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More on Capital-Gains Taxation

Posted By Don Boudreaux On January 20, 2012 @ 12:53 pm In Seen and Unseen,Taxes | Comments Disabled

A variety of e-mails prompts me to elaborate on my previous post on J.S. Mill and capital-gains taxation [1].

My point there was not to argue that capital-gains shouldn’t be taxed, or that they shouldn’t be taxed at rates higher than those rates at which they are taxed now in the U.S.  My point was simply to make the case that failure to tax capital gains – or failure to tax them at rates higher than they are currently taxed – is not such clear evidence of ‘favoritism toward the rich’ as the popular narrative (found, of course, in the NYT) would have it.

Not surprisingly, I believe that capital gains in fact should not be taxed at all.  But I do not – and cannot legitimately – reach that conclusion by way of Mill’s argument exclusively.  To make a case against capital-gains taxation requires far more argument than I supplied in my previous post.  And it requires also an exercise of value judgments.

….

It’s true that deferring consumption today in exchange for the prospect of being able to consume more tomorrow generates gains that can as legitimately be called “income” as can those gains made possible by choosing to labor today (rather than taking leisure) be called “income.”  (Kevin Martin, commenting on my previous post, made the familiar and valid point that deferring consumption today to pay for education that, in turn, results in higher wage income tomorrow results in taxation of that higher wage income that is very similar to taxation of the gains from, say, investing in shares of Apple.)

The fact is that defining what is and what isn’t “income” suitable for taxation is not as objective a process as it might appear to be at first glance.  Economic and value judgments, as well political realities, must be made in reaching such a definition.  And this fact, in its turn, means that any decision to exclude capital-gains from taxation (or to tax them at lower rates than are used to tax “ordinary” income) cannot easily be dismissed as being nothing more than favoritism to ‘the rich’ or to investors.

Put more succinctly, just as it is obvious that capital gains might well be justly classified as “taxable income,” it is – and for the same reasons – also obvious that capital gains might justly escape being so classified.

….

Consider the following case.

Joe earns this year $70,000 in wage income.  On this income he pays $20,000 in taxes to the IRS.  On 31 December 2012, he spends all of the remaining $50,000 on a new car which he immediately and happily drives away shinily from the showroom to a New Year’s Eve bash.

Jenny – also this year – earns $70,000 in wage income and pays $20,000 to the IRS.  And on 31 December 2012 she, too, turns every cent of her remaining $50,000 over to an auto dealer.  But in exchange she receives not the keys to a car that she drives away that day, but, instead, a promise that one year later she will have waiting for her at this auto dealership a car ten-percent better (bigger, more powerful, more reliable, whatever) than the car that she could, but chooses to not, drive home today.

Should Jenny be taxed, on 31 December 2013, on her “capital gain”?  Should the IRS levy on her a levy for the additional 10-percent of the car that she chose to wait to enjoy?

Given America’s current income-tax system, if it’s obvious to you that Jenny should be taxed on this additional 10-percent of the car that she drives home on 31 December 2013 (but which she paid for in full on 31 December 2012) – or if it’s obvious to you that she should not be taxed on this increment - then you are more perceptive or wiser or more knowledgeable (or all of the above) than I am.

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[1] my previous post on J.S. Mill and capital-gains taxation: http://cafehayek.com/2012/01/are-low-capital-gains-tax-rates-evidence-of-favoritism-toward-the-rich.html

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