WHY IS THE CAP GAINS RATE SO LOW?

Mitt Romney, a multi-millionaire, pays a 15% tax rate.  Warren Buffett, a multi-billionaire pays a lower tax rate than his secretary.   It’s primarily due to the fact that they make huge gains in investments every year and pay the very low cap gains rate.   Does this make sense?   As Paul Krugman noted the other day, cap gains are at an all-time low (see chart below).   This trend in declining cap gains started in 1997 and clearly hasn’t correlated with a booming economy.  So the traditional argument that high cap gains hurt the economy doesn’t seem to hold.  In fact, the most illuminating comments come from Warren Buffett on Charlie Rose who cites the fact that an investor rarely considers potential tax rates when making an investment (a general observation obviously):

BUFFETT:  I have yet– and I’ve worked with capital gains rates of 39.9 percent and 36 percent and 25 percent, I have yet to hear one person say to me, “If I call you in the middle of the night Charlie and I say Charlie I’ve got this hot investment idea.”  Your reaction is not to say “No matter what the tax rate, forget it, I’m going back to sleep because the capital gains rates are too high.”  No, what you’re going to do is you’re going to say, “Tell me the name, quick, Warren, before you change your mind.”  And you know, I have never had one person decline to invest with me.

ROSE:  Yes.

BUFFETT:  And I was running money 40, 50 years ago when rates were much higher and I never had one person to show the slightest reluctance to take an investment idea and run with it.

The point Buffett is making is that people don’t rule out broad investment decisions because of capital gains.   They might play a role, but how many times have you flat out decided not to buy a stock, bond or invest in something else solely because of the tax implications?  My guess is not very often.  Making money in the investment world is the goal.  The government gets a cut.  Those are just facts of life.  If you build portfolios entirely around taxes then you’re likely neglecting the more important part of portfolio building – the actual money making strategy!  This doesn’t mean taxes don’t matter, but I don’t think a cap gains rate of 25% is going to suddenly cause Americans to stop investing in corporate America….

Don’t get me wrong.  I love low cap gains rates because I’ve benefited from this as well (clearly not to the extent that some others have!), but unless I am missing something, this seems like another neoliberal myth that is helping no one except people who don’t really need the help….

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. OK, help me out on this. I earn money at my job, and I’m taxed on it-City, State, Federal, FICA – roughly 60% in all. What little that is left over, I save.This endures another, more pernicious tax – inflation.

    If, despite periodic 50% declines in the stock market due to government(Obama & The FED) mismanagement of the economy I risk it in the stock market, ignoring the permabears who regularly tell me I’m going to lose it all, and magically I actually MAKE money, I’m taxed AGAIN based on its historic cost – which overstates my REAL gain.

    Then, and here’s the really good part; when I die, you tax me AGAIN!

    You ask is the cap gains rate enough? It’s NEVER enough for you liberals!

    • Typical knee-jerk conservative response. Just call people names. Blame taxes on liberals. But, hey, maybe you prefer the path W took – increase spending, fight two wars, create a new prescription drug program, and deregulate. Yet you blame Obama for our economic mess. You really are clueless.

  2. “Don’t ever take a fence down until you know the reason it was put up.”
    G. K. Chesterton

    The 15% rate wasn’t arbitrary…. There was a reason. What was it?
    I believe the cap gains tax was part of the negotiations that executives should derive most of their compensation from the companies stock performing well. Do you all want us to revisit a time when officers were paid in cash and didn’t care about the stock price?
    Rich

    • They shouldn’t care about the stock price. They should care about the company strategy and longevity. The short-term thinking geared towards quarterly statements destroyed US companies , US economy and US labor market.

  3. Buffett pays himself a paltry salary. His main income is from dividends which are taxed (as stated in this thread) at 15%. So, he structuring his income in such a way that he pays as little taxes as possible. Buffett doesn’t like paying taxes as well. He isn’t that altruistic as he wants to portray himself. He’s a Wall Street crony a well.

    In the country I live we have a flat taxrate since 2001. One is worth X at the beginning of the year and one is worth Y at the end of the year. Then one adds X to Y and divide it by two. And on the outcome one pays one flat rate. And the house one lives in isn’t considered to be an investment. Dividends and interest received aren’t considered to be income any more, which is, like in the US, taxed progressively.
    No funny things like “”qualified dividends”", “”capital gains tax”" or “”tax exempt munibonds”" or interest taxed at e.g. 33%. No wonder the US taxsystem is such a good source of income for US taxadvisors/councillors.

  4. Like I said, people get locked in to investments when the cap gain tax is too high. That’s why, at times when it has been lowered, there are a flood of cap gains taken to take advantage the lower rates. It happens every time.

  5. Stop the presses— Forget Bill Vickrey’s modification of the capital gains tax to create a de facto wealth tax, earlier this month the Wall Street Journal (!?!) published a Ronald McKinnon op-ed earlier this month arguing for a wealth tax
    (To read the whole thing, search for the top headline at Google news).

    The Conservative Case for a Wealth Tax
    A modest levy on the overall wealth of the very rich would allow lower incentive-distorting income tax rates for them and everyone else…

    http://online.wsj.com/article/SB10001424052970203462304577139232881346686.html

    “In order to have a fairer tax system, we should implement a new federal wealth tax in addition to the federal income tax. Unlike the current income tax, the wealth tax would not rely on how income is defined. Rather, it would require that households list all their domestic and foreign assets on, say, Dec. 31 in the relevant tax year. With a large exemption of $3 million that effectively excludes more than 95% of the population, a moderate flat tax—say 3%, on wealth so defined—could then be imposed.”

    Let’s ballpark tax base at $30 trillion (factoring in both $3M deduction and that top 1% holds 35% and next 4% owns 27% of Nation’s $60T household wealth).
    3% would raise $900 billion a year, essentially you could zero out $15.3% FICA tax which raises about the same. Of course Uncle Sam doesn’t raise taxes to fund programs, it taxes to control inflation. So tie wealth tax to interest rates. Peg it to 3 month T-bill. which today was at 0.05%. A wealth tax levied at that rate would bring in $15 billion– less than half of what federal gas taxes bring in.
    Ahh, but the CBO projects interest rates will go back to 5% in the next five years.
    This hundredfold increase in T-bill rate would bring in $1.5 trillion a year. Since the CBO measure budge deficit over 10 years; levy the wealth tax now (at 0.05%) but immediately cut other taxes by $750 billion. By the CBO (and Joint Tax Committee’s) lights, that extra $1.5T a year starting in 5 years will cover the tab.
    By the time the CBO figures out (oh, in about 5 years) that their budget scoring model has been hacked and that interest rates aren’t budging from zero, it will be too late for them to do anything about it. :o)

  6. This is just confused:

    they might play a role, but how many times have you flat out decided not to buy a stock, bond or invest in something else solely because of the tax implications?

    Look, they either play a role, or they don’t. You can’t have it both ways like you try to in this single sentence above. Are you saying that you never take into account the gains rate when you sell a stock or bond? If so, you are definitely in a minority. If that is not what you meant, then that “solely because” is rather meaningless since it is the margin we are talking about, and the tax implications changes where/when you make selling/buying decisions.

  7. Andrew Mellon disagrees with you. Not only was he Secretary of the Treasury in the 1920s, he personally paid more taxes that decade than any citizen except for John D. Rockefeller and Henry Ford.

    The fairness of taxing more lightly income from wages, salaries or from investments is beyond question. In the first case, the income is uncertain and limited in duration; sickness or death destroys it and old age diminishes it; in the other, the source of income continues; the income may be disposed of during a man’s life and it descends to his heirs.
    Surely we can afford to make a distinction between the people whose only capital is their mental and physical energy and the people whose income is derived from investments. Such a distinction would mean much to millions of American workers and would be an added inspiration to the man who must provide a competence during his few productive years to care for himself and his family when his earnings capacity is at an end.

    http://rethinkecon.org/2011/11/10/old-school-1-the-fairness-of-taxing-more-lightly-income-from-wages-salaries-or-from-investments-is-beyond-question/

  8. Two major points I have not seen commented on sufficiently:
    1. Marginal projects: As a non New Yorker/ non silicon valley resident, I can personally vouge that a higher tax cost will reduce economic activity, capital projects, and LLc formation in the sub 50 million dollar arena. A higher tax rate would reduce the expected ROR and prevent some small business activities. I work with local businesses which fly under the radar scope of the big boys, exactly the type of companies who do contribute the most to job formation. This is not theoretical, we work on a smaller margin. Change this tax rate after the economic recovery gains strength.
    2. The carried interest rule is the problem. Hedge funds can trade 100 times a second and have gains washed as long term. The same goes for futures and options to a degree. I hazard a guess that this constitutes a large portion of the top annual income earners per year. This hyper trading is exactly the type of capital market foundation we do not want, and it should be taxed differently. This is the huge loope hole that only accredited investors can use.

  9. 15% cap gains tax seems about right…the issue is that the income taxes are far too high.

  10. The term ‘Monetary Realism’ was coined by Merrill Jenkins (deceased 1979) in his ‘Treatise on Monetary Reform’. Jenkins is referred to by his followers as the first ‘Monetary Realist’. There is a Monetary Realist Society based (with a facebook page) which continues to propagate his ideas.

    Funnily enough, Jenkins absolutely detested fiat money, calling it “the greatest hoax on earth”, and was a gold currency/ competing currency advocate. Members of the Monetary Realist Society appear to be mainly rightwing so- called ‘libertarians’, Ron Paul supporters and conspiracy nuts.

  11. Why is the cap gains rate for US equities zero if you are a foreigner? Or if you are a hedge fund based in the caymen islands, owned by a trust in bermuda, with a beneficial account holder that is a BVI company, held by another trust, and ultimately by a partnership of US investors?

    Don’t tax the savings, tax the transaction. If congress were smart, they would slap a .5% tax on each side of a trade. that would go a long way to reduce volatility and programmed trading, while increasing the tax take.