

Ordinary Income vs Capital Gains  - cwan
http://www.avc.com/a_vc/2011/05/ordinary-income-vs-capital-gains.html

======
spenrose
The thrust of this post is wrong; while I'm looking for a good breakdown of
tax burden by quintile I'll just observe:

"We live in NYC and according to our accountants, we pay a marginal fully
loaded tax rate of 47.62%. That means we keep about half of the ordinary
income the Gotham Gal and I generate." The second sentence glides over the key
word in the first sentence, "marginal". AVC and GG pay much lower rates on the
first income they earn during the year -- it is only the income that exceeds
what most people will ever earn during a year that is taxed at the higher
income rate. Conversely, the first income -- the income they have in common
with ordinary people -- is subject to social security and unemployment tax --
but the extraordinary income that makes them very wealthy is not. They also
probably pay much less of their income in sales tax and small fees that most
Americans.

Finally, according to the IRS in several recent years 10% of the capital gains
income in the entire country has gone to the richest 400 tax payers, whose
average tax rate is not the 47% rate AVC cites, but 17%:
[http://krugman.blogs.nytimes.com/2011/04/30/who-benefits-
fro...](http://krugman.blogs.nytimes.com/2011/04/30/who-benefits-from-
bubbles/)

Edit: here's total tax distribution by quintile:
[http://curiouscapitalist.blogs.time.com/2009/01/07/moving-
fr...](http://curiouscapitalist.blogs.time.com/2009/01/07/moving-from-judd-
greggs-dubious-tax-math-to-robert-reichs-dubious-tax-language/) . Note that
the 34.5% paid by the richest 20% drops sharply for the very richest.

~~~
yummyfajitas
Yes, instead of paying taxes directly, the corporations owned by those 400
taxpayers paid taxes on profits (15-35%). Then their owners paid an additional
15-35% tax on those profits (averaging out to 17% for the top 400).

I agree - we should make it fairer. We should eliminate taxes on corporations
and replace it with taxes on their owners. It's unfair that the owners of
corporations are taxed at such high rates, but the taxes they pay are ignored
by journalists and propagandists.

~~~
yequalsx
When dealing with corporate tax rates one should talk about effective tax
rate. There are quite a few examples of corporations paying very little tax on
their profits. Some even pay zero tax whilst making billions in profit.

I believe that the effective tax rate on U.S. corporations is roughly the
industrialized nation average. Having no corporate tax would make the U.S. an
outlier in terms of tax policy. This doesn't make it unsound but does make me
hesitant to agree with you on this point. Are the tax policies of most nations
unfair to corporations? I have a hard time believing this to be so.

Imagine a business with one owner. The owner employs 5 workers. Shouldn't the
business pay tax on the profits? Suppose the business owner makes a profit of
$100,000. Should this be tax free because he/she owns a business? If the
business owner made $100,000 while working at 3M then the salary (profit)
would be taxed.

I think the philosophy under girding the tax system is that, roughly speaking,
any entity that gets money [edit] should pay tax on it. This seems fair to me.

There are notable exceptions of course. If I find $5 million dollars in gold
while on a walk I pay tax on the whole amount. If I get the money because
someone died I don't.

~~~
yummyfajitas
_Some even pay zero tax whilst making billions in profit._

Yes, typically because they lost billions in prior years. Sometimes also due
to various tax subsidies (e.g., green energy tax credits in the case of GE).

 _Are the tax policies of most nations unfair to corporations?_

I didn't say it was unfair to corporations. I don't believe that a claim like
"unfair to corporations" even makes logical sense.

I said it was unfair to their owners. Consider your hypothetical business
owner. Out of the $100k in profits, the business pays perhaps $20k. The
business owner then pays another $15k. But then people trying to score
political points complain that he is getting away with something, and paying
only $15k on $80k (19%). I think that's unfair.

Under my proposal, the business pays $0k and the owner pays $35k. This way, he
gets to take (moral/political) credit for the taxes he pays just like a
salaried employee. (Similarly, I favor eliminating payroll taxes.)

~~~
yequalsx
In the example provided, the business does not pay tax on the $100,000 given
to the owner (as salary or other form of compensation) as that is an expense
of the business. The business only pays tax on the profits to the business (as
an entity separate from the owner).

There is nothing illogical with the phrase "unfair to corporations". A
corporation is a person in the U.S. Is is it illogical to say, "unfair to
people"? It can be said of a policy that it is unfair to corporations. Suppose
the only entities that were taxed were corporate entities. In such a case one
would reasonably say that the tax structure was unfair to corporations.

Owners of a corporation are stock holders. They make a profit on their holding
via dividends and selling the stock at a higher price than what they bought it
for. I disagree that it is unfair to a stock holder to pay taxes on the
dividends received or on the capital gains. I believe it is a sound principle
- for the maintenance of consistency, which is what fairness really is about
in this issue - that entities that make a profit pay tax on it.

~~~
yummyfajitas
You are conflating salaries and dividends. The business doesn't pay tax on
$100k salary (it's an expense) and the owner pays ordinary income tax on that.
The same is true for pass-through corporations, which make up a large fraction
of the profitable corporations that pay no taxes.

The business does pay tax on profits and spends _after tax_ dollars
distributing dividends to shareholders. Similarly, _after tax_ dollars
contribute to a corporate valuation which enables owners to sell shares and
take capital gains.

 _A corporation is a person in the U.S._

The term "person" has been overloaded and you are conflating different uses of
the term. A corporation is a legal person, which means they can enter
contracts, file lawsuits and be sued. This provides a common interface for
counterparties, nothing more.

A corporation is a set of assets, liabilities, a web of contracts governing
the management of said assets/liabilities and a government guarantee of
limited liability. I can't see how it makes sense to discuss whether something
is unfair to my company. Similarly, it makes no sense discussing whether
something is unfair to my cell phone and service contract.

 _I disagree that it is unfair to a stock holder to pay taxes on the dividends
received or on the capital gains._

Me too.

All I said is that it's unfair to tax profits to the tune of $20k, dividends
to the tune of $15k, and then pretend the owner of the corporation is only
paying $15k in taxes.

If you want to discuss the taxes paid by the top 400 taxpayers in the US,
include the corporate taxes paid by the companies they own.

~~~
yequalsx
In my example the $100,000 was salary. When you wrote:

"I said it was unfair to their owners. Consider your hypothetical business
owner. Out of the $100k in profits, the business pays perhaps $20k. The
business owner then pays another $15k. But then people trying to score
political points complain that he is getting away with something, and paying
only $15k on $80k (19%). I think that's unfair."

I thought you were talking about salary. Sorry for the confusion.

I can't think of an example where it makes sense to say, "that isn't fair to
your cell phone". I can think of lots of examples where it makes sense to say,
"that isn't fair to cell phone providers [companies]".

------
ulf
The major problem with the much cheaper taxing of capital gains remains the
growing inequality: Of every you dollar you earn through your own labor, you
get less (until you pass the max threshold). And this while your capacity of
personal labor is clearly somehow limited. On the other hand, people earning
one million dollars from capital gains are taxed equally with people who earn
one billion.

~~~
cynicalkane
There are two counterpoints to this. The first is that capital gains taxes
tend to be on investments made with income you've earned, so there's already
been an income tax. The second is almost all of the uber-rich made their
fortunes by growing a small company into a big one, so it's not as though
they're already being taxed (through progressive corporate taxes).

There are obvious flaws to this scheme, but it's pretty hard to tax income in
a fair way. Some places (notably the EU) favor using a consumption tax
instead.

~~~
_delirium
> The first is that capital gains taxes tend to be on investments made with
> income you've earned, so there's already been an income tax.

I don't really get this counterpoint; isn't _everything_ in the economy a flow
of money that has been taxed at a previous point in the flow? If I have
$100,000 that I've already paid taxes on, I could invest it in external assets
and hope to make capital gains on them; or I could plow it back into my own
occupation and use it to generate income (say, by setting up an art studio).
Why should I pay more taxes in the second case?

Consider two eBay-painting-seller scenarios. In the first, I buy painting
materials, paint paintings, and then sell them on eBay. In the second, I buy
existing paintings on eBay that I think are underpriced, and then resell them
later for a profit. Why should I pay _more_ taxes in the first case, just
because I painted the paintings? In both cases my occupation is basically
"selling paintings on eBay", but in one I'm creating new ones and selling them
for an income, and in the other I'm flipping existing paintings, making a
capital gain. In both cases the starting capital is money I've already paid
taxes on. If anything, the first occupation seems like the one policy should
encourage, rather than the second, but at the very least I don't see any
reason to actively encourage the second version over the first.

~~~
cynicalkane
I am not a tax lawyer, but my understanding is that capital gains only count
as such if you've held the asset for at least a few years.

By the way, in the first case, your outlays are tax-deductible.

(edit: I'm not an expert, so downvoters, please explain your disagreement.)

~~~
_delirium
The outlays being tax-deductible is the same in both cases: you only pay tax
on the gains between what you put in and got out, not on the total revenue. If
you spend $100k on art supplies and sell $110k in paintings, you pay taxes on
the $10k net profit. Same as if you bought a bond for $100k and sold it for
$110k; you only pay taxes on the $10k net gain.

But in the second case, you're taxed at a lower rate, so the tax code appears
to want to discourage you from investing your capital in your own work. If you
ever find yourself in a situation where you could make a 10% return on capital
by putting that capital to work yourself, or could make the same 10% by
putting that capital into a passive investment, the tax code promotes the 2nd
option.

------
dbfclark
Several points from a NYC taxpayer:

47.62% is the top marginal fully loaded tax rate on ordinary income. That is,
35% individual federal plus 8.97% state tax plus 3.88% city, less rounding and
maybe a few dollars of unused credits. This is the rate on the next dollar of
ordinary income (and the number you use if you wish to maximize your claimed
tax rate). The claimed capital gains number of 27.63% is 15% plus that same
amount for state and local taxes, which do not treat capital income
differently (the .62% on the end of both is the giveaway). Neither of these
numbers is an _effective_ tax rate (=tax actually paid/pretax income), or "tax
pressure," whatever that is -- at my guess, Mr. Wilson probably pays effective
tax in the 30-40% range, depending on how much capital gains he realized in
the year.

On capital gains rates generally, tax does work on the margins, but this means
that we should worry about what kind of investments are incentivized by lower
capital gains rates. I seriously doubt that a Mr. Wilson taxed at the regular
income rate for capital gains would put even one fewer dollar into his fund,
making 20+% pretax, if his other choice were, as he says, the mattress making
0%. Even at equal income and capital gains rates, the incentive to maximize
your returns is pretty strong, so the idea that the differential rate is
changing behavior in a useful way needs more analysis than Mr. Wilson gives
it.

For corporate taxes, effective rates are indeed what matters when comparing
tax burdens since corporations get such a variety of credits; that said, the
fewer deductions/lower rates tradeoff is free economic growth and we should do
it (it'll never happen, though, since congress is too dysfunctional).

And last on "double taxation": gopi is right that most corporations are
organized as passthrough entities -- they pass all income through to their
owners, who then pay tax on it. Those that aren't do have lower taxation of
dividends to make up for the equivalence of share buyback and dividends.

------
gopi
Most of the small business in US are pass thro entities so they pay ordinary
income tax rates and also they reinvest the money back into business. They are
inherently non-scalable business so the owners don't realize wealth by selling
the business instead they get it thro the profits from operating the
business... IMO, its not ethical that his tax rate is double than that of a
tech entrepreneur or a wall street hedge fund guy.

My personal preference would be a lower overall rate (25%) with no deductions
for both ordinary income and capital gain. For a brief time in US history (in
the Reagan administration) this was the case and from what i read it never
discouraged capital investment.

------
kleiba
> _And when you go to the pay window [...], you will be sharing a lot less
> with the government and keeping a lot more._

Ever used a road? Or went to a public school? Do you have a local library?
Your tax money doesn't go to the government, it goes to the state. And yes,
the state has an expensive administration, but by and large the state is all
of us.

~~~
dpatru
Roads are paid for with gas taxes, something that is hard to avoid if you
drive. Public schools and libraries are supported by property taxes, again,
something all residents pay. Income taxes primarily go to the federal
government to pay for military bases abroad, wars, and a lot of other
functions that either aren't needed or could be better done by non-government
entities.

~~~
maigret
Interesting. In Germany, the law states that taxes can't be bound to a certain
goal. Taxes all go to a big budget basket, which is then allocated by the year
budget. It means that the oil tax can finance school, military, or anything.

------
jbellis
Note that many _states_ , including California, tax capital gains at the same
rate as ordinary income.

------
truthtechnician
Taxing income higher than capital gains encourages investment over
consumption.

