Economics, Pethokoukis

Michael Kinsley’s very strange take on taxing capital gains

It just kind of bugs Michael Kinsley, at a gut level, that the US tax code gives a preference for investment income. Kinsley in his Bloomberg column:

 Critics of the capital-gains tax are absolutely correct when they say that a tax on capital hurts our economy by reducing the incentive to save and invest. They say the same thing about the tax on investment interest, and they’re right about that, too.

Unfortunately, this is true of every method of taxing capital, just as any tax on labor reduces everybody’s incentive to get up in the morning and go to work. When you tax something, you discourage whatever it is you’re taxing. That is the tragic nature of taxation.

For me, the argument more or less ends when Kinsley concedes investment taxes hurt economic growth. We should want the tax code to be as neutral as possible. Right now, the tax code penalizes savings and investment as opposed to consumption, though that is somewhat offset by the capital gains preference. I don’t think Kinsley gets that. As AEI’s Alex Brill and Alan Viard explain:

We can illustrate this penalty with a simple example. Consider two individuals, Patient and Impatient, each of whom earns $100 in wages today. Impatient wishes to consume only today and Patient wishes to consume only “tomorrow,” which is many years in the future. Saving yields a 100 percent rate of return between today and tomorrow. With no taxes, Impatient consumes $100 today. Patient saves the $100, earns $100 interest, and consumes $200 in the future.

What happens with a 20 percent income tax? Impatient pays $20 tax on his wages today and consumes the remaining $80, which is 20 percent less than in the no-tax world. Patient also pays $20 tax and saves the remaining $80, earning $80 interest. However, $16 tax is also imposed on the $80 interest. That leaves Patient with $144, which is 28 percent less than in the no-tax world, compared to a mere 20 percent reduction for Impatient. The income tax imposes a higher percentage tax burden on Patient solely because she consumes later. The income tax’s penalty on saving causes an inefficient distortion of consumer choice and lowers the accumulation of national wealth and the long-run rise of living standards.

Eliminate that penalty and faster economic growth, more jobs, and higher incomes would likely be the result. I should also note that the US integrated tax on capital gains is extremely high both on an absolute and comparative level. When someone pays a capital gains tax, that income has already been taxed previously. No inequitable free lunch here:

16 thoughts on “Michael Kinsley’s very strange take on taxing capital gains

  1. “Right now the tax code penalizes savings and investment as opposed to consumption, though that is somewhat offset by the capital gains preference”

    And also by preferential tax treatment on dividends, Jim. To my mind, savings is being compensated more than consumption, even at these low rates, as people chase yield to get something on their investments. (Something I am a master of)

    If taxes were raised on dividends and cap gains, someone might reason it may pay to live it up a bit instead of hoarding the cash.

    As it is, I was pleased by POTUS’s modest increase, to just 20% for both, which is prudent and wise at this stage.

    • Dear Mr. Krugman,

      Yes, we all know it’s you… The hapless, dunderheaded “economist”, vicariously projecting through your lame alias, the same irreconcilable positions you espouse to your slope-headed readers who frequent your day-gig.

      Sorry. Imperial evidence is what it is.

      As painful as it might be, I suggest Peter Ferrara’s work on Obamanomics vs. Reaganomics as a starting point. Unless, of course, you want to argue here that Keynes is the bomb.

      Oh… I have to ask: Does the New York Times provide you with a Lincoln Town Car limo?

      • “Sorry. Imperial evidence is what it is.”

        Yes, it certainly is, isn’t it?

        Thank you for comparing me to a Nobel Laureate. My mother thanks you.

  2. Dallas Fed chief Richard Fisher on capital:

    “[The economy] is already flush with $1.6 trillion in excess private bank reserves owned by the banking sector and held by the 12 Federal Reserve Banks. Trillions more are sitting on the sidelines in corporate coffers. On top of all that, a significant amount of underemployed cash—or fuel for investment—is burning a hole in the pockets of money market funds and other nondepository financial operators. This begs the question: Why would the Fed provision to shovel billions in additional liquidity into the economy’s boiler when so much is presently lying fallow?”

    It also begs the question: How is preferential tax treatment for capital helpful when no one will spend it? Alternatively: Is it possible that, on occasion, cutting labor some slack — more money to spend — is the right answer? Just asking.

  3. James Pethokoukis counters Michael Kinsley’s argument on taxation with: “We should want the tax code to be as neutral as possible. Right now, the tax code penalizes savings and investment as opposed to consumption, though that is somewhat offset by the capital gains preference.” A couple of points come to mind. First, is that the financial assets and land assets given preferential treatment under our tax laws are not actually forms of real capital (i.e., capital goods). Gains on financial assets and land are gains largely experienced outside of wealth production. Our economy would benefit significantly if income flows generated by goods production or providing services were lightly taxed. A simplified but progressive income tax could exempt earned income (up to say, the national median), then impose rising rates of taxation on higher ranges of income with no exemptions or deductions permitted. In addition to lowering the tax burden on earned income, some modest levels of interest, dividend and gains on asset sales would also be lightly taxed for most taxpayers. Want to stimulate the economy, stimulate employment of people by giving businesses a tax credit for every person employed full-time in the United States. At least Kinsley understands that an even more basic problem with how our government raises its revenue is that land rents are taxed lightest of all, whereas (as Smith, Mill, George and the classical political economists knew) land rent should be treated as public revenue so that taxes on earned incomes and private produced assets could be greatly reduced or eliminated.

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