Skip to comments.Thomas Sowell: A Lesson on Capital-Gains Taxes (Something even Warren Buffet must learn)
Posted on 10/03/2012 5:08:41 AM PDT by SeekAndFind
One of the many false talking points of the Obama administration is that a rich man like Warren Buffett should not be paying a lower tax rate than his secretary. But anyone whose earnings come from capital gains usually pays a lower tax rate.
How are capital gains different from ordinary income?
Ordinary income is usually guaranteed. If you work a certain amount of time, you are legally entitled to the pay that you were offered when you took the job. Capital gains involve risk. They are not guaranteed. You can invest your money and lose it all. Moreover, the year when you receive capital gains may not be the same as the years when they were earned.
Suppose I spend ten years writing a book, making not one cent from it in all that time. Then, in the tenth year, when the book is finished, I may sell it to a publisher who pays me $100,000 in advance royalties.
Am I the same as someone who has a salary of $100,000 that year? Or am I earning $10,000 a year for ten years work?
It so happens that the government will tax me the same as someone who earns $100,000 that year, because my decade of work on the book cannot be documented. But the point here is that it is really a capital gain, and it illustrates the difference between a capital gain and ordinary income.
Then there is the risk factor. There is no guarantee to me that a publisher will actually accept the book that I have worked on for ten years and there is no guarantee to the publisher that the public will buy enough copies of the book to repay whatever I might be paid when the contract is signed.
Even the $10,000 a year which is less than anyone would earn in an entry-level job is not guaranteed. If my years of work produced an unpublished manuscript, I would not even have been among the first thousand writers who met this fate.
Very similar principles apply to businesses. We pay attention to businesses after they have succeeded. But most new businesses do not succeed. Even those businesses that eventually turn out to be enormously successful may go through years of losing money before they have their first year of earning a profit.
Amazon spent years losing money before turning a profit for the first time in 2001. McDonalds teetered on the edge of bankruptcy more than once in its early years. The people who ran McDonalds resorted to desperate expedients just to keep their noses above the water while hoping for better days.
At one time, you could have bought half interest in McDonalds for $25,000 and there were no takers. Anyone who would have risked $25,000 at that time would be a billionaire today. But there was no guarantee at the time that they wouldnt just be throwing 25 grand down a rat hole.
Where a capital gain can be documented when a builder spends ten years creating a housing development, for example then whatever that builder earns in the tenth year is a capital gain, not ordinary income. There is no guarantee in advance that the builder will ever recover his expenses, much less make a profit.
There are whole industries where no one can expect to make a profit the first year publishing a newspaper for example. Virtually every major American airline has lost money in some years, and some of the biggest and most famous airlines have ended up going bankrupt.
If a country wants investors to invest, it cannot tax their resulting capital gains at the same rate as the incomes of people whose incomes were guaranteed in advance when they took the job.
It is not just a question of fairness to investors. Ultimately, it is investors who guarantee other peoples incomes in a market economy, even though the investors own incomes are by no means guaranteed. Reducing investors incentives to take risks is reducing the jobs their investments are likely to create.
Business income is different from employees income in another way. The profit that a business makes is first taxed as profit and the remainder is then taxed again as the incomes of people who receive dividends.
The biggest losers from politicians who jack up tax rates are likely to be people who are looking for jobs that will not be there, because investments will not be there to create the jobs.
Thomas Sowell is a senior fellow at the Hoover Institution
“Ultimately, it is investors who guarantee other peoples incomes in a market economy, even though the investors own incomes are by no means guaranteed. Reducing investors incentives to take risks is reducing the jobs their investments are likely to create.”
Great, great article. Every word.
Then work his way through the arguments on behalf of different exclusions from income for each type of transaction ~ finally, he can ask why when I make no profit at all I am still taxed, and GE isn't.
The problem here is that Sowell’s logic is flawed as viewed by the left because they want it all. Paychecks for everybody should come from the government with the paystubs showing no taxes. The govt cut is silently removed. To each according to what the govt gives him/her.
Very good explanation on the risk in capital gains. But how about an independent contractor or consultant? He makes an income that is taxed same rate as a wage earner or man on a salary but his earnings can be highly variable. They are hardly guaranteed.
Plus these days the workforce is more and more independent contractors and consultants rather than being a direct employee of company X
What Sowell is forgetting is probabally the most important thing to state. Money put into ventures that will be taxed as “Capital Gains” is money that has already been taxed when it was earned.
One of the first things you learn as an economics student is that all growth in an economy takes place form savings. Even in an economy like ours there is no REAL growth unless there is savings that is invested in a new venture. That venture can be plant expansion or a new business but the money has to come from somewhere.
Our government thinks it can change the laws of economics by printing fiat money, then using that money just as it would savings, or taxes, to put into a venture. It doesn’t work, it seems to for a while but the new money in the economy shrinks the value of everyone elses money.
Inflation is simply an unlegislated tax on the people. Since the government gets to spend the fake fiat money first, before it inflates the money supply it gets full value for it. After the money gets into the economy it decreases the value of everyone elses money and then we actually have less than before the fake money was created just like if the government would have taken it from us in the form of tax. Actually, the taxation would be much better because it wouldn’t effect the value of our capital, like our homes and cars and most importantly our savings.
When governments inflate the money supply by printing fake money they steal not only from our pockets and future earnings but from our past years of work via our savings.
What this administration has done by the reckless spending of trillions of dollars is to wipe out the value of our savings. Gold hasn’t gotten more valuable because there is less of it, in fact there is more being produced everyday, it should be going down in value. The value of gold has been relatively stable, it is the value of the dollar that has gone down.
If any politician could properly explain this so that people could understand it easily the masses would rise up against the fiat printers. It is the most regressive form of taxation there could be. It steals from the poor the most because the poor are not earning interest on their money, the poor do not have investments that grow, they have their homes, their cars and their retirement savings, and those savings are very modest. The value of all of them are being destroyed.
What the Democrats have done to us with their printing presses is simply evil.
Not to mention that the money invested was taxed as income or cap gain before it was invested in the first place.
That is because libs lack what I call “assembly neurons”. They want to launch the space shuttle but they don’t have that “assembly building” where all the inglorious work is done, where the bolts are tightened, the systems checked, the tiles inspected. They go directly from the pile of parts to “launch” without regard to the tedium of having to think out the preliminaries.
That’s why you hear them saying “let’s do launch” all the time. Ba da bump.
“.....But how about an independent contractor or consultant? He makes an income that is taxed same rate as a wage earner or man on a salary but his earnings can be highly variable. They are hardly guaranteed.”
True, they are not guaranteed, but, an IC does have the opportunity to take as biz expenses the array of items businesses can deduct. IMO, Sowell was saying not so much that a wage-earner’s salary is guaranteed, but that in effect, each hour of labor as traded for each hourly piece of his wages *are* guaranteed...and to a large extent, they are.
“Plus these days the workforce is more and more independent contractors and consultants rather than being a direct employee of company X”
More and more, yes, but I suspect that salaried workers or wagearners (as defined by how those individuals file their taxes) outnumber ICs by well over 20:1...maybe 50:1.