Are Capital Gain or Dividend Income Taxes Double-Taxation?

The Capital Gains tax is not double-taxation.

How many times have you heard a justification for treating Capital Gain and Dividend Income differently than earned income?

Most often the phrase justification sounds something like this:
“Capital gain should be free from taxation or taxed at a lower rate because to tax gain is taxing income twice”.

The other commonly stated justification is:
“Without a lower rate on Capital gain, inventors and entrepreneurs will never take risks or continue to invest in economic opportunity”.

I see Bigfoot Riding a Unicorn.

Both of these justifications are inaccurate, self-serving, misleading and outright lies.

If you earn $1,000,000 and you pay 40% tax on that million, you end up with $400,000 in net income after taxation. Now frankly, I am a supporter of paying as little tax as possible however I also understand that at some point, the tax rate is the tax rate and I therefore pay it.

Now, if I take my $400,000 and invest it in a new venture or into the market and I am so successful that I generate new gross income of $1,000,000, the Capital Gains tax I would be required to pay will be 25% of $600,000 … not 25% of $1,000,000. Although my gross income from the investment is $1,000,000, I have previously been taxed on $400,000. Therefore my taxable income from the investment is $600,000. That income is not taxed as “personal-income” which would be 39%, it is taxed as investment income and therefore taxed at 25%.

In other words, the new gross income of $1,000,000 is not taxed only the gain over the original $400,000 investment because the $400,000 was already taxed. The $600,000 net gain is taxed only once and taxed at the lower capital gains rate of 25%. I would be paying $150,000 in taxes on the $600,000 in gain netting $450,000 in net income.

Now I have $450,000 to invest again which will also be free from future taxation.

In conclusion, the initial $400,000 gain was taxed once. The next $600,000 in investment gain was taxed once. I am free to use the $450,000 for a future investment which may or may not create a future profit which will be taxed only once as well.

The example works in the same fashion for Dividend Income. Capital Gain and Dividend Income are only taxed once.

Now, I do agree with this reality: capitalists and entrepreneur’s respond to incentives. We respond because any person with any common sense will pick up a dollar laying on the floor if you leave it there. If you offer a lower rate of taxes on investment, it stands to reason that more investment may occur – especially if you offer an added tax benefit in the event the investment loses money, (carry-forward or carried interest write-offs). This gives investors a chance to win when they win and an opportunity to win or at least offset prior winnings when the lose. Not a bad deal.

We just need to be careful not to create a disincentive to ventures that create personal income (like regular employment) because as you can tell, the system needs to create personal income as well as investment income since ventures creating personal income can be as risky as ventures creating capital gains income. I hope this makes sense?

A simple example might be how we currently tax the income a Hedge-Fund Manager makes as 100% investment income while at the same time taxing 100% of the salary the President of Harley Davidson makes as personal income ( or basically any salary for anyone other than a Hedge -Fund manager). In 2012, the Hedge-Fund dude paid a tax-rate of 15% on his income while the Harley dude paid 35%. Why does this make sense and what behavior does this incentive drive? The incentive might therefore create more hedge-fund managers but why did we create this unique incentive for the HF dude and not the Harley dude? Another way to say it is why tax 99% of the people earning salaries over $400,000 at 30+% while taxing a very small group of folks earning 7 figures at 15%?

We can argue which rate is the correct rate but I assure you, there are a handful of hedge-fund managers at that lower rate so how why do they deserve that unique tax treatment? I do not believe there would be zero hedge-fund managers if their income was taxed at the level of the Harley President. Therefore the incentive is a nice benefit for just a few and feels like just another a welfare program.

However, the theory of enticing real capitalists to do that which they should do anyway as risk-taking entrepreneurial capitalists (invest) feels a bit socialist if you think about it. Why do capitalists need government incentives to invest? Most capitalists invest not for the tax rate but for the gain from their successful investment. The opportunity to invent a new product and sell it in a free marketplace for a price that generates a substantial profit and positive rate-of-return is an awesome deal for any business person. The lower tax rates on Capital Gain and Dividend Income are a very nice plus. Whether it is the sole reason for getting investment to occur is suspect; but as I said, we’ll take the good deal for as long as it is offered.

If Capital Gains rates were 0%, would we have more investment? Maybe. Perhaps but only if no other country matched the 0% rate. I mean, who wouldn’t move their money to the region offering 0% as long as you could pull out whenever you wanted without risk?

However, just as we saw in Ireland prior to 2008, a country can only give away their economic wealth for so long. During the 2007 Presidential campaign, one candidate spoke glowingly about Ireland’s very favorable tax rates and how corporations flocked to their shores to take advantage of those rates. However, Ireland was one of the first economies to implode in 2007. Many credit the balance between the proper incentives and the rush to grow at any cost as the main driver of the failure of their economy. 0% of anything is never a recipe for a sustainable business model.

Once again, I am not saying I want to see an end to these sweeteners and incentives for investment. I am a proud user of these incentives. I am just saying we should not confuse tax-rate sweeteners with principled fiscal policy. I know that even without the incentives, if I or any other entrepreneur thought investing $1 would make $2, we would take that deal in a New York minute! In other words, I invest because my investment generates a return … hopefully a huge return and the tax-rate sweetener plays a smaller role in my decision to invest that many imply it does. As I said, if you are giving me a sweetener, I’ll take it but if I have an investment opportunity that stands to make me $5million net profit and my net tax-rate was 15% or 35%, at the same time interest rates are less than 3%, the Federal Funds rate is low, and Bonds are paying less than 5% , I would take the investment plunge even at a 30+% rate.

I just want to be honest and admit these incentives do cost something to offer and in many cases, if a city, state or a country is not careful, they can serve as a type of welfare; especially if they exist but can not be proven to actually drive new investment.

I leave you with one last example. When you get paid and earn a dollar. You then take some of that money to pay for entertainment, vehicles, property, and electronic equipment. In most cases you pay sales/use/property taxes on those purchases. This feels more like double-taxation than taxes on Capital Gain or Dividend income.

Neither Capital Gain taxes or Dividend Income taxes are double-taxation. Don’t let anyone tell you differently.

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This entry was posted in "We-the-People - 1 Business Dude's Perspective on Current Political Theatre, elections, Equal Pay, Fiscal Cliff, Jobs, Politics, Presidential Debates, Sequestration, States Competetng with States, tax avoidance, tax loopholes, Tax Rate Discussion, Uncategorized and tagged , , , , , , , , , , , , . Bookmark the permalink.

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