Thursday, July 12, 2012

Why are long-term capital gains tax rates lower than ordinary income tax rates?

In the United States, capital gains rates are lower than ordinary tax rates e.g. the 15% ordinary income bracket pays 0% on capital gains, and the 35% ordinary income bracket pays 15% on capital gains.  What's the justification?
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Mike EmeighExperienced tax preparation specialis...
The main economic policy justification is to incentivize people to make long-term investments, and thus to encourage economic growth.
1+ Comments • Post • Thank • Jan 20, 2011
Mike Emeigh
Joe WallinStartup and high growth company attor...
I personally think the justification is inflation. A good portion of every capital gain is nominal, not real. Meaning, it is an inflationary gain.
Comment • Post • Thank • Jan 19, 2011
Joe Wallin
Four reasons. (1) The effect of inflation.  You invest $1 million today and cash it in four years later during a period of time when there was 4% inflation per year. If you realized $1.16 million when you sold it, you would pay tax on a 16% gain.  In fact, your investment merely kept pace with inflation and the "gain" you realized was not a real gain.

(2) The effect of the time value of money.  This is very closely related to inflation but can be slightly different.  When you make an investment, you have to wait a certain amount of time before you can realize the gain. A guarantee to receive $1 million in five years is worth less than a payment of $1 million today.  Most of this has to do with inflation...but not all.

(3) Risk of the investment. There is no guarantee that the investment will make a profit at all; it could end up losing money.

(4) The effect of progressive tax rates. Suppose you sell stock that you owned for 20 years and make $200,000 in long term capital gains.  You are probably going to end up in a much higher marginal tax bracket because all of that $200,000 of gain is going to be included in income in the year of sale.  If you had spread that out $10,000 per year over the 20 years you held it, you probably would have not ended up in a such a high marginal tax bracket.

There is no way we can account for the risk element.  But for the other three elements, we could index the computation of the gains in order to eliminate the effects of inflation, time value of money, and the progressive tax rates.  If this type of indexing was done, then taxing resulting capital gains the same as ordinary income would not be unfair.Suggestions Pending
1 Comment • Post • Thank • Feb 7, 2012
Hugh Greentree
Ronald Jay 
1 vote by Neel Kumar
I dont see a justifiable explanation... Why can a wealthy, working aged indivudal living of his investments be taxed less on his 'income' (playing golf, while his money works for him by itself...(ok somewhat stereotypical))  than someone who has to work 12 hours a day to receive his income.

Surely a significantly higher tax on capital gains, and lower income tax would incentivise capital rich people to take their money out of long term cushy investments, and start their own business, thus creating real income (at a lower tax rate) and new real  

For those that argue it would effect long term economic growth...Could this not be done for a limited period of time.
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1+ Comments • Post • Thank • Jan 25, 2012

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