More On Capital Gains Taxes

A continuation of (and a bit of a counter-weight to) this post from yesterday... Even though capital gains taxes are double taxation (assuming you invest money that was taxed at the income level), there are still reasons to support it. Basically, it can be just another way to make sure our taxes are progressive, since people who make a lot of money from investments will usually be much better off than people who don't.

Also, even though in theory our tax system could just tax wages and that should already be a tax on future capital gains, in reality this would create very high incentives for people to find (and/or create via lobbying) loopholes. This seems to be Paul Krugman's main reason for taxing capital gains. For instance, using the carried interest loophole, some people can currently get their income taxed at the rates of capital gains. If we only taxed "wages", some very rich people would pay zero taxes because their income would qualify as carried interest.

I assume a common objection to taxing capital gains extra would be that it punishes good behavior. Basically, if 2 people make the same income, the person who invests more of it is "doing the right thing" comparatively. I don't happen to believe in just deserts, but even if you do, you can't assume that a person who invests more is more virtuous than one who spends more. For instance, right out of college I was able to invest a good portion of my income compared to most people my age because I had no student debt. The fact that I was lucky enough to have parents that could and would pay my tuition doesn't make me "better" than anyone. I'm better than everyone for other reasons.

The best objection to taxing people extra for investments is its effect on incentives - we should want people to save/invest more, and having extra taxes for people to do so probably discourages more people from doing it. But the evidence is not clear-cut here. For instance, Germany used to have no capital gains tax, but in 2009 they created a capital gains tax rate of 25%. But their average savings rate has hardly budged. Of course, this isn't conclusive; there are many other variables that would be involved in their savings rate and maybe the economic crisis in the EU is temporarily hiding the long-term effect of that tax hike. Or maybe savings rates are mostly decided by culture, and cultural values shift very slowly in response to new circumstances. I'd be interested to see more data on cap-gains-tax-changes compared to average-savings-rates-changes from other places and times.

So putting all this and the previous post together, capital gains taxes aren't something I strongly oppose. But, all in all, I think we should get rid of them in favor of a progressive payroll/consumption tax. It's a shame that almost any politician who wants to get rid of them also wants to make our taxes much more regressive. I would definitely oppose ending capital gains taxes if that just meant shifting much more of our taxes onto the poor. But I would also strongly oppose making our capital gains tax rate as high as the income tax rate.