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Cap Gains Taxes - What is Fair?
Old 01-23-2012, 12:12 PM   #1
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Cap Gains Taxes - What is Fair?

I've always meant to do the math just to see how the current cap gains 15% tax rate would compare to cap gains taxed as ordinary income. At $100K/yr and saving/investing 10% per year, at the end of 15 years it doesn't make a big difference. In that the money invested has already been taxed (and reduced what you have to invest for yourself), does it make sense for gains to be taxed as ordinary income - double taxed?"

I am not as interested in the impact on the super-rich, that doesn't apply to anyone here AFAIK.

I am not talking about Corp income, hedge funds, etc. - just personal income and cap gains. What's "fair" isn't readily apparent to me...

Effective Tax Rate:
- on income (no investing/cap gains) = 15.6%
- on income with cap gains @ 15% = 15.5%
- on income with cap gains as ordinary income = 16.3%


NO POLITICS PLEASE, BUT FIRE RELATED IN THAT MOST IF NOT ALL OF US WILL HAVE CAP GAINS TO DEAL WITH IN RETIREMENT.
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Old 01-23-2012, 01:05 PM   #2
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Midpack, sorry but I don't follow what you are comparing or analyzing here.
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Old 01-23-2012, 01:09 PM   #3
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There appears to be something wrong in your calculations.

How can the tax rate be higher with no capital gains tax than with it at 15%?


Quote:
Originally Posted by Midpack View Post
I've always meant to do the math just to see how the current cap gains 15% tax rate would compare to cap gains taxed as ordinary income. At $100K/yr and saving/investing 10% per year, at the end of 15 years it doesn't make a big difference. In that the money invested has already been taxed (and reduced what you have to invest for yourself), does it make sense for gains to be taxed as ordinary income - double taxed?"

I am not as interested in the impact on the super-rich, that doesn't apply to anyone here AFAIK.

I am not talking about Corp income, hedge funds, etc. - just personal income and cap gains. What's "fair" isn't readily apparent to me...

Effective Tax Rate:
- on income (no investing/cap gains) = 15.6%
- on income with cap gains @ 15% = 15.5%
- on income with cap gains as ordinary income = 16.3%


NO POLITICS PLEASE, BUT FIRE RELATED IN THAT MOST IF NOT ALL OF US WILL HAVE CAP GAINS TO DEAL WITH IN RETIREMENT.
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Old 01-23-2012, 01:13 PM   #4
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Originally Posted by Hamlet View Post
How can the tax rate be higher with no capital gains tax than with it at 15%?
Greater income...
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Old 01-23-2012, 01:19 PM   #5
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Why would you have greater income with a capital gains tax than without?

I would expect you to have less income, since some of your capital has been taxed away over the years.

I don't appear to understand at all what you are calculating.


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Greater income...
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Old 01-23-2012, 01:28 PM   #6
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Midpack, sorry but I don't follow what you are comparing or analyzing here.
The calcs may confuse the issue, I just wanted to actually see the exact result for the three scenarios. Just curious what people think is fair and why? Is paying taxes on cap gains as ordinary income "fair" remembering the double tax aspect? Is the lower rate an incentive to save and invest?

Maybe that's all semantics and it's just a total tax revenue question...

Not helping myself here probably. You're welcome to kill the thread if you think we can't have a non-political exchange (seriously), that's not what I'm hoping for.
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Old 01-23-2012, 01:32 PM   #7
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Quote:
Originally Posted by Hamlet View Post
Why would you have greater income with a capital gains tax than without?

I would expect you to have less income, since some of your capital has been taxed away over the years.

I don't appear to understand at all what you are calculating.
The capital gains are additional income vs not investing at all, then it's just a matter of what rate those gains are taxed at.
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Old 01-23-2012, 02:07 PM   #8
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I wouldn't think that not investing at all would be a scenario we'd be looking at. I assumed that the investing behavior was staying the same and that the only thing changing was the tax rate on cap gains.

The vast majority of us are going to invest regardless of the tax rate on capital gains. The rate may change some behavior at the edges, and if rates got ridiculously high it might change behavior more dramatically, but most people are not going to stop saving for retirement to avoid paying capital gains taxes, even at ordinary income rates.


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The capital gains are additional income vs not investing at all, then it's just a matter of what rate those gains are taxed at.
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Old 01-23-2012, 02:16 PM   #9
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I'm a big advocate of treating all income the same, whenever possible.

If corporations did not pay income tax, I would be in favor of having cap gains (and dividends) taxed at ordinary rates (with cap gains indexed to inflation).

Since that is not the case, I am ok with a modestly lower rate to compensate for corporate taxes and inflation (say 20%). I would note that the double taxation caused by corporate income taxes is becoming less and less important as most of our large corporations seem to be getting better and better at tax avoidance.

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.

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Originally Posted by Midpack View Post
Just curious what people think is fair and why? Is paying taxes on cap gains as ordinary income "fair" remembering the double tax aspect? Is the lower rate an incentive to save and invest?
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Old 01-23-2012, 02:36 PM   #10
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Quote:
Originally Posted by Midpack View Post
The calcs may confuse the issue, I just wanted to actually see the exact result for the three scenarios. Just curious what people think is fair and why? Is paying taxes on cap gains as ordinary income "fair" remembering the double tax aspect? Is the lower rate an incentive to save and invest?

Maybe that's all semantics and it's just a total tax revenue question...

Not helping myself here probably. You're welcome to kill the thread if you think we can't have a non-political exchange (seriously), that's not what I'm hoping for.
Thanks for the explanation, it is much clearer. I'm not sure taxes and fairness can be discussed anywhere without getting political (or disagreeable) but we can try. Another question - what is the double tax aspect you refer to?
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Old 01-23-2012, 03:00 PM   #11
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Quote:
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Thanks for the explanation, it is much clearer. I'm not sure taxes and fairness can be discussed anywhere without getting political (or disagreeable) but we can try. Another question - what is the double tax aspect you refer to?
It can be argued that income taxes reduce the money you have to invest, so your capital gains have already been reduced by the initial investment basis. Then the gains are taxes "again."

From the Corp side, instead of me butchering the explanation.
Quote:
One other peculiar aspect of the capital gains tax has made many economists conclude that it is economically inefficient: it is a form of double taxation on capital formation. Economists Victor Canto and Harvey Hirschorn explained:

A government can choose to tax either the value of an asset or its yield, but it should not tax both. Capital gains are literally the appreciation in the value of an existing asset. Any appreciation reflects merely an increase in the after-tax rate of return on the asset. The taxes implicit in the asset’s after-tax earnings are already fully reflected in the asset’s price or change in price. Any additional tax is strictly double taxation.6

Take, for example, the capital gains tax paid on a pharmaceutical stock. The value of that stock equals the discounted present value of all of the company’s future proceeds. If the company is expected to earn $100,000 a year for the next twenty years, the sales price of the stock will reflect those returns. The “gain” the seller realizes from the sale of the stock will reflect those future returns, and thus the seller will pay capital gains tax on the future stream of income. But the company’s future $100,000 annual returns will also be taxed when they are earned. So the $100,000 in profits is taxed twice—when the owners sell their shares of stock and when the company actually earns the income. That is why many tax analysts argue that the most equitable rate of tax on capital gains is zero.
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Old 01-23-2012, 03:00 PM   #12
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Quote:
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Is paying taxes on cap gains as ordinary income "fair" remembering the double tax aspect? Is the lower rate an incentive to save and invest?
I never have really bought the 'double tax' argument. You are not really being double taxed. You earned some money, presumably paid taxes on it, then invest what's left. The capital gains becomes due on the income, or increase in value, that that after-tax investment made. You don't get double taxed on the original income...or perhaps I am just not understanding it.

As far as fair, I see no reason why investors income should be taxed less than 'worker' income personally. Especially since you already don't have to pay SS/Medicare on investment income.

HOWEVER, I am all in favor of lowering spending (by the govt) and lowering taxes as well. I'd prefer to pay none.

EDIT: Now I see what you are referring to with your latest post, and I still don't really buy it. Perhaps it makes a difference if you are talking about holding something for 20 years (in your example), versus 20 minutes. If I flip a stock in 20 minutes, which I often do, its hard to argue somehow that taxing my gains as income is 'unfair'. I could possible be in favor of very low, or inflation adjusted basis, on capital gains that are held for a very long time, but even then I am not sure. Wouldn't that just let the wealthy keep growing their nut, generation after generation, and tax the 'worker bees' for the needs of govt. IMO, better to cut the spending, before we decide who should get to keep more of their money.
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Old 01-23-2012, 03:02 PM   #13
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Since the thread is all about taxes on money, I moved it to the FIRE & Money forum.
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Old 01-23-2012, 03:12 PM   #14
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The places in the world with no taxes at all are pretty scary.

I subscribe to this taxing philosophy--

I am proud to be paying taxes in the United States. The only thing is I could be just as proud for half the money. Arthur Godfrey, entertainer


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HOWEVER, I am all in favor of lowering spending (by the govt) and lowering taxes as well. I'd prefer to pay none.
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Old 01-23-2012, 03:15 PM   #15
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I don't get it. Companies make money. They subtract expenses (complicated topic itself) and end up with profits. They pay taxes on the profits and return the remainder to owners as dividends. Beyond that the owners get general growth in the value of the stock. I can see why economists would say the dividends have already been taxed but what about the growth (more than 2/3 of investor's income, right). How has that already been taxed?
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Old 01-23-2012, 03:26 PM   #16
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As to fair, I don't think there is a right or wrong answer. I am more interested in what is practical from an economic impact POV. At some level increasing CGs would presumably be counter productive in terms of the US economy. I don't see any reason to assume that zero is best from that perspective or that 15% is ideal. It does seem that the market has done fine in periods with substantially higher rates so why did we drop CG rates in the absence of a balanced budget?
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Old 01-23-2012, 03:49 PM   #17
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Better question, would you be willing to see taxable capital gains rates increase (say to 20% or 25%) with an increase in deductable amounts to 401k plans and higher contribution limits to IRAs (maybe 20k 401k and $10k Roth).
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Old 01-23-2012, 03:49 PM   #18
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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.

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, 04:08 PM   #19
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Back when I had to pay my first cap gains tax I couldn't believe cap gains were taxed at all. That was my money that I had paid taxes on already! Guess I'm used to it now.

Of course it's not just income taxes, it's SS and Medicare as well. Seems like a case could be made for medicare taxes on cap gains. SS a little less if it was actually like buying an annuity.

On the plus side, income tax brackets are inflation indexed, which might help out a little bit.

Given the tax/AGI numbers in another thread, looks like most of us would benefit from treating cap gains as regular income. That might be especially true if the cap-gains tax goes back up to 20% and the 15% tax bracket stays put.

Then there was that year that I moved from individual stocks to mutual funds/ETF's. I took a very high capital gain. In fact it moved me out of the income region where deductions and exemptions were rolled back, with an effective cap-gains rate well above 15%, and back into straight 15% cap gains. If I had to do that with progressive income tax rates instead I would have had to move very slowly across several years to gete it done inside a reasonable tax bracket.

Guess I'd stay with a flat tax for cap gains just to avoid that drag on changing investments.
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Old 01-23-2012, 04:09 PM   #20
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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.

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!

Cap gains tax rate goes to 20% when the Bush cuts expire in 2013.
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