Why raising the capital gains tax on millionaires will backfire: Mark Altieri
KENT, Ohio – There are two types of income taxed under our federal income tax system. Labor income (ordinary income such as wages) is taxed at the maximum rate of 37% under the law in force. This is the type of income that W-2 employees pay taxes on. Successful entrepreneurial wealth creators typically produce this type of income and are taxed at the regular income rates just mentioned.
The second category of “rich”, the passive rich is different from active and entrepreneurial wealth creators. We are now talking about millionaires and billionaires, people who more often than not live on investment income rather than earned income like wages. Under current legislation, investment income such as dividends and capital gains are taxed at the rate of 0% for low income taxpayers, 15% for middle income taxpayer and 20% for high income taxpayer, with an additional Obamacare surcharge of 3.8% typically for the latter group.
Although I adore the creators of entrepreneurial wealth, I have little in common with, or special sympathy for, wealthy state liabilities. If Congress wanted to impose a higher tax rate on wages and other income generated by the passive rich, that would be OK for me. But under no circumstances should Congress increase tax rates on anyone’s capital gains.
When I teach Capital Gains Taxation, I always point out to my students that there are a number of very good reasons why capital gains rates should be much lower than regular income rates. The first and most important reason is that there is an almost pure correlation between capital investment and employment growth in the private sector. Common sense and reality indicate that since we Americans want less of anything (not just capital investments), we just need to tax them more, rather than less.
President Joe Biden and his party, however, promote the reverse by proposing to double the capital gains rate about millionaires. Less capital investment and less job growth will be the inevitable consequence of implementing this proposal.
Here are some other reasons: Capital gains and dividends are largely or fully double taxed. By the time an individual receives a stock dividend, that money has already been taxed at the corporate level. Likewise, when one sells shares of a company with a capital gain, that gain normally reflects years of profitable growth that have already been taxed at the company level.
Another reason: lower rates of capital gain allow capital to migrate from less productive investments to more productive investments. For this reason, many European countries do not tax long-term capital gains at all, including Belgium, the Czech Republic, Luxembourg, Slovakia, Slovenia, Switzerland and Turkey. European countries that tax capital gains averaged 19.3%.
Finally, and the icing on the logical cake, is that when you significantly lower the tax rate on capital, the US Treasury generates more (not less) revenue. This is exactly what happened in the late 1990s and early 2000s when the rate of capital gain fell from 28% to 20% to 15%. This phenomenon has contributed significantly to the annual surpluses of the last years of the Clinton administration.
How can this be? This is the point I just pointed out to you a few lines ago – when rates are drastically reduced, there is less tax “blocking” effect, capital moves to more productive places, and there are many more capital-to-tax transactions, albeit at lower rates. History tells us that a substantial increase in tariffs has the opposite effect – less revenue.
Raising the rate of ordinary income for entrepreneurs, the wealthy creators of wealth, or increasing the rate of capital gain for anyone will be a disaster for our macro economy.
Mark Altieri is Emeritus Professor of Accounting at Kent State University, where he taught advanced courses in tax and special tax advisor at the law firm Wickens, Herzer and Panza in Avon, Ohio.
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