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Are Low Capital-Gains Tax Rates Evidence of Favoritism Toward ‘the Rich’?

Here’s a letter to the New York Times:

You assert that because Mitt Romney pays a top rate of 15 percent on his investment earnings – a rate below the top rate at which ordinary income is taxed – that “the tax code has been tilted in his favor” (“The 1% and That 15%,” Jan. 19).  Matters, however, are not so simple.

John Stuart Mill (no one’s idea of an apologist for the rich) argued that, in a country with income taxation, taxation of capital gains at any rate tilts the tax code against people who earn investment income.

When Romney earned the income that he invested, and on which he now enjoys returns, he was taxed on that income at ordinary (higher) income-tax rates.  Had he spent that income on fast cars and Alpine vacations, he would not have been further taxed on the satisfactions he enjoyed from such consumption.  But in fact he deferred consumption by saving and investing those after-tax dollars.  Mill argued that, because the present value today of the larger consumption that a saver expects to enjoy tomorrow equals the value of the smaller consumption that that person could enjoy today were he not to save, taxing capital gains puts an additional burden on savers – a burden not borne by non-savers.  In effect, capital-gains taxes cause consumption opportunities deferred into the future to be taxed more heavily than are the same quanta of consumption opportunities seized today.

Mill’s argument is intricate, and not above challenge as a guide for tax policy.  But it does reveal that taxation of capital gains at rates lower than rates on ordinary income is not, contrary to your conclusion, necessarily evidence of unjust favoritism for ‘the rich.’

Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030