Is the Capital Gains Tax System Unfair for Average Americans?

[Pengwuino]

Does anyone else think that capital gains taxes for the average person is rather unfair? My family currently has about $50,000 in debt. We could sell a rental we own for a profit of $80,000. Sounds great right? Well... of course... the government comes in and takes a HUGE slice (reduced to higher 20% range thanks to President Bush) of this away. Of course, the $80,000 is also before all the costs involved in selling a house. Now is it just me... or is it is weird that when you get the facts straight and look at the situation through non-political glasses... the tax makes no sense. Am I wrong in wondering why the government will get $15,000 or so on basically the act of an asset changing hands? I mean i can pretty much trade anyone a cup or a computer or something and the whole idea of a tax on that would be proposterous. Is it just me or does it seem kinda odd that we're paying a huge tax on basically a change of hands. And i hope no one starts crying about "oh big liberal rich people want this" or "big republican business wants that"...

 

[Chi Meson]

This would apply to anything that is taxed, really. Why are there taxes in the first place? THey are supposed to pay for public servces, to run the government, and support the armed forces. The citicenz are going to have to cough up the money in the form of taxes somehow. THe alternative is the "libertarian" angle where everything is privately owned, and instead of taxes we pay fees. Same thing.

So if you make money, you pay a percentage of what you earn because (it is assumed) the more money you have, the more you use up public services plus the more you can pick up the slack for those who can't pay their fair share.

Capital gains are a form of income, so they are taxed. Gambling winnings are taxed (minus losses of course), lottery winnings are taxed, money you find on the street is also supposed to be taxed.

I never understood the reasoning for the special level of taxation for capital gains: I suspect that CG is mostly earned by rich folk, so the richer you are, the less overall you pay. Oops, I'm getting political.

 

[Grogs]

Just a little off-topic here, but assuming you own the property free-and-clear, why not take out a home-equity loan on the property, pay off the debt, and use the other $30,000 for anything else you need? You could also deduct the interest from repayment of the loan, reducing your current tax liability as well.

 

[russ_watters]

True, taxes are somewhat arbitrary (regardless of what politicians claim), but capital gains are a toughie (to me) depending on where they come from. I think its right that long term capital gains are taxed lower than normal income because they aren't normal income, they are multi-year income (<1 year capital gains are taxed as normal income). Ie, if you make $50,000 this year or $25,000 this year and the same next year (both in normal income), they are taxed at different rates because taxes are calculated yearly. Trying to calculate capital gains based on yearly appreciation would be extrordinarily difficult, so the result is a flat 15% (currently, iirc) for long-term capital gains.

The next reason to keep capital gains low is simply to stimulate investing. If you invest instead of spending and make money, that's money that didn't exist before and the government wouldn't have had an opportunity to tax if you hadn't invested it. I'm sure economists can figure out where the supply/demand curves meet on that - optomizing government revenue by keeping the tax rate low enough to stimulate investing but high enough to make tax revenue.

Now, for "old money" or guys like Bill Gates, who derive virtually all of their income from capital gains, I fully support making that ordinary income. But it needs to be done in such a way as to not penalize the other 99% of investors who aren't multi-millionaires for saving their money. Perhaps a ratio - ie, if more than half of your income is capital gains, it gets taxed as normal income. edit: observation: Its always strange to me how when people think about investing and capital gains, they think of the super-rich and not themselves. The vast majority of investors in the US are not multi-millionaires.

Also, there needs to be an exepmtion for guys like Pengwuino based on the planned usage of that money (ie, if you use it to pay off a mortgage, its not taxable as income).

And, most importantly, it needs to not penalize guys like me who have saved for 5-10 years for a house and plan to sell some stock for a downpayment. As above, had I bought a $30,000 car instead of a $20,000 car, the government would not have had the opportunity to tax the profit that that $10,000 generates over 10 years (made-up numbers). Yes, that money would allow more taxes for the car company, but it does not create as much new wealth to be taxed as investing does.

 

[BicycleTree]

The creation of wealth and the investing of money are two different things. If you invest in the entertainment industry then no or very little new wealth has been created; if you invest in research than possibly much wealth has been created. If you buy a car and this contributes to the research budget of the car company then this creates more wealth than investing the money in a frivolous business such as entertainment, tourism, or luxury goods. If you invest in something like cigarettes then your investing might actually destroy wealth.

 

[BicycleTree]

Wealth is determined by the useful value of goods. Goods that are destructive, such as Double Whoppers, or contain no value in themselves, such as hood ornaments, do not contribute to the total wealth available.

 

[selfAdjoint]

BicycleTree, both your posts are based on the idea that wealth has a moral component. It doesn't. The money from hood ornaments and Whoppers spends just as good as money from a cure for cancer.

 

[russ_watters]

Two separate misunderstandings (SA addressed the second) - the first, BT, was that you don't seem to buy into the idea that a good is worth whatever someone is willing to pay for it and that "intrinsic" value is meaningless in economics.

The way economics works, BT, is that a stock that is worth $2 today but was worth $1 yesterday really has generated $1 of new wealth out of nothingness. You may not agree that it should, but it does work that way.

 

[BicycleTree]

The intrinsic value of goods might not matter so much to an economist who is only trying to understand how the goods are exchanged, but it certainly does matter in terms of the well-being of a nation. A stock that increases in value by $1 can only be said to have created $1 of new wealth when using "wealth" solely in the sense of "monetary value." In a real sense, the increase from $1 to $2 has only increased the potential buying power of those holding the stock, and therefore proportionately decreased the buying power of everyone else.

For example, if hypothetically there are $5 in circulation, and 2 of the $1 stocks are held by person A, then when the stocks increase in price person A has gone from controlling 2/7 of the buying power to controlling 4/9 of the buying power, and all other people have gone from 5/7 to 5/9 of the buying power. Where is the increase in total wealth? The things available to buy with the money are exactly the same; all that has happened is a redistribution of power.

I recognize that economists do use the term "wealth" to mean monetary value instead of intrinsic value. But do competent economists speak of "creating wealth" while using that same definition of wealth as monetary value?

 

[russ_watters]

The intrinsic value of goods might not matter so much to an economist who is only trying to understand how the goods are exchanged, but it certainly does matter in terms of the well-being of a nation. A stock that increases in value by $1 can only be said to have created $1 of new wealth when using "wealth" solely in the sense of "monetary value."

No, it doesn't, because you can use that $1 to buy anything you wish - even something with value that you care about.

In a real sense, the increase from $1 to $2 has only increased the potential buying power of those holding the stock, and therefore proportionately decreased the buying power of everyone else.

Since when has relative buying power mattered? Except for inflation (which will absorb only a tiny percentage of that $1), getting that dollar does nothing to harm someone else with $1 - that other person's $1 will still buy the same things it did yesterday.

For example, if hypothetically there are $5 in circulation, and 2 of the $1 stocks are held by person A, then when the stocks increase in price person A has gone from controlling 2/7 of the buying power to controlling 4/9 of the buying power, and all other people have gone from 5/7 to 5/9 of the buying power. Where is the increase in total wealth? The things available to buy with the money are exactly the same; all that has happened is a redistribution of power.

That simply isn't the way money works. You are assuming wealth is a zero-sum game and it isn't. The total wealth available increases in a healthy economy.

I recognize that economists do use the term "wealth" to mean monetary value instead of intrinsic value. But do competent economists speak of "creating wealth" while using that same definition of wealth as monetary value?

Yes, they do - because that's just plain the way money works.

 

[BicycleTree]

Russ, I thought I knew what definition of "wealth" you were using but perhaps I was wrong. Could you define it as you are using it?

 

[BicycleTree]

In summary, the kind of wealth that can increase is "practical" wealth, real intrinsic value of goods. Wealth as "monetary value" is nothing more than a relative measure of buying power, so in the absence of an increase in practical wealth, total wealth as monetary value stays constant since it is nothing but the sum of the monetary values of the things that can be bought. If you double the money supply and let everything else remain constant, all you get is 100% inflation.

 

[Pengwuino]

Hey my thread got somewhere even though i made it at 5am without having slept the night before :D

 

[russ_watters]

Russ, I thought I knew what definition of "wealth" you were using but perhaps I was wrong. Could you define it as you are using it?

The dictionary definition is just fine: "All goods and resources having value in terms of exchange or use"

BT, what you were describing is inflation. Inflation happens if the quantity of money increases, but that has nothing to do with the amount of available wealth. The amount of wealth available is based on the sum total value of all the goods and resources (and now services) in circulation.

The quantity of wealth available is almost always increasing - and it would have to be, otherwise it couldn't support a growing population. People would keep getting poorer and poorer - but they don't - most people are getting richer.

In summary, the kind of wealth that can increase is "practical" wealth, real intrinsic value of goods.

Maybe you need to define "intrinsic value" - I mean, if the market says gold is worth $350 today and $325 tomorrow, what is its "intrinsic value" - and more importantly, is that relevant?

You said a Double Whopper has no intrinsic value. Even if true, so what? People pay real money for it and in so doing create real new wealth for the shareholders of Burger King.

If you double the money supply and let everything else remain constant, all you get is 100% inflation.

Ok, it appears you were assuming I was talking about "wealth" as just being cash money (now I understand why you used that example...). I wasn't. My example was stocks. Stocks are not cash and their market value fluctuates.

 

[so-crates]

The way economics works, BT, is that a stock that is worth $2 today but was worth $1 yesterday really has generated $1 of new wealth out of nothingness. You may not agree that it should, but it does work that way.

No actually, that could just be due to inflation. Inflation does not create wealth, at least not directly. Wealth is a measure of the total amount of goods and services available. Like money, no one wants to own stock merely for the sake of owning stock. They own stock because they want to trade it for money. Because a stock increases in price does not mean that wealth has been created.

 

[russ_watters]

No actually, that could just be due to inflation. Inflation does not create wealth, at least not directly. Wealth is a measure of the total amount of goods and services available. Like money, no one wants to own stock merely for the sake of owning stock. They own stock because they want to trade it for money. Because a stock increases in price does not mean that wealth has been created.

We've covered inflation - the stock market increases in value at an average rate of about 8% a year after inflation is taken into account.

Another measure is GDP - its, essentially, the total value of the economy. The amount of wealth that moved around in a given year. In 1929, it was $103 billion (adjusted for inflation). In 2004, it was $11.7 trillion.

 

[BicycleTree]

The dictionary definition is just fine: "All goods and resources having value in terms of exchange or use"

Wikipedia has a more involved discussion on wealth. There are many different interpretations of the word so it's not a trivial question.

Value in terms of exchange or use does imply that wealth depends on the intrinsic value of goods.

Maybe you need to define "intrinsic value" - I mean, if the market says gold is worth $350 today and $325 tomorrow, what is its "intrinsic value" - and more importantly, is that relevant?

I would say that no matter its price, gold has no intrinsic value, and only has exchange value.

Intrinsic value is a term you introduced to this discussion to describe my argument. The term I originally used was "useful value"; for example, the useful value of a bicycle is that you can ride it places much faster than walking and often faster than a car, it does not require gas to function, and it's good exercise. "Useful value" is what I have been meaning by "intrinsic value." It's not easy to quantify but it does generally increase over time.

When you say that someone is "wealthy" what it ultimately means is that they have access to goods that have useful value. A wealthy person can buy a car, eat well, own a house. The important things are the car, the food, and the house; they exist as real things that have real value. The money the wealthy person uses to buy the car, the food, and the house does not have real value and are only a measure of his relative power in his society. Say fifty dogs are fighting over 100 bones. The bones represent the real, useful wealth, the things like cars and houses. The strength and size of each dog represents the buying power of the dog. Making some of the dogs stronger does not increase the available wealth; only increasing the number of bones does that. And in as much as you can say that the strength of one of the dogs is "valuable," you mean that it indirectly represents some of the bones; that it can be used to obtain those bones.

Now, what if some of the bones contain poison but smell very good (call these "cigarette" bones). Does the presence of the cigarette bones increase the total wealth of the group of dogs? The bones are certainly worth "buying power" because dogs are willing to pay for them with flesh and blood, but the dogs are not any better off by the presence of the poisoned bones. Is it reasonable to say that the dogs are wealthier for them?


The distinction must be made between the creation of wealth and the mere transfer of wealth. If people pay money for double whoppers, and the shareholders of Burger King therefore obtain more money, all that has happened is a transfer of wealth. The people buying double whoppers have wasted their money by buying things that lack much real value or are harmful, so their buying power decreases without gaining anything in return. The shareholders' buying power increases. The process doesn't "create wealth" for the shareholders; it robs wealth from the customers and transfers it to the shareholders.

Money and stocks, in the absence of any increase in real useful value of goods that they can be traded for, are a zero-sum game. Only the useful, real value of goods matters in terms of wealth. In the real world the total useful value of goods usually does increase but this is not a result of stock trading.

My example was stocks. Stocks are not cash and their market value fluctuates.

The market value of dollars fluctuates too. There is not much essential difference between dollars and stocks--the fluctuation is only a matter of degree.

 

[Chi Meson]

In discussing value, I always think of my favorite concept from Econ 105: the notion of "diminishing marginal utility." Value is is slippery concept, whether "intrinsic" or not. The reason gold is valuable is because people want it. Thiat is the same reason for anything of value. The reason a dollar bill has bvalue, is because people expect that it will buy $1 worth of value. But here's that funny concept: the one hundred and first dollar that you own is not as "valuable" (to you) as the very first dollar. To Bill Gates, the 40,000th million dollar bundle was nowhere near as valuable as the first million bucks (to him). So wealth and value are far too tainted by our momentary human perception of what is important. This is part of what makes economics so difficult: it is not an exact science, it's more like weather forecasting.