Mike Kueber's Blog

August 23, 2011

Increase the capital-gains rate and balance the budget

Filed under: Issues,Politics — Mike Kueber @ 6:33 pm
Tags: , , , ,

As the federal government struggles with its deficit and debt, an item that has escaped much public attention is the preferred treatment of capital gains.  As Warren Buffett recently pointed out, this preferred treatment enables him to pay taxes at a lower rate than his secretary:

  • “Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as ‘carried interest,’ thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.”

James Stewart, a business/finance columnist for the NY Times, recently elaborated on Buffett’s argument about carried interest:

  • For most hedge fund and private equity partnership managers, carried interest is compensation in the form of a percentage (usually 20 percent) of any gains they generate for investors. If a hedge fund manager generated $1 billion for investors by betting against mortgage-backed securities before the real estate market collapsed, the hedge fund manager is entitled to keep $200 million as compensation. The tax code treats that as a capital gain, taxed at a lower 15 percent rate. (The top rate on ordinary income is 35 percent.) The argument that this should be ordinary income rests on the notion that hedge fund managers earn these fees from their labor, just like other workers get a salary for theirs and are taxed at ordinary income rates.

Although managers of private equity and hedge funds provide a (un)popular target for tax reform, the far richer target is the complete elimination of a separate, reduced rate for capital gains.  If the capital gains rate were the same as an individual’s income tax rate, Warren Buffett wouldn’t pay taxes at a rate lower than his secretary.  Furthermore, the elimination of the reduced rate is not an extreme idea.  In fact, it was included in the estimable report of the bi-partisan Simpson-Bowles commission.

The aspect of this reform that fascinates me is the prospect of implementation would surely motivate millions of people with locked-in capital gains to claim those gains at 15% before the new 35% rate kicks in.  I have searched high and low to find an estimate of how much capital gains are waiting to be taxed, but I have been unable to find an estimate.  Although the capital-gains tax plays a relatively small part in supporting the federal government (see below), I suspect that the surge of activity to avoid a higher rate would go a long way toward balancing the federal budget that year.

Table 1 Sources of Federal Revenue (billions of 2003 dollars)

——————————————————————————–

Capital gains tax 45

Corporate income tax 132

Individual income tax 794

Social Security taxes 713

Total revenues 1,782

 

3 Comments »

  1. In your liberal quest to have the government take more money from the people, I hope you are advocating raising the tax rate on investment income (capital gains and dividends) ONLY for those mega-wealthy folks like Buffett.

    Buffett said: “But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.”

    Raising the investment income tax rate on smaller investors like myself would hurt me and curb my desire to invest more.

    Here is a link to another good article on this issue: http://www.politifact.com/truth-o-meter/statements/2011/aug/18/warren-buffett/warren-buffett-says-super-rich-pay-lower-taxes-oth/

    Comment by Semolina Pilchard — August 24, 2011 @ 4:39 pm | Reply

    • I like the current capital-gains tax rate on people in the 10% and 15% brackets – zero. But like Buffett said, people are not going to seek a smaller return on their investment just because the tax rate increased.

      Comment by Mike Kueber — August 25, 2011 @ 4:45 am | Reply

    • The Politifact article was interesting – I would be interested in Buffett’s explanation of the 41% tax on a colleague, which doesn’t seem possible. But I am reluctant to 2nd guess Buffett.

      Comment by Mike Kueber — August 25, 2011 @ 4:55 am | Reply


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