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Old 01-23-2012, 04:15 PM   #21
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The thing about capital gains is they hit all in one year on big investments. So say you bought an apartment building for 100K many years ago and now sell it for a million that is a capital gain. If you add that to your annual income it is taxed at a high rate. Knowing a huge amount of taxes are due you might not sell it since you couldn't replace it on the money leftover. You also might not get cash if you sold on contract so would need to find the cash some where else.

That is why we need a reasonable capital gains rate like 15% and to spread installment sales to the years the money is collected and to have section 1031 exchanges.

It doesn't really matter much when you are only buying stocks because you can spread the sales over many years too or harvest losses to offset.

We currently tax 401K gains at ordinary income rates where if we invested after tax it is capital gains or ROTH is tax free. That doesn't seem fair and limits most people into only withdrawing the RMD to avoid really high rates.
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Old 01-23-2012, 04:18 PM   #22
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I doubt that current law will be what actually happens.

There is no predicting what taxes will actually be in 2013 and beyond, because it depends on the results of elections that are not predictable at this point (IMO).


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After 2013, I understand that Cap Gains will be taxed as ordinary income. Now there is something to consider in how it will hit your retirement plans!
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Old 01-23-2012, 04:47 PM   #23
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Cap gains tax rate goes to 20% when the Bush cuts expire in 2013.
Sorry, you're right! Dividends go to ordinary income in 2013.
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Old 01-23-2012, 05:19 PM   #24
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If corporations did not pay income tax, .... Since that is not the case, I am ok with a modestly lower rate to compensate for corporate taxes and inflation (say 20%). ...
I think 15% is a little too low compared to our earned income tax rates, and I think the efforts to remove cap gains taxes entirely are ill-advised.
Since the title and OP is all about what is 'fair' - I will say that any fixed inflation adjustment on cap gains is not fair at all. It's been discussed here before, but if we want to adjust for inflation, then do it. A table will give the inflation factor, and it's simple math (and easy for any tax program).

Someone 'earning' $1,000 in cap gains over 20 years is far different from someone earning it over 2 years, yet the current tax code treats them the same. Please note, after adjusting for inflation, many capital gains would become capital losses, and should be allowed to offset other capital gains. Why tax someone on a 'gain' that was really a loss in buying power? I don't think that is 'fair'.

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I'm a big advocate of treating all income the same, whenever possible.
And I think the fairest way to do that is to tax spending (National Sales Tax). I honestly think that is a better measure of your ability to pay. If someone has $25 million in fixed investments making near zero (or stock not paying divs and no cap gains sales), and spends $1 million a year, they have more ability to pay taxes at the same rate as someone who had $1M income and spent $1M.

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The thing about capital gains is they hit all in one year on big investments. So say you bought an apartment building for 100K many years ago and now sell it for a million that is a capital gain. If you add that to your annual income it is taxed at a high rate. ...

That is why we need a reasonable capital gains rate like 15% and to spread installment sales to the years the money is collected and to have section 1031 exchanges.
Good example. The inflation adjustment would at least soften this.

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My humble two cents:

I see threads here (and elsewhere) where the impact of a mutual fund's expense is debated to death. All the investment advice says that your portfolio's expense cost is a major factor in reaching your goals.

Nobody seems as worried about taxes as an impediment to their retirement as they do a .75% expense hit.
OK, but remember that the .75% expense hit is on the whole nut. The tax deltas are only on the part that represents 'income', and that is probably closer to the 4% 'SWR' number, so that .75% would be X25 to compare, which would be about an 19% point tax hit. 19% points would get our attention, I assure you.


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Old 01-23-2012, 06:42 PM   #25
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NO POLITICS PLEASE, BUT FIRE RELATED IN THAT MOST IF NOT ALL OF US WILL HAVE CAP GAINS TO DEAL WITH IN RETIREMENT.

I think it's impossible to have a discussion of "fair" that's not also a political discussion.

My political opinion is that we should tax all capital income (interest, dividends, capital gains) at the same rate as ordinary income. I can see an inflation adjustment. I would favor making dividends tax deductible on corporate income tax returns to avoid the "double taxation" of dividends.

But, I see no reason to load up taxes on labor income just so we can reduce taxes on capital income.
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Old 01-24-2012, 08:56 AM   #26
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I think a National Sales Tax is a terrible idea.

It would reduce the amount paid by the wealthy and increase the amount paid by everyone else.

It would create a huge incentive to increase black market activity.

It would encourage Americans to leave the country to make purchases and discourage tourism by foreigners.

I suspect that it wouldn't actually end up replacing the income tax. We would eventually end up with both an income tax and a national sales tax.


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And I think the fairest way to do that is to tax spending (National Sales Tax). I honestly think that is a better measure of your ability to pay. If someone has $25 million in fixed investments making near zero (or stock not paying divs and no cap gains sales), and spends $1 million a year, they have more ability to pay taxes at the same rate as someone who had $1M income and spent $1M.
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Old 01-24-2012, 09:01 AM   #27
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I'm fine with indexing the gain to inflation if it is taxed at ordinary income rates (or say 25% to compensate for corporate income taxes).

I suspect that most people will end up paying more that way than with a flat 20%, although I don't have any numbers to back that up.


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Since the title and OP is all about what is 'fair' - I will say that any fixed inflation adjustment on cap gains is not fair at all. It's been discussed here before, but if we want to adjust for inflation, then do it. A table will give the inflation factor, and it's simple math (and easy for any tax program).

Someone 'earning' $1,000 in cap gains over 20 years is far different from someone earning it over 2 years, yet the current tax code treats them the same. Please note, after adjusting for inflation, many capital gains would become capital losses, and should be allowed to offset other capital gains. Why tax someone on a 'gain' that was really a loss in buying power? I don't think that is 'fair'.
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Old 01-24-2012, 09:01 AM   #28
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I guess I should have known all POVs would surface (0%, 15%, ordinary income - and even broader tax recommendations), so I didn't learn much if anything, but I tried...
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Old 01-24-2012, 09:22 AM   #29
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This is a tough subject to discuss because of so many different parts....

To the OP question, NO, I do not think it is fair to tax cap gains at the same rate as ordinary income.

But one of the problems is why is there cap gains? IOW, what makes it up. Most people talk about a stock. So let's use ABC as an example. I buy the stock at $10. It explodes and is making huge profits which it pays a very high tax on. But it does not pay out a dividend. The sales keep growing, the money keeps piling up etc. etc. In 5 years I sell at $100. The question is why is it now worth $100? It is because the company has a higher book value with all that cash (which has been taxed) and that it will be earning lots of money going forward (which will be taxed) Would it make a difference if I had only held the stock 1 year? Not in my opinion.

Now, if you get rid of the corporate taxes, then I would agree that the income had not been taxed and should be taxed as ordinary income.


But, lets take the case of property. I bought land at $1,000 and acre. Little town grows up and surrounds my land. The value is now $100,000. Was there any income that had not been taxed? No. The land is still the land. It did not earn anything the whole time. It is just that someone now wants it more and is willing to pay a high price to get it.


The other problem with taxing cap gains as ordinary income is that people will not want to take on as much risk. IOW, the actual cost of capital to business will go up. When someone invests capital in a business they want a certain return AFTER TAXES on that investment. If they can get that same after tax return by investing in bonds or something else, then why put your money at higher risk? You will not. So, the cost to business to attract common shareholder investors will go up. This will cause a number of businesses to fail, or even worse not to ever get started. Our economy would grow at a slower rate.
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Old 01-24-2012, 09:24 AM   #30
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I guess I should have known all POVs would surface (0%, 15%, ordinary income - and even broader tax recommendations), so I didn't learn much if anything, but I tried...

Sure you did.... that what is 'fair' is very hard to pin down.
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Old 01-24-2012, 09:30 AM   #31
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I don't see "double taxation" of the earnings on cap gains. Yes, you paid taxes on the amount invested already...but you've not yet paid taxes on the gains themselves.

Sometimes I think the cap gains rate should be HIGHER than ordinary income...as for the most part it's passive in nature....and therefore would be an incentive to have "earned" income.

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Old 01-24-2012, 09:34 AM   #32
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IMO, Long term capital gains should be taxed as ordinary income BUT have the gains indexed to inflation. If an asset bought for $10K is sold at $20K but prices have doubled over that time, there is no *real* gain even though half the sale price is taxed as a gain.
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Old 01-24-2012, 09:39 AM   #33
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I think a National Sales Tax is a terrible idea.
You are entitled to your opinion.

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It would reduce the amount paid by the wealthy and increase the amount paid by everyone else.
Not necessarily. I gave an example where a rich person has no report-able income for the year, yet spends $1M. I think that in the long run, spending is a better measure of someone's ability to pay taxes, than the current spider-web of code that defines and excludes 'income'.

The fairtax.org people propose a 'prebate', to offset the taxes on the first $X of income, which means people below a certain spending point effectively pay no federal sales tax (just as they pay no FIT today). So it is a progressive tax when the prebate is included.

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It would create a huge incentive to increase black market activity.
There is already a huge black market in hiding income today. Some of it is literally 'criminal' (drugs, non-reported cash transactions, etc), and some of it is part of our tax code which favors certain types of income and might be considered 'criminal' by many (I won't go further to avoid getting too political, but taxes are set by Congress, kinda hard to completely ignore the 800# gorilla in the room).

So the real question is: Which system would produce the least hiding of taxable transactions? The fairtax.org people claim theirs is better, but I'm not sure there is any clear answer. But it's not all-or-nothing.

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It would encourage Americans to leave the country to make purchases and discourage tourism by foreigners.
I'm pretty sure that the expenditures would be captured if they brought the purchase back to the US. I doubt that the amount of expenditures moved outside our boundaries and kept there would be very significant, and don't most of those countries include ~ 18% VAT? Not really escaping anything, are they?

Would we need to apply the sales tax to visitors? They don't pay income tax now. Maybe it could be rebated to them when they leave? Even at that, with the elimination of corp taxes and cost of compliance, prices would come down some, offsetting the tax to some degree.

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I suspect that it wouldn't actually end up replacing the income tax. We would eventually end up with both an income tax and a national sales tax.
This always strikes me as a circular argument. Couldn't I say the same about the income tax? They could always add a sales tax to it, so let's not have an income tax?




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I guess I should have known all POVs would surface (0%, 15%, ordinary income - and even broader tax recommendations), so I didn't learn much if anything, but I tried...
Sure you did.... that what is 'fair' is very hard to pin down.
+1 - you beat me to it!

Hopefully not getting too political here, but I think it partially explains the tax code tangle we have now. People have different views, and different people have different amounts of political sway at different times. So we get tax code that favors one view for a while, and then some from the other, then some from yet another. So it is just a mess of conflicting views rolled into one, rather than some structured top-down approach to 'fair'.

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Old 01-24-2012, 09:42 AM   #34
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I will say in addition, regardless of where tax rates are set, that the constant tug of war over tax policy and the uncertainty it creates about how today's financial decisions could be impacted by tax law changes is very damaging to the economy. Even more than whether taxes are a little lower or a little higher, I think it's important to lock them in place for a while at some point, giving more certainty to individuals and businesses deciding how to invest for the long term.
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Old 01-24-2012, 09:46 AM   #35
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I guess I should have known all POVs would surface (0%, 15%, ordinary income - and even broader tax recommendations), so I didn't learn much if anything, but I tried...
Probably you should have had a different title on the thread. Maybe, "Did I do the math right?"

IMO, the answer there would be that you used a marginal rate for capital gains and an average rate for earned income, so you are comparing apples and oranges.

Suppose John and Jane have the same wages and file a joint return. If we think of John's wages as the "base" income, and Jane's as "excess", we'll discover that they are paying more on Jane's earnings than on John's.

OTOH, if we say that Jane is the base and John is the excess, then they pay more on John's earnings than on Jane's.

I don't see how either of those calculations can be used to conclude anything about "fair".

Similarly, you decided the earned income would be the "base" and the cap gains would be the "excess". Try doing the math with the roles reversed and see what happens.
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Old 01-24-2012, 09:54 AM   #36
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Probably you should have had a different title on the thread. Maybe, "Did I do the math right?"

IMO, the answer there would be that you used a marginal rate for capital gains and an average rate for earned income, so you are comparing apples and oranges.

Suppose John and Jane have the same wages and file a joint return. If we think of John's wages as the "base" income, and Jane's as "excess", we'll discover that they are paying more on Jane's earnings than on John's.

OTOH, if we say that Jane is the base and John is the excess, then they pay more on John's earnings than on Jane's.

I don't see how either of those calculations can be used to conclude anything about "fair".

Similarly, you decided the earned income would be the "base" and the cap gains would be the "excess". Try doing the math with the roles reversed and see what happens. If cap gains are taxes as ordinary income, the results would be exactly the same.
That all seems like semantics to me. In the 'tax cap gains as ordinary income case,' any increase in income will be taxed at the applicable marginal rate for that level of income.

The calc was optional reading. Out of my own curiousity, I was simply trying to quantify how much did the eff tax rate go down with the current 15% cap gains rate, and how much did the eff tax rate go up if cap gains were taxed as ordinary income. I regret posting the calcs now, as it seems to have confused the issue for some, sorry.
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Old 01-24-2012, 10:00 AM   #37
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Bruce Bartlett often posts about taxes and this week his blog entry is an excellent short summary of the two competing philosophies of taxation - taxing income or taxing consumption - and then links to a Treasury study published in 01/1977 that describes both. Bartlett's column here Bruce Bartlett: How to Avoid Reinventing the Wheel on Tax Reform - NYTimes.com and the US Treasury study here http://www.treasury.gov/resource-cen...ments/full.pdf titled Blueprints for Basic Tax Reform
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Old 01-24-2012, 10:08 AM   #38
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I'm fine with indexing the gain to inflation if it is taxed at ordinary income rates (or say 25% to compensate for corporate income taxes).

I suspect that most people will end up paying more that way than with a flat 20%, although I don't have any numbers to back that up.
Per the following table, the average income tax paid in 2009 was 11% of AGI:
http://www.taxfoundation.org/blog/show/27899.html
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Old 01-24-2012, 10:23 AM   #39
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Per the following table, the average income tax paid in 2009 was 11% of AGI:
The Tax Foundation - Romney
We have to be careful with wording here.

That 11% is the average of collections as a % of AGI. The 'average' person (and I'm just ballparking/eyeballing here from the table - it looks like the median is in the $30-$50,000 range) is paying ~ 4%-5% of AGI as FIT. And that 30-50K group pays about 5% of the total FIT, though they represent about 18% of the population of those filing.

I make no statement here as to whether that is 'fair' or not, I just wanted to break out the numbers so no one (or even noone) got the wrong idea.


MichealB - thanks for those links I will check them later.

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Old 01-24-2012, 11:52 AM   #40
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I don't see "double taxation" of the earnings on cap gains. Yes, you paid taxes on the amount invested already...but you've not yet paid taxes on the gains themselves.

Sometimes I think the cap gains rate should be HIGHER than ordinary income...as for the most part it's passive in nature....and therefore would be an incentive to have "earned" income.


That is why I put down that it make a difference in where the gain is coming from... IOW, if you buy a small company stock, and it grows like gangbusters... then the increase in price is due to the company making lots of money and keeping it (and paying a high rate on that income).. so the company paid income tax on their income and you pay cap gains tax on the increase in price...

Now, I had not thought about the gain in price due to the future income of the corp that will also be taxed when earned... that would indicate that gap gains on stocks etc. should be zero.... as all income will be taxed inside the corp... or that all corp taxes should be zero as all income will be taxed at the individual shareholder....
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