Thursday, December 29th, 2016

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Why Capital Gains Serve a Purpose

Low capital gains taxes are designed to encourage investment in the market.Many legislators and political activists have made the argument recently that capital gains represent an unacceptable loophole in the country’s tax code, but the argument can be made that the problem lies with the perception of capital gains.

Daniel Indiviglio of The Atlantic points out one particular article in The Washington Post that contends the capital gains tax hurts the poor by creating a disproportionate tax rate. Those with a substantial amount of their annual earnings coming from capital gains rather than income will pay a substantially lower effective tax rate than those living off wages alone.

“For the very richest Americans, low tax rates on capital gains are better than any Christmas gift,” Steven Mufson and Jia Lynn Yang wrote in The Post.

The two note that, with a 15 percent cap on capital gains taxes, the marginal federal income tax rate surpasses the maximum capital gains tax at an annual income of $34,500.

Indiviglio boils the article down to a few main points. Most importantly, he notes the idea that a higher capital gains tax would benefit the poor relies on the assumption that higher tax revenue leads to improved standards of living for lower income Americans. This assumption, however, depends on either effective social programs, direct disbursement or effective government investment, none of which is guaranteed.

Of course, higher taxes on the wealthy would lead to increased income equality, but only in the abstract and without necessarily gaining any social benefits. In the meantime, money that would likely see reinvestment in the market and potentially lead to the creation of jobs or higher income for middle and lower class Americans would be funneled into government.

The article’s second point argues with the idea that investment ultimately leads to job creation. Syracuse University professor Leonard Burman argued to the Post that such low rates encourage using capital gains as a tax shelter and suggests that most only invest for the tax benefits. Indiviglio notes that this is ultimately the point.

The U.S. has a long history of using taxes to encourage certain behavior, rather than more direct methods, with exemptions for mortgages and marriage offering strong financial incentive for behaviors seen as socially useful. Ultimately, this is also the purpose of graduated tax rates, with higher incomes taxed at a higher rate because redistributed wealth serves a social purpose. The capital gains tax must be understood through its purpose and made to effectively fulfill it, rather than simply raising it as a less controversial means of increasing taxes. Indeed, a recent letter to The Financial Times notes that the U.K.’s 28 percent capital gains tax could be stifling investment in that country and calls on the government to substantially lower the rate.

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