One of the tax changes in the just-passed bill to avert the so-called fiscal cliff is a rise in the long-term capital gains tax for upper-income people (over $400,000 for single filers). During the George W. Bush years, the tax on capital gains (and dividends) dropped to 15 percent. Under the new law the tax will rise to 20 percent for those wealthier taxpayers. During the recent controversy over taxes, some people wondered why capital gains should be taxed at a lower rate than ordinary wages and salaries, the top rate on which is now 39.6 percent. Is this a favor to the rich or does the difference have a basis in sound economics?
On the face of it, the difference looks suspicious, indeed. Why should "unearned income," which is what investment income is called in the tax code, be less subject to taxation than "earned income," wages and salaries? But such a framing of the question prejudices the matter. In fact, there is a sensible reason—if income is going to be taxed at all—to hit capital gains at a lower rate, or better yet, not at all. It's time people put aside their emotions and looked at the matter with clear heads.
Capital gains is of course not ordinary income. It results from an investment decision, that is, a decision to forgo consumption in the present, perhaps for greater consumption in the future. Someone buys an asset, say, shares in a company today with hopes to sell it at a higher price later. The difference between the purchase and sale prices is a capital gain (assuming inflation hasn't made the gain illusory.) But note that in order to buy the asset, the investor had to put off consumption. The gain consists at least partly in the reward for waiting while others use his capital in a productive purpose. (This is most clear if the person lends the money and reaps interest.) Time is valuable, and other things equal, people prefer present goods to future goods. That's why the present value of future goods is discounted. This is known in economics as "time preference." In the market one is normally rewarded for letting others use one's capital for production rather than devoting it to immediate consumption. The person who invests $1,000 in hopes of having 10 percent more in a year demonstrates that he prefers $1,100 a year from now to $1,000 today.
No comments:
Post a Comment