On Capital Gains and How Things Work

At the end of last night’s debate, President Obama took an opportunity to remind voters that he really really really believes in free enterprise and capitalism.

…I think a lot of this campaign, maybe over the last four years, has been devoted to this nation that I think government creates jobs, that that somehow is the answer.

That’s not what I believe. I believe that the free enterprise system is the greatest engine of prosperity the world’s ever known.

I believe in self-reliance and individual initiative and risk takers being rewarded. But I also believe that everybody should have a fair shot and everybody should do their fair share and everybody should play by the same rules, because that’s how our economy’s grown. That’s how we built the world’s greatest middle class.

And — and that is part of what’s at stake in this election. There’s a fundamentally different vision about how we move our country forward.

Of course, this was needed in light of “didn’t build that” being a lodestone. The Presidents understanding of capital, and who benefits from free enterprise, though, continues to crop up in his responses on taxes and tax rates, particularly Mr. Romney’s:

Now, Governor Romney has a different philosophy. He was on 60 Minutes just two weeks ago and he was asked: Is it fair for somebody like you, making $20 million a year, to pay a lower tax rate than a nurse or a bus driver, somebody making $50,000 year? And he said, “Yes, I think that’s fair.” Not only that, he said, “I think that’s what grows the economy.”

Well, I fundamentally disagree with that.

And these points have been echoed by some (not all, some) on the left on Twitter today:

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Every year I do my own taxes. I view it as necessary to remind myself of how much I dislike them, but I also take a look “under the hood” with the tax preparation software to see what I like to refer to as “people like me”. When you’re done, the software will show detailed averages of those who have submitted taxes in your income group so you can see where people like you get their income from.

Most years of late, “people like me” from an income perspective have a good percentage of their income from Capital Gains. I’d say it represents about 25 percent of income in my grouping (these are typically $10,000 groupings).

That tells me there are a fair number of the following in my group:

  • Retirees with investment income;
  • S-Corporations filing 1040s with gains; and
  • People selling houses at a gain and buying new, lower valued homes.
  • I’d say the last group is small, and the first is largest. It’s more than an educated guess: I’ve seen enough of my parents’ returns to know how investment movement creates gains.

    Now, the Twitter point above, echoing the President’s statement to Governor Romney, both essentially say

    Why won’t you pay more taxes? You cold-hearted Scrooge!

    To which I says other (a) you’re ignorant of how the economy works, or (b) you know how it works, but your desire to play class politics betrays you.

    You see, the reason why there are different tax rates for ordinary income (income, interest) and for capital gains is twofold:

    First, capital gains are on money already taxed at least once. For a person, that would be the Federal and State income, Social Security, Medicare, and other taxes paid when you earned the money you invested; even if it was an inheritance (and recall, Romney gave all of his inheritance away) it faced the inheritance (or death) tax.

    Second, capital gains taxes are lower to reflect the risk taken with capital. When you trade your employment for income, there is little inherent risk to you – the risk is the employer’s. You can give notice and move on to another paying job (providing you can find one). The same, in essence goes for basic interest as from a bank account; the account is insured by the government to a certain amount, no risk exists if you keep the amount below the limits specified). Capital Gains reflect the placement of one’s capital at risk. There is no guarantee that an investment will pan out. As commercials for investment houses say in their disclaimers: investments can and do lose money.

    So the Capital Gain reflects the amount earned above what was originally invested; the tax on that Capital Gain is lower than the tax on ordinary income both to recognize these dollars have been taxed at least once, and that their use in markets is valuable to the free flow of the economy. if you tax Capital Gains at the level of ordinary income you disincentivize investment and risk-taking in the economy. And successful investment leads to capital and economic growth (to quote Paul Ryan’s mentor, the late Jack Kemp, “the pie grows bigger”), which leads to job growth.

    Capital Gains, and investment in the economy that leads to them are, as I suggest in my review of my own tax group above, everywhere. Retirees or those planning for retirement who are living on or plan to live on a 401(k) have Capital Gains propelling the growth of their portfolios. Unions and other employers with pension plans need their investments in the economy, and in so doing in profit-seeking private enterprise, to pan out to meet planned defined benefits.

    You’ll note from HotAir in June that public employee unions had no problems with Bain Capital, Mitt Romney’s old firm; they had over $1 Billion invested through Bain because Bain has an established track record for how to make money. If the way in which that money is made is so objectionable, I’m sure someone on the left will establish a “social justice” investment firm, that invests to protect unsuccessful firms at the expense of successful ones.

    Actually, that sounds like what government has become.

    This isn’t to say that there isn’t a role for responsible capital investment. Balance is a good thing. But don’t for one minute pretend that working from a rule that says “at a certain point, you’ve made enough”, whether to an individual or to a business, doesn’t cascade to those interrelated, reliant on that amount.

    When do we get to tell government, “at a certain point, you’ve taxed enough”?

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