FISCAL ANALYSIS:

The Spurious, Curious Case for Low Taxes on Capital Gains

There’s no good reason for this preferential treatment, and powerful reasons to end it. Leading the list is the simple fact that stock market “investors” are almost never real investors in the first place.

A potent blend of myth, propaganda and misimpressions. Let’s look instead at some truths.

It’s routine on Wall Street these days for trading volume to run in the billions of shares. On any given day, only a tiny fraction of those billions has any valid claim to growing jobs or businesses or the economy. On many days not a single share qualifies as a bona fide investment.

Almost all the time, all that’s happening is money changing hands as shares move from sellers to buyers. Not a cent goes to the companies whose shares are traded. No jobs are created (except in the financial community, which is not the point here). No businesses are expanded. Investments are really being made not in the economy but in personal portfolios.

Securities markets clearly play an energizing role in the American economy. All the same it’s nonsense to claim that buyers of stocks deserve a tax break when they sell their shares at a profit. A tax break? For making money in the market?

Now for more reasons why this is poor policy.

There’s the issue of income inequality, which has soared in America lately. According to the David Cay Johnston book Perfectly Legal, the top one percent of taxpayers controls about half the nation’s financial assets. Two-thirds of the income of the 400 highest-income Americans comes from long-term capital gains. Undeniably, the benefits of tax breaks for capital gains flow overwhelmingly to the already-wealthy; undeniably, preferential rates on capital gains exacerbate income inequality.

Finally there’s a tax equity issue which our forebears even considered a moral issue. In 1924 Congress first differentiated between earned income (wages and salaries) and unearned income (e.g., capital gains and dividends), and taxed the unearned income at higher rates. It was deemed the right thing to do; old-timers would have shuddered at the notion of taxing wages at higher rates than capital gains.

Those were the days. Now it’s 2007.

The latest capital gains tax cut is set to expire in 2010, and the new Democratic Congress has indicated that it has no plans to visit the issue until after the 2008 elections. This gives them plenty of time to look beyond the propaganda, and to consider taxing capital gains at least as much as earned income. A political pipedream? It was the rule not long ago: from 1988 to 1992, long-term realized gains were essentially taxed at the same rate as other income.

Then the K Street apostles went forth and preached, and the spurious, curious case became gospel.

• Johnston, David Cay. Perfectly Legal (New York: The Penguin Group, 2003), pp. 16-17, p. 310
• Stein, Ben. “It’s a Great Country, Especially if You’re Rich,” Sunday Business, The New York Times, February 11, 2007
• Weisman, Steven. The Great Tax Wars (New York: Simon and Schuster, 2002), p. 351