A Taxing Dilemma

By Dave Smith, Contributor to US Daily Review.

A commonly-heard proposal from the Obama Administration lately has been that we should raise taxes on “millionaires and billionaires”, which in the convoluted doublespeak of Washington, DC, and our federal tax code, actually means anyone making more than $200,000 per year ($250,000 for a couple).  Among his most vocal supporters in this endeavor is one of the most popular and successful business magnates in history, Warren Buffett.  According to Buffett, his secretary pays a higher percentage of her income in taxes to the federal government than does he, a situation that, if true, would certainly appear to be evidence of unfairness in the federal tax code.  Other billionaires, such as Bill Gates and Mark Cuban, have also advocated at one time or another for higher taxes on the wealthy.  These calls were rebuked by Republicans, claiming that the higher taxes would be imposed on “job creators” and amounted to “class warfare” by President Obama and his allies.

The fundamental issue of taxation, however, goes much deeper than anecdotes about millionaires and billionaires” and their employees or the rich vs. the poor and middle class.  The President’s calls for a so-called “Buffett Rule” during a time when the economy is still struggling to improve, and when job creation is scarce, amount to advocating for for higher taxes on capital investment and business, not just individuals.

Under United States tax code, business profits and individual wages are treated differently than gains realized from capital investment.  Capital investment is the key to capitalism; it fuels the creation of wealth, innovation, jobs, and prosperity.  Whether the investment is real estate, or a factory, or stock and mutual funds for a pension or retirement account, capital investment is the engine of a free market economy.  Also noteworthy is that such investment is typically made with money that has already been taxed once, such as corporate profits or wages.  Thus, with a few exceptions, such investment has been incentivized in the tax code with lower rates since being separated from regular income in the 1920s. 

Ostensibly, the purpose of any taxation framework is to raise the revenue necessary to fund the activities of the government, whatever those activities might be (which itself is, of course, the source of much debate).  However, looking at the history of the capital gains tax provides some interesting information — raising the capital gains tax paradoxically tends to produce less revenue, not more, while decreasing the capital gains tax tends to produce more revenue.  According to IRS data, this has consistently occurred in every single instance over the past 50 years.

For example, the capital gains tax was increased in 1968, increasing from 25% to 36.5%; not only did capital gains tax revenues decrease, it took 8 years before revenues reached 1968 levels again.  The rate was cut to 20% in 1979, and revenues immediately increased, with the government collecting new record revenues each year until 1986 — that’s 7 straight years of record-setting collections following a cut in the capital gains rate.  The next rate increase was in 1986, and this time it took ten years for revenue collections to reach 1986 levels.  The rate was cut in 1998 and 2003.  In both cases, revenues once again increased.

Why is all this important?  Because the reason so many “millionaires and billionaires” can potentially pay lower percentages of their income to the federal government than less well-off earners is because their income doesn’t come from salary and benefits, but rather from gains on capital investments.  Warren Buffett is only paid a salary of $100,000 per year; his wealth is built on stock ownership and capital gains, not a high salary.

Pursuing an increase on capital gains taxes might seem at first glance to be a fair reaction, but the evidence shows that not only is this an impediment to the types of investment that can promote economic prosperity, but it also actually reduces the revenue collected by the government.  Pursuing a policy that requires an 8-to-10  year window to break even does not sound like the advice the “Oracle of Omaha” would impart on a company he owns.  It certainly isn’t the right policy for the American economy.

All opinions expressed on USDR are those of the author and not necessarily those of US Daily Review.

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