From: MEDELMA@cms.cc.wayne.edu (Michael Edelman)
Newsgroups: talk.politics.misc,alt.politics.elections,alt.politics.clinton,alt.politics.bush
Subject: Re: Taxing capital gains (was: why progressive tax rates)
Date: 27 Aug 92 16:33:25 GMT
Organization: Wayne State University, C&IT

In article <1992Aug27.140342.12810@panix.com>
eck@panix.com (Mark Eckenwiler) writes:
 
>
>In <1992Aug26.175435.20270@anasazi.com>, john@anasazi.com sez:
>
>> Finally, capital gains taxes today tax imaginary (inflated)
>>gains which makes it often confiscatory, and capital losses cannot
>>be used to offset the gains in a reasonable manner.
>
>I don't intend to start a flamefest, but there's one thing about this
>argument that puzzles me.  What makes capital gains so different from
>any other sort of income in this respect?
>
>Here's the hypo: take two investments with identical returns, the only
>difference being that A spins out annual dividends and B appreciates.
>Calculate the value of each at the end of X years, being sure to apply
>tax annually to A while taxing B exactly once (in year X).  Result:
>you wind up with more dollars via B than with A.  (Obviously, if you
>invested in A, your dollars would be just as deflated as if you'd
>stuck them in B.)
>
>Note that I am not asserting that there are no *policy* arguments in
>favor of capital gains.  (I'm sure we could spend all day talking
>about why it's good to encourage one form of savings/investment over
>another.)  Rather, I'm questioning the oft-repeated mathematical
>argument that capital gains recipients get the shaft because of
>inflation.
>
>Reasoned rebuttal welcome.  True Believer flames ignored.
>
Both are capital gains, and in the absence of a large number of tax rate
brackets, both would be taxed identically. I.e., there's no difference
either in yeild or tax burden.
 
You're making a few errors in your assumption; not least of these is the
assumption that the dividends paid out are not reinvested (why would you
keep them in cash?) A more important one is in assuming that apart from
inflation, $10 today is worth the same as $10 tomorrow, which it is not,
of course. You have to consider the present discounted value of that $10
tomorrow. If banks are paying 10% p.s. (for sake of argument and to make
the math easier) then $10 today is worth $11 next year, before any
inflation is factored in.
 
In an efficient market, the cost of paying yearly dividends for 10 years
should exactly equal the cost of borrowing the same amount at a discount for
the full term. If you look at bond trading figures you see that that
assumption holds true.
 
What makes a difference in the actual return is the way the tax code
taxes inflation and disproportionately affects short-term investments.
We've run the arguments here many times, but you might find it interesting
and useful to build a spreadsheet and experiment with different tax rates
and inflation rates and see how an arbitrary marginal tax rate gets shifted
upward rapidly.
 
Your statement about why it's good to encourage one form of savings or
investment over another is the critical one. Investments in government
securities do not result in increased GNP; capital investments in private
firms do. The current tax structure provides the opposite incentive, taxing
private investment at a high rate while not taxing government securities.
It's a de jure disincentive to growth.
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