Tax Tax Revolution

Good Econoblog discussion between Max and Tyler. It evolved into a bit of a food fight over the Capital Gains tax, which is alright by me. Max is of the rather sensible opinion that it is only fair to tax capital gains at the same rates as any other kind of income, like say, wages. Tyler violently disagrees and think capital gains should not be taxed at all. At one point, he threw down this following challenge with a flourish:

Max, are you willing to raise your hand and say: "I want to in essence double the real rate of taxation on capital income. I don't think the growth rate will fall"?

Max, being wily, didn't take the bait. Tyler, you see, is begging the question. As Max established near the top of the debate, we're not discussing ideals in a vacuum. A certain amount of revenue has got to be raised -- that point is not in contention. The choice is not between high capital gains tax and low capital gains tax. The choice is between taxing all incomes, wage and capital gains, the same or having higher taxes on wages to support tax cuts on capital gains. The onus is not on Max's position, but on Tyler's to justify why the current subsidy on unearned income should continue.

As Kevin Drum noted, Tyler supplied much in term of debating style but little of substance. "I am asking you to believe that low rates of capital taxation are good for an economy; this accords with most empirics and with most theory", he exhorted. Now, it is good policy to be skeptical indeed when anybody commands you to "believe" them in the course of a debate, and so it proves in this case. You want us to believe you, Tyler? Show us the empirics and theories. Don't tell us about them. I've never seen any coherent theory from the supply-side capital-gains tax-cut hawks. Just talking points, and easily demolished talking points at that. Here's a collection of the most popular ones:

1) Raising the capital gains tax hurts small, working-class investors more since they have less money.
-- But small, working-class investors also get most of their money through wages rather than capital gains. Since a rise in the capital gains tax would be accompanied by tax cuts elsewhere, the working class comes out ahead.

2) The rich will simply avoid the tax by rolling over the investments.
-- But they can't keep rolling over that investment for ever. Eventually they will have to cash out. As long as the capital gains tax is kept permanantly at the higher level, they will eventually have to be paid.

2b) The rich have will simply avoid the tax by hiring cunning lawyers.
-- The way the rich is avoiding taxation *right now* is getting their cunning lawyers to structure their wages as capital gains (stock options, etc). This argument is tantemont to saying we can't patch up the leak in the pot in case patching the leak eventually cause the pot to overflow.

3) Capital gains is tantemont to double taxation since businesses already have their profits taxed.
-- The same dollar rolls around the economy passing through many hands. If it is truly taxed once and then set free, then we wouldn't be able to collect any taxes at all unless we issued new money. There's nothing contradictory about putting one tax on profits for the business and another on the capital gains for the individual as the money changes hands.

However, if you insist on efficiency grounds the government should only take one bit at the cherry, let's abolish the business tax in favor of a high capital gains tax. Saves paperwork and makes evasion much harder.

4) If you made returns on investments lower, people would invest less.
-- And do what with their extra money? Stuff it under the mattress out of pique?

4b)Ah, but they won't have extra money because...people would invest less and spend more.
-- No. People still need to invest for their retirement, for their kiddie's trust funds, for the pure love of lucre. Lowering their returns on investment makes their task harder. But as there is no other way of of achieving their goals through consumption, invest they will.

4c)Ah, but they won't have extra money because...people would invest less and work less.
-- No. In the real world when your income is decreased, you have to make up for it by working more.

5) If you made returns on investments lower, people would put their money in safer rather than riskier investments.
-- Why? Safer investments always have lower rates of return than riskier investments, whether the capital gains tax rate is set at 0%, 20% or 50%. But even if the lower rates of return made people decide they don't want to bother with risky investments, the free market will come to the rescue -- banks will take their money and lend them to entrepreneurs at higher rates of interest if there is money to be made.

And besides. Why are we starting from the assumption that the limiting factor on the growth of our economy is the lack of investments? It is much more likely that growth is demand driven. If that is so, any tax cuts we can afford should be given to lower-waged workers who are more likely to spend them. And why are we also assuming that growth is automatically good? It is if it increases the overall welfare of citizens in this country, not for its own sake.

To paraphrase Warren Buffett, class warfare is going on in this country, and his side is winning.