Capital-Gains Tax

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March 26 1997 3:30 AM

Capital-Gains Tax

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Dear John,

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       You are not going to waylay me into a debate about the so-called flat tax. Anyone interested in why it's a fraud can click here for a short article I wrote on the subject in the May 1, 1995, New Yorker. It is clearly illogical, though, to say that because some rule would apply under your "flat tax," the same rule should apply under the current system. For example, under a "flat tax," there would be no charitable deduction. I presume that even you do not favor eliminating that deduction without taking the other steps involved in the flat tax, such as lowering marginal rates.
       Let's return to my two examples. I have conceded to you that our current system taxes corporate income twice: once at the corporate level and again when it is paid out to the shareholder. I favor "integrating" the individual and corporate taxes by counting retained earnings as income to the shareholder. Your corporate friends would hate that more than the current system, but it would be a powerful disincentive to the "lock-in" of capital you and they pretend to be so concerned about. But all this has nothing directly to do with the capital-gains issue.
       What you must concede--or refute, which you don't even attempt so far--is my contention that there is no difference between the person whose remuneration for a year of work takes the form of $100,000 salary and the one whose remuneration takes the form of $40,000 salary and $60,000 capital gain. Ditto the person whose $5 return on investment takes the form of a dividend and the one whose $5 is a capital gain. Why should the amount labeled "capital gain" be taxed at a lower rate--or not at all, as you propose? As my examples demonstrate, a "capital gain" is not by its nature the result of greater risk or harder work or anything else more virtuous than the sources of ordinary income. The examples also demonstrate the emptiness of your argument that capital gains aren't income at all.
       Capital losses. I don't believe for a minute--nor do you--that those pushing this idiosyncratic cause are moved by "sympathy for life's losers." Losers do not have the money or influence to have kept this issue on the political agenda. The people pushing unlimited deductibility of capital losses are winners who want to be taxed like losers. You concede as much by repeating that a system with unlimited loss deductibility "would yield no net revenue" from capital gains. I repeat the question you avoid: Do you imagine that under the arrangement you advocate there would be no net capital gains in our economy? Sounds grim! Or only no capital-gains tax revenue? Much nicer--for people with capital gains. A bit harder on other taxpayers who will have to make up the difference.
       As for "consistency" in the treatment of gains and losses, the tax code is inconsistent in many ways. You want to make it even more inconsistent in its treatment of different forms of capital income. The proper goal is not consistency per se but the collection of adequate revenue as fairly and efficiently as possible. Unlimited deductibility of capital losses would clearly produce unfairness (allowing vast amounts of capital income to go untaxed) and inefficiency (an explosion of wasteful tax shelters). Therefore it's a bad idea.
       Your studies showing that poor people have all these capital gains: I should have guessed that farmers were the explanation! Ideologues of all stripes seem to abandon their principles when it comes to farmers. "They have low incomes, but own valuable property," you say. But are we capitalists around here or are we not? If they own valuable property, it is apparently their own choice to settle for low incomes. They could sell the property and enjoy high incomes. Indeed if they are reporting capital gains, they apparently have sold at least some property and possibly aren't farmers anymore. A sensible thing to do, but no reason to give them special treatment.
       As for "selling against the box," it is indeed a loophole that should be closed if possible. But I do not follow your logic that the existence of this loophole means that capital gains shouldn't be taxed at all. And I reject your totally unsubstantiated contention that "selling against the box" allows the rich to escape all capital-gains taxes, leaving the entire burden on the middle class. Statistics show otherwise. So does political common sense: If the rich didn't feel the burden of the capital-gains tax, we wouldn't even be having this discussion.

Yours,
Mike

John C. Goodman is president of the National Center for Policy Analysis, a public-policy research institute. Michael Kinsley is editor of Slate.

This dialogue grows out of Michael Kinsley's article "Eight Reasons Not to Cut the Capital-Gains Tax," which appeared recently in Slate.

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