capital gains. Last year I paid a 22.2% effective tax rate. However, Romney’s tax return shows that he has kept his tax rates quite a bit lower by taking advantage of low capital gains tax rates. Last year Romney paid a 15.4% tax rate, and claims that he hasn’t paid less than 13% in the prior ten years, although he won’t release any prior returns.

Obviously, taking advantage of capital gains and paying a lower tax rate isn’t a crime. But that doesn’t mean that the capital gains tax rate should be kept so low. And frankly, I’m not quite sure why some people support the tax rates. Okay, actually I do. I’ve heard the same soundbites and arguments. I used to believe them. But over time, some of my philosophies have changed and I prefer to look at the data rather than the theories or soundbites. We all know that the government has some current revenue and spending imbalances that have to be corrected. To help increase tax revenues, President Obama has proposed extending the bush-era tax cuts for households making less than $250,000, while allowing them to expire for those making over $250,000. This would increase the capital gains tax rate from 15% to 23.8%.

I understand why people making $260k aren’t big fans of this proposal. If they’re like many people, they aren’t saving as much as you might think, even with their high income. That means that they aren’t getting significant amounts of their yearly income from investments. But what about those people who do earn a significant amount from investments? I find it difficult to comprehend why someone who earns $500k on investments during a year should pay $75k in taxes, while a world-class heart surgeon should pay $200,000 or more on the same income.

And trust me, I really have heard the arguments…

  • lower capital gains tax rates encourage risk-taking and entrepreneurship
  • lower capital gains tax rates offset double taxation of company profits
  • lower capital gains tax rates would encourage people to move assets to other countries
  • lower capital gains tax rates would decrease tax revenues because fewer people would sell assets with gains

These arguments are dreamed up in order to try to justify a belief that some people have…for whatever reason. Unfortunately, many of these people hold high positions in our government. Paul Ryan, Republican Vice Presidential Candidate, introduced A Roadmap for America’s Future in 2010, which proposed eliminating taxes on capital gains and dividends. Romney, in a debate with Newt Gingrich, said that “under that plan, I’d have paid no taxes in the last two years.”

Here are some facts that I think make the case against low taxes, particularly capital gains taxes, pretty clear:

  • Between 1950 and 2010, in years when the top marginal tax bracket was 25-39%, average real GDP growth rate was less than 2.5%
  • Between 1950 and 2010, in years when the top marginal tax bracket was 39-100% (some years were 90%+), the average real GDP growth rate was above 3.5%
  • Between 1929 and 2009, the correlation between higher overall tax rates and the growth rates for that year and the next has been positive.
  • In 2010, 97% of all capital gains went to those with incomes above $1,000,000.
  • Forbes found that there is a positive correlation between higher capital gains taxes and real GDP growth, which means that growth was typically better when capital gains were higher – and growth certainly wasn’t slower.
  • Total government tax revenues over the past few years have been at the lowest level seen in the last 40 years.
  • Government spending is higher than at any point since World War II, but it’s less than 5% higher than it was during the 1980s and the first half of the 1990s.
  • During the 1950s and early 1960s, marginal tax rates for the super wealthy were over 90%, yet both the economy and stock market boomed. High tax rates didn’t didn’t thwart the boom.
  • Super low tax rates on the wealthy or correlated with high levels of inequality.

With no correlation found between lower taxes and actual growth in the economy, and the fact that lower capital gains benefits the rich at an insane proportion, I am not sure why anybody but the super rich would argue for lower capital gains taxes or argue against increasing the capital gains taxes on the wealthy. I know that many people hear soundbites on TV or the radio and love to bring those up as “evidence”, but from what I’ve seen, the facts just don’t support the ideas and theories.

What do you think? Should capital gains taxes be increased, decreased, or kept the same? Have you seen an evidence to support either opinion? I am quite open minded and absolutely love for my existing beliefs to be challenged with facts.

2 Responses to “The Capital Gains Tax Rate is too Low”

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  1. Will, I used to totally agree with you, however, this year I will be selling my business. A very small business that has done very well.I have paid what I feel is more than my fair share of taxes. I pay self employment tax. I pay payroll taxes. I pay personal property tax on the things the business has, and I will pay tax again when I sell them. I have never been close to the $250K income that seems to be the gold standard for more taxes, but depending on how we are able to categorize the sale, I could be close this year, and it really, really sucks at how much tax I will have to pay. While 250K seems like lots of money, when it is your sweat and tears you are selling, it doesn’t seem like that much and I would never consider myself particulary wealthy. I do have the decision not to sell, so I don’t want to complain too much, but someone earning $250K is not the same as Obama or Romney. My brother in law is a surgeon. He makes a huge salary, but also has office overhead, staff costs, high malpractice insurance cost, and huge student loans. Why should he have to pay so much for putting himself through school and saving lives? It never really is black and white, I guess.

    • Will says:

      I don’t know whether $250k should be a gold standard for more taxes; it’s not very high. I definitely plan on getting there. But I also don’t mind paying the additional taxes if I get there. Like anyone, it’s not that I want taxes to be raised on myself, but I also recognize when it makes sense. I think that raising the capital gains rate makes sense. And heck, increase the contribution limits for IRAs, and then raise capital gains taxes for everyone. As long as those without 401(k)s aren’t disproportionately taxed just because they don’t have an employer with a 401k. There needs to be some other way to invest tax-deferred for retirement to encourage people to do so. I guess I just don’t believe that it makes sense for passive income to be taxes at a much lower rate than earned income. If I had no bias from knowing how it currently stands, and someone asked me which should be taxed at a higher rate, I probably would say that passive income should be taxed at a higher rate than earned income (conceptually, not saying this makes the most sense economically).

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