If you work for a living, America taxes you at double the rate of wealthy investors with "unearned income"

boing
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All of these come back to the same thing, it’s the definition of an “investment” and what things get the special capital gains rate.

If instead of buying $1M in IBM stock, you actually invested $1M in an IBM capital improvement, build something like a factory, office building, data center, new machinery, whatever. Probably through a bond/loan that would be more beneficial than just buying the stock.

But, regular interest income, income made by putting money in the bank so the bank can make loans, doesn’t get that special treatment. This could be argued to provide just as much or more benefit and economic growth through the loans the bank makes.

Actual real tangible capital investment also involves more risk. Invest in that new machinery and then it doesn’t actually provide the improvements needed and now it’s just a huge expense with no return at all.

That’s where I see the justification for a lower rate. To invest in tangible advancements that include greater risk. The lower rate being a nudge to get people to take the larger risks on advancing improvements.

An IPO or new issue stock has that type of look to it. But, the more times a stock changes hands, the farther and farther it gets from being an actual investment in the company. The more it starts to look just like trading baseball cards instead. Hoping for a rare one that goes up in value.

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42

I’ve been thinking about this a lot lately too. If you think about venture capitalists who literally invest directly into the company. Same with an IPO, the money actually goes into the company.

But after that if I sell existing stock to you, that’s basically trading baseball cards.

I mean, they aren’t just fads or collectibles, they are backed by something real. But if I decide to get my money out of IBM and into gold then I effectively end up trading someone my piece of IBM for their pile of gold. I’m trying to figure out what happened there other than a couple of people doing a swap. Neither of us is going to employ what we’ve obtained in any way to actually make something or do something. We are just going to sit back and watch society funnel wealth to us as a reward for already having wealth.

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I suppose on the pro investment income side, the gold bug now has a right to income from and a stake in IBM so is likelier to take an interest in what IBM is up to and whether it is well managed (in theory at least), thereby ensuring that IBM makes stuff that is good and valuable to society (you can hear the theory creaking can’t you).

You have a certificate stating that you own a pile of gold allegedly held in some vault somewhere which you can’t even lie on or take a bath in. :frowning:

image
THIS IS NOT ALLOWED

From that point of view the utility has decreased by your swapping shares for gold.

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44

If IBM was a small business and this purchase gave them even a 1% share in IBM, sure all of those sound likely. They can exercise their voting rights to influence the direction of the company.

However, IBM has about 908,794,000 shares outstanding, at about $132 a share. Buying 9,087,940 shares would cost you $1,199,608,080. For your billion plus dollars, you still only get a 1% say.

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45

I did say you can hear the theory creaking…

But I’ll bite…

So? The principle still stands. Somewhere there are a bunch of people who can collectively have some control over what IBM does.

Gold is still sitting in a vault.

The fact that your vote in particular doesn’t change much in isolation is not a good argument for anything other than the divine right of kings.

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46

Ha! I don’t want to make you do that.

Honestly I was really hoping that @Avery_Thorn would explain it. I felt their explanation of why we shape tax policy the way we do was long on how we use tax policy to motivate behaviour and short on why we actually ought to “encourage” investment in that way. I thought the latter was the thing that bore the most explanation.

I mean, I don’t even think that the way we are using tax policy to shape behaviour works. I think the idea that we can get people to do things by dangling carrots and wagging sticks is largely wrong. But I’m willing to let that go for the sake of argument because my position is so anti-zeitgeist as to just sound insane.

I agree. There are different things we call “investment” and some of them pay big returns for society and others don’t. I think if we move off the baseball-cards-for-millionaires idea of investment and look at investing in actual productive things then there is a good case that we want to encourage that somehow.

But we are encouraging it with lower tax rates while obvious investments the public could be making are going unmade. If we tax capital gains at 10% instead of 30% then maybe it makes some people more likely to invest in capital projects.

But if we tax it at 30% instead of 10% then the public has more money to fix bridges before they fall down, which is a major capital project and probably pays greater societal returns than any business venture. When you get into “what’s the best return on investment for society” arguments you have to reckon with the fact that public education, public health, roads, bridges, communications infrastructure and a bunch of other things are super great ROI. The entire project of trying to talk about ROI makes it sound like we’re a bunch of communist central planners anyway. If we actually know how to spend the money, why not just take it and spend it the right way?

No matter how you look at it, investment is always getting money in exchange for already having money. I can’t see why we’d prefer that to getting money by doing something productive yourself.

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47

You did, and I left out the joke about how much creaking. :slight_smile:

Holders should still vote, even if their individual contribution is small. But, that’s not really the question here.

The question is, is that say enough collectively to justify the special treatment as capital gains tax rate vs ordinary income tax rate. Is the lower tax rate getting us the incentive it’s intended to get in economic activity.

To the earlier point about the tax code trying to influence behavior and produce an outcome.

Assuming you bought physical stuff. What’s the carrying cost on that and how much does the investment shrink as you pay the expenses around storing it? What’s the extra cost for a place that will let you swim in it? At what price is it more expensive to store it than what you paid? Or, maybe someone just bought gold futures or a gold based EFT, in which case it’s back to just paper cards being traded…

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48

I think there are a few not completely fringe politicians and economists who are toying with that point of view.

I was hoping someone would take pity on my attempt and come up with what they think is the real answer but so far no dice…

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I think the explanation we got above is the real answer. The real answer is that if you talk in a sufficiently condescending tone and just smuggle it in as an assumption then no one will ever ask you because they won’t want to talk to you.

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50

The rules and measures in any environment definitely impact the behavior of the people in the environment. Just not always in the way you think. And, its definitely not like using a TV remote to change the channel.

Change the tax code to make one category more attractive than another. And things will flow from the less attractive to the more. But, only so far as the actual metric used to define those categories works. That may get you the outcome you want, or it might get you something totally different. It all depends on how close that measure is to what you really want. At the scale of the tax code, it’ll be a broad stroke measure too.

For example, tax savings on R&D drives more R&D at companies, sort of. What it really drives is companies finding way to call more things R&D so it qualifies. Completely independent from if it’s really what was meant by R&D or if they would have done it anyway but found a way to shoehorn it into the definition.

The age old example of the Help Desk. Measure call completion time as a way to know if an analyst is solving problems fast enough and making customers happy. Except call completion time doesn’t actually measure those things. It just measures call completion time. So, if a customer has a hard problem, they’ll get a crap answer that doesn’t really solve it but closes the call. The measure will go up, but the problem will not be solved and the customer will not be happy.

Influence through measuring things is super hard. Likewise for the tax code.

Those examples are mostly good ones that some level of government should be funding. But, even within them, there’s room for simply providing incentives to get others to work in that space.

Even the bridge one, which sounds like a slam dunk, government should definitely build the bridge (and they should). But, a bridge depends on materials science, construction technique, functional design, and other things. Providing incentives for companies to work on those enabling things is going to be better than centrally planning them. Incentives allow for larger groups, more creativity, unexpected results compared to direct control but they give up that direct control.

It’s not that one is always better than the other, it’s that each has a place.

Back to the topic, of why do we treat investment income as preferable to earned income. I would argue the answer is, to get people to invest in things to grow the economy as a whole. But, we’ve messed up the measure and predictably, people have found ways to call things investment income that don’t grow the economy.

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51

The Capital Gains tax doesn’t just get applied to stock sales and purchases; it involves basically all forms of regulated investment. It goes all the way from small business LLCs all the way up. If you give your buddy $100 to start a brewery and he gives you back $2000 after he sells the brewery to AB Bev, as long as you have all the paperwork you can use the capital gains tax.

People are focusing on a very, very small part of the stock market: the day-to-day fluctuations and stuff. This is actually the least important part in a lot of ways.

When a company needs money, it can get it in several ways. It can borrow the money from someone, but then they have to pay it back, with interest. They can keep profit from sales and re-invest it in the company - but this presumes that they have enough profit to do this. Or, the company can sell partial ownership of the company for money. This way, it doesn’t have to pay the money back.

To sell part of itself for capital, the company can either do this via investment firms, which may buy a certain percentage of ownership of the company for a specific amount of money, or they can issue stocks. The first time is called an IPO, then subsequent offerings can be made at any time. This is when the company gets it’s investment.

The stock represents a partial ownership of the company, the dividends are the share of the profit that the stock owner gets, and the value of the stock is based on the ownership of the ongoing business or the value of the assets of the company.

Each share had an initial investment into the company. The raise in price over the IPO price or the strike price is the appreciation of the investment.

So why is buying an old stock still investment, when the company doesn’t see any of the money?

Because why would anyone buy a stock if they could never sell it?

You’re not investing in the company directly - but what you are doing is you’re buying the benefits of an investment someone else made a while back. The company doesn’t have to pay back the investment because instead of going back at the company for the money, you stepped up and said “I want to own that investment instead. I’ll give you $5 for it.” and they said “Great!”

The company can still get more investment by selling more stock. It can also do stock buybacks and either destroy the stock or keep it and sell it later for more money. Having the stock be a liquid asset that can be bought and sold encourages investment into the company because it makes the process easier to go through.

(I mean, consider if you had a 1% share of IBM that your grandpa bought in the 20’s and you needed to cash out to pay for medical bills and you had to run an add in the back of a newspaper to try to find someone who wanted to buy it. Or what would happen if you owned half the company and you wanted your money so you forced the company to liquidate to give it to you?)

The cool thing about the way the tax is structures (pay a percentage on the gains) is that (if the stock is always sold for more than it was purchased for) the government gets the same amount of taxes from the stock no matter how many times it is sold.

While you don’t get taxed on losses, if the stock looses money and you sell it and it eventually sells for more, the government gets more tax on it. (Imagine you buy a stock for $100, and sell it for $80, then someone sells it for $120. The government taxed the person you bought it for to $100, then gets to charge the person who bought it from you taxes on the profit from $80 to $120.

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As for why investment is better for the economy than buying stuff:

Say you have an idea to sell widgets. You need $100 to make the widgets for sale. You need to spend $50 on widget making machines and $50 on raw materials to make the widgets. That $50 will allow you to make enough widgets to sell for $150. If you do this, you not only buy $100 worth of stuff from other people, you also sell $150 worth of stuff to other people. (Which means you can pay back you original $100 investment, and buy $50 more in raw materials to make another $150 in widgets!)

If instead you decide to order $100 worth of pizza with your money, you’ve only caused $100 worth of economic activity.

Obviously these numbers are nerfed, but it kind of gives you an idea of why investment is better than purchase most of the time for economic activity.

In terms of taxes, the investment normally ends up causing a lot more taxable events for other people, so (in theory) the government ends up making more in taxes.

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People definitely react to the environment they find themselves in by mitigating the problems and maximizing the benefits. I think one of the big mistakes we make when we think about this is we assume that other people are just another part of the environment. There’s a certain logic to that, but it’s not a good model of how people really behave.

People see other people as a very different kind of thing than environmental factors. Very often people who try to use negative reinforcement to get other people to stop doing things are instead met with an attempt to negatively reinforce the negative reinforcement and the whole thing goes into a maladaptive cycle.

Like a friend of mine who got caned every day at school when he was growing up (it was in Indian in the 70s, I think). Every day he broke the rules even though every day he got caned. But also importantly: every day the administrators caned the kid even though every day they got the same bad behaviour. Every behaviour in this cycle is being negatively reinforced but that is leading to those behaviours happening more rather than less.

I’m sure everyone in this thread has had experiences like this in their own life.

Trying to set out the carrots and sticks is asserting power over the person you set out those carrots and sticks for. A lot of people, when power is asserted over them, assert power back. It’s easy to guess that faced with an R&D tax cut companies will try to play games with classifications, but that’s because we live in an environment where we think it’s normal for everyone to distrust the government, think of the government as useless or as thieves, and for companies to be psychopathic. Reducing taxes on R&D might actually increase R&D if people thought that government worked for them and companies felt they had social responsibility.

Any attempt to control people using rewards and punishments should be met with the question: Wait, why aren’t they controlling me using rewards and punishments. We need to think of people in terms of relationships with one another, not as simple machines. Unless, I guess, we’ve always found in our own lives that we can be easily manipulated as a simple machine by anyone who cares to do so.

That’s just trickery with words and numbers.

I’ve got $100. I can either give it to another person to spend it to buy a machine and widget parts, or they can spend it themselves on pizza. In either scenario the money is “spent” it’s just spent on different things.

In one case it’s spent on a machine and widget parts in the other case it’s spent on pizza. In both cases those will have other economic spin-off activities. You talk about what a widget manufacturer does with money (buy more parts to make more widgets) but write as if the pizza maker eats the money. In reality they also buy more parts to make more pizzas, and if their business is booming they spend money on another oven. There is no reason to guess one economic activity is better than another, maybe the pizza is a better return.

Another way to look at it is that in either case I’m giving the money to someone else in exchange for something (spending it). The pizza maker gets the money but has to give pizza in return. The widget maker gets the money but has to give money in return in interest. In either case some person gets $100 from me. I don’t even know which of them is able to employ more of the money to build their business (which is cheaper, the interest or the cost of making the pizza?).

Charging rent is not generating economic activity, it’s taking a cut of economic activity. The example you gave is just me choosing whether to charge rent on my money or spend my money on food - a decision I will presumably make based on whether I am hungry or not.

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54

I tried some googling, but I can’t find anything (probably my search terms). Do we have any information about the distribution of capital gains sources? How much is the result of direct investment and how much is the result of stock trading?

A functioning stock market, and other financial markets are definitely desirable to create liquidity and reduce friction on the movement of money. To your point about being able to sell a stock vs require liquidating some asset.

But, that’s not the same thing as giving the income from selling a stock preferential treatment with a lower rate.

I would argue that the indirect types of capital gains categories around financial instruments that are not direct investment shouldn’t need the incentive of a lower tax rate.

As examples of why it doesn’t need a special rate, I would point out that only long term holding gets the special rate, and there’s clearly lots of short term trading happening on the market. Additionally, regular interest on savings doesn’t get the same special incentive, yet the bank paying that interest does it by loaning the money to someone who may be using the loan in capital improvements. Perhaps to build that brewery.

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As I said, you don’t always get what you expect. Good measures and incentives are very hard. Broad based general direction incentives are easier, since you’re not trying for a specific thing but just general movement in a direction.

It’s got nothing to do with trust of the government. Companies as a whole don’t “trust”. People in the company may trust others, but the company doesn’t possess those qualities. The expectation of how the government should act vs what it does or doesn’t do is just part of that environment, another part of the process.

They’re not the same though. The difference is subtle. It’s the difference between something like an operating expense vs a capital expense. They’re both expenses, but they have different impacts to the thing with the expense and to the economy surrounding them.

If you give the pizza guy money to buy an oven, and they pay you back with $100 worth of pizza or you just buy $100 worth of pizza, you’re right, it’s the same to you. But, that’s not really a valid comparison. It’s more like you give them $100 to buy an oven and maybe they pay you back or maybe they go out of business first and you never get all your pizza. If they do succeed, the new oven has expanded their ability to produce more. The economy has grown some, and you contributed to that. A reduced tax rate is an incentive to encourage you to take the risk that will grow the economy.

If the pizza guy just sells you the pizza and uses the profits to buy the oven themselves. Then the pizza guy has made the capital investment, not you. They’ve taken the risk themselves, and can account for it.

If the pizza guy just sells you the pizza, covers his costs but doesn’t buy the oven. There’s no capital improvement, the economy hasn’t grown at all. We’ve all had pizza, but there’s no expansion.

Incentives in general that result in growing the economy are a good thing. Getting incentives to actually achieve that goal vs outcomes that are neutral or shrink the economy instead is difficult.

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it helps the company in other ways.

employee stock incentives become stronger, so they attract and retain better talent. they can use stock to purchase other companies, acquiring new technology, personnel, and markets. they can issue more shares, or sell existing shares for cash.

it’s not a direct investment, but long term investments are not exactly gambling.

computer assisted day trading? totally. and that’s part of why there should be a financial transaction tax. not just a tax on gains, but a sales tax for trading.

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In the US, the tendency is the opposite. Huge corporations try to play the PR game of decreasing taxes for the benefit of “small businesses,” which, in our tax system, have much more in common with individuals than with big businesses. Their purchased politicians talk about helping small businesses, but then turn around and stab them in the back in favor of the big businesses

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You make a really good point. In fact, I think if you take the discussion above and flip it on it’s head, we hit on something like an answer. If you use the incredible “value” that sits in derivatives and investments that are further and further removed from reality as evidence about what we’re incentivizing, it’s pretty clear that the very low capital gains tax compared to earned income causes a damaging imbalance in the economy. The simple fact that banks go to such extremes to provide more archaic and divorced-from-reality investments shows that low tax rates on investment income is already badly balanced relative to earned income.

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Operating expenses and capital expenses are different, but that’s not the same as saying investment and spending are different. In the example I was given of the $100 borrowed by the widget manufacturer 50% when the capital and 50% went to operating expenses. So I wasn’t trying to compare those two things. What we call “investment” might be capital or operating, but if you make money buying and selling stocks you pay capital gains taxes, not income taxes.

And as I said, I just don’t think it’s true. Like, we have a theory that says people respond to incentives in a certain predictable way (that is, they seek things that benefit them and avoid things than hurt them) but then:

  • That isn’t how we observe that people actually behave in their interactions with one another with any consistency
  • We aren’t able to actually predict people’s behaviour using the theory
  • The idea originated from the diary of an 18th century person with trust issues*

My reaction is to say: wait, why do we think this is true at all? Mostly when I see people talk about incentives they use equivocation between a vacuous tautology - people respond to incentives and an “incentive” is something people respond to - and a dangerous falsehood - you can control people’s behaviour in a mechanistic way. One idea is used to smuggle in the other.

* I regard all works of philosophy as diaries.

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60

This is a perfect example of why the capital gains tax rates should be progressive instead of flat.

In contrast to the brewery investment example, you have the CEO with the $15M income. The company structures it such that most of it comes in as capital gains. $300k salary and $14.7M in direct share and option incentives. So $300k gets taxed at 35% and $14.7M at 15%. That’s how a CEO pays a lower effective tax rate than a family of 4 making $150k.

I’m not. We’re talking about income taxes, not sales taxes. Why is earned income taxed at a higher rate than investment income? Highest marginal tax rate on earned income in the US is 37%, more than double the capital gains tax on any investment income of any amount.

I’d submit for consideration that system is insane. :slight_smile:

BTW, your summary of the stock market and its whys and wherefores is excellent!

That’s the kind of thing I was looking for earlier. However, I’d submit that the real comparison (as noted) is income, not sales tax. I see the big problem with the accumulation of wealth is that someone who makes $10M/yr has much of that income sitting idle without putting it back into the economy. Someone who makes $100k puts almost all of it immediately back into the economy, yet they get taxed at a much higher rate.

ETA:
Let’s say the capital gains tax were made progressive and the same rates as earned income. That would increase revenues by, what, 60%? Would people stop investing? No way. However you earned the capital in the first place, once you have it, investment income is fundamentally more desirable than earned income, because it is earned passively. If I have a $10M investment portfolio earning 3% income after my investment manager takes their cut, I’m making $300k. I’m going fishing on a tropical beach somewhere, see you in a few months, thanks. If I’m a senior engineer at Apple making a straight salary of $300k with no stock incentives (I know, unlikely), I’m working my ass off. I could probably afford to go on a tropical fishing vacation, but I have maybe a couple of weeks to do so. Hell, it takes a few days just to unwind.

In the current system, the US taxes the first guy 15%, and the second guy 35%. THIS MAKES NO SENSE. Even at an equal level of taxation, the first guy has a much, much nicer quality of life.

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