Saturday, November 12, 2011

Why is investment income taxed less?

On the highest levels people don't earn money from work, they earn money from investments. Unearned income is taxed at 15%, which is a lower rate than what it taxed for the money you work for. Why is this?

39 comments:

Crude said...

On the highest levels people earn money from work, they earn money from investments.

I guess you mean 'don't earn money from work'?

Unearned income is taxed at 15%, which is a lower rate than what it taxed for the money you work for. Why is this?

I suppose one reply is, because (sans government bailout, ha ha) you can lose your investment.

Victor Reppert said...

It still seems less productive than actually working.

Why should I get taxed less for gambling? If I win money in Vegas, I still have to pay taxes.

Crude said...

It still seems less productive than actually working.

I think I get why you'd say this, but it could be fleshed out. One thing to keep in mind is that investment, I'd think, always or almost always involves other people working. It's not like you put gold bullion in the ground and water it and, hey, perhaps more gold will sprout up. An investment is giving money (without a guarantee) to some group of people who will then (ideally) work, being paid in part by the money you invest, etc.

Why should I get taxed less for gambling? If I win money in Vegas, I still have to pay taxes.

This sounds to me like you're getting at the claim that making a profit on investment is like winning at the craps table. And I think this is hampered by two problems: first, while gambling has a luck factor, it's not the only factor. For instance, you can improve your performance at the poker table with strategies.

Second, even if you ignore the work and research aspect of investment, isn't there arguably a difference in kinds of investment? A man has 50k. He can either bet it all on a football game, or he can invest it in a start-up business. Does it make sense from your point of view to encourage the start-up business over the football game bet?

Victor Reppert said...

But why not just tax it at the same rate that we tax income from work.

J said...

What is... because rich investors control the GOP for 800, Alex.

Bush slashed them---remarkably, at about the same time the Iraq war kicked off and the markets were booming.Merely coincidence of course in Zig Ziglar-land.

B. Prokop said...

Aquinas wrote that there were two legitimate ways to make money. Using the terminology of the times, these were Art and Nature. Nature referred to what we today would call an extraction economy (e.g., oil and gas, mining, timber, agriculture, fisheries, etc.). Art referred to craftsmanship (making stuff). today that would include all industries.

Investment income (making money "breed"), on the other hand, was condemned as unnatural. Dante brilliantly used this doctrine in The Inferno, where in the lowest rung of the circle of the Violent Against Nature, he placed homosexuals (those who made sterile what God had intended to be fertile) alongside usurers (those who made fertile what God had intended to be sterile. Dante liked pairing up opposites.)

If Dante were alive today, he perhaps would have placed polluters and despoilers of the environment alongside Wall Street Bankers there, as his pair of opposing sinners.

Crude said...

But why not just tax it at the same rate that we tax income from work.

Are the rationales for the rate we tax work income exactly the same for the rate we tax investment income? Are there different positives and negatives for the result of a hypothetical 10% work income tax than for the result of a hypothetical 10% investment profit tax? I think the answer to these questions will be 'no' and 'yes', and that leads us towards a reply.

I'll say again, one big difference between investment and work is that in the case of investment, you can lose your money (barring, again, the government savior or the like.) Outside of illicit work, I don't think we really have a comparable situation in the labor market.

Crude said...

Bob,

What do you think of how the muslims handle interest? It seems to me this would be a point you'd find common cause with them.

I'm arguing here under the assumption that interest-on-loan is not being regarded as entirely immoral, since that doesn't seem to be the route Victor is taking.

B. Prokop said...

The "Islamic banking System" seems to be a not-very-subtle attempt to change the terms one is using, and basically still have the same system as the rest of the world.

Although I do have an MBA from Boston University, I am not an economist, and therefore will not presume to speak authoritatively on this subject. I merely brought up in my posting a voice from another age as a thought-provoker, and (dare I say it) as an Outsider Perspective on our current situation. It always helps to have a second set of eyes on a problem, and perhaps we can learn something here from the Middle Ages. God knows the way we're doing it now isn't working!

BeingItself said...

Because the U.S. is a plutocracy.

Crude said...

Bob,

Although I do have an MBA from Boston University, I am not an economist, and therefore will not presume to speak authoritatively on this subject.

C'mon, who here's speaking like that? Or thinks an MBA is necessary here? Hell, I'm not sure it would even help, given their track record.

Nothing wrong with free conversation that's civil.

The "Islamic banking System" seems to be a not-very-subtle attempt to change the terms one is using, and basically still have the same system as the rest of the world.

Well, there's not just one system, there's a number of them.

Here's something you may find interesting.

Ilíon said...

Why is income taxed at all, rather than taxing consumption? Because "liberal" covetousness always gets in the way of enacting rational policies.

Anonymous said...

Part of the answer is that the money used to invest has already been taxed once at the normal income tax rate, generally.

Anonymous said...

Why is income taxed at all, rather than taxing consumption? Because "liberal" covetousness always gets in the way of enacting rational policies.

Income is taxed because a Republican President (Taft), a Republican-dominated Congress, and Republican-run Statehouses passed the 16th Amendment to the Constitution. Not because of liberals.

Anonymous said...

This one seems easy, Professor Reppert.

One invests one's savings, generally. We want to encourage this for two reasons: it increases one's savings (a good thing) and helps others along the way.

Ilíon said...

"This one seems easy, Professor Reppert."

Indeed, this one is so easy -- the answer to the OP's question is so freely and widely known -- that even Congressional Democrats have been witnessed, from time to time, admitting it in public.

Ilíon said...

"Part of the answer is that the money used to invest has already been taxed once at the normal income tax rate, generally."

In the same way that the corporate dividends in which those wicked rich are rolling were already taxed as corporate profits (and as sales).

Ilíon said...

Ilíon: "Why is income taxed at all, rather than taxing consumption? Because "liberal" covetousness always gets in the way of enacting rational policies."

Anonymouse, the idiotic one: "Income is taxed because a Republican President (Taft), a Republican-dominated Congress, and Republican-run Statehouses passed the 16th Amendment to the Constitution. Not because of liberals."

Translation: a century ago, a bunch of Progressives (and proto- “tax collectors for the Welfare State”), which is to say, “liberals”, convinced the majority of US citizens and their elected representatives to vote, on the basis of covetous envy, for an income tax which would never, never, ever apply but to the richest of the rich – those “evil/greedy” bastards – and would never, never, ever be assessed at more than one or two percent.

And, since that time, “liberals” have continuously demagogued the matter, have continuously expanded the scope and depth of the taxation, and have continuously demonized anyone who has tied merely to slow them down, much less reverse them.

If you want to dispute what I say, then you need both to get your facts right and to actually read what I wrote in the first place.

Anonymous said...

Idioton, You have your reality.
The rest of the world has another.(a.k.a. the real reality)

Ilíon said...

Anonymouse, the idiotic one: "Idioton, You have your reality.
The rest of the world has another.(a.k.a. the real reality)
"

Oddly enough, reality, the real reality, is biting the self-proclaimed "reality-based community" in the ass, and is poised to take a really huge bite out of that collective fatass.

Unfortunately, I and all those others who really do care to see reality as it really is, and who strive to conduct our individual and collective lives in accordance with what really is, are also going to have to suffer for the obstinate foolishhess of the "reality-based community".

Ilíon said...

… if you fools were just committing collective suicide, I’d say “Let them have at it”. But, you’re not content to destroy only yourselves; No, no, no! you insist upon taking all of us down with you.

adc said...

The answer lies in economic incentives. Economies are made up of people - and people respond and act according to incentives (Not "Animal Instincts" like Keynesians tend to claim.). Therefore investing money should be incentivized over say - Paul Krugman-like "spending". As anyone who has tried to start a business knows, Business development relies heavily on investors. Because investing is "risky" - as you rightly allude - it needs encouragement and it must be able to win out if you make wise decisions.

It may "seem less productive," but it plays a crucial role in economic activity and job creation. Yes, it does seem like gambling - but so is STARTING a business. Business creating is EXTREMELY risky, even more so than investing because it isn't diversified - and thus, there must be enough incentive for people to take on this risk.

If you can't create jobs from investing - then you won't collect much money from "working," now will you? ;)

Ilíon said...

"... Economies are made up of people - and people respond and act according to incentives (Not "Animal Instincts" like Keynesians tend to claim.). ... If you can't create jobs from investing - then you won't collect much money from "working," now will you? ;)"

Indeed, it isn't "working" (or "creating jobs") that is important and that is what a rational policy aims at, it is, rather, the creation of wealth.

Consider this thought experiment –

IF having the government "create jobs" were enough to generate prosperity in our society, and make everyone economically comfortable, THEN we ought, immediately, to set up an office (probably at Cabinet level) tasked to ensure that all able adult Americans are given a “job” at a “living wage”. For example, of those who currently have no a job, half could be assigned to dig holes, and the other half assigned to fill back in the holes that the other half dug.

Such a scheme is fool-proof, is it not? There are no down-sides to it, are there? It’s perfect!

But, of course, such a scheme is not only *not* fool-proof, it is very fool’s bait; it is the height of foolishness and social self-destruction; and I expect any half-way rational being to be able to spot at least some of the serious flaws in it. And, thus, one expects socialist fools to be intrigued by the idea, as a “bold, new” concept for “eliminating” “poverty” – perhaps not understanding that the scheme I have laid is just a restatement of the same old, decrepit policies they already favor, and which already are destroying our polity.

In fact, the above foolish, self-destructive scheme is essentially what we are currently doing, and have been doing since the New Deal era. The only difference between that self-destructive scheme and what we are in fact doing is that we have skipped over the steps of actually digging the holes and filling them back in.

Anonymous said...

Victor Reppert wrote:

"On the highest levels people don't earn money from work, they earn money from investments. Unearned income is taxed at 15%, which is a lower rate than what it taxed for the money you work for. Why is this?"

In my home country tax rate for capital income is 30 %. In some countries there is not tax for capital income. So it depends about country and the world view that is shared there.

J said...

"Render unto Caesar". I.e. pay your taxes. Also..Psalm 15:5. Luke 6:35,etc.

Id., falsified

B. Prokop said...

Don't forget this passage of scripture:

Tax collectors also came to be baptized, and said to [John the Baptist], "Teacher, what shall we do?" And he said to them, "Collect no more than is appointed you." (Luke 3:12-13)

Obviously, John the Baptist saw nothing wrong with tax collection. He did not tell the tax collectors to quit their jobs; he just told them to be honest about it.

Mike Darus said...

I agree with adc. The reason that a flat tax will not work is because the government wants to (needs to) incentivise behaviors that it considers beneficial. Encouraging investment has been important in the past so it is incentivised by a tax break. This is why mortgage interest is a deduction. It encourages home ownership. The challenge is to identify when incentives should stopped. This may be when the behavior is not longer a priority or if the behavior has been reinforced enough that the incentive is no longer necessary.

However, it is unlikely to expect the tax code to become this agile.

On the more cynical side, it is appropriate to note that those with the gold are most active in making the rules.

Ilíon said...

"On the more cynical side, it is appropriate to note that those with the gold are most active in making the rules."

Or, as I cynically/realistically put it yesterday (on my own blog):

"Another reason, over-and-above the economically rational one that 'adc' discusses, that in the US investment income is taxed at a significantly lower rate than earned income is that the “liberals” would never stand for taxing the two sources at the same rate. Compared to conservatives, “liberals” get significantly more of their income from investments than earnings – working is for “the little people”, after all – and to tax investment income at the same high rate as earned income would put a real crimp in their further accumulation of wealth. "

Ilíon said...

... I mean, really! who can honestly see the Kennedys (as just one example) surrendering-without-a-fight on the question of whether they should pay the same tax rate on their income derived from Papa Joe's "investments" as you and I must pay on our earnings?

Ilíon said...

Whether intentional or not, the present US tax code is set up to make it more difficult for mere hoi polloi to rise to the economically (and socially!) exhalted state of, say, The Kennedys.

And, my! how the "liberals" fight and demonize them when conservatives try to make it easier for members of hoi polloi to save and invest.

Mike Darus said...

B. Prokop said: "Obviously, John the Baptist saw nothing wrong with tax collection. He did not tell the tax collectors to quit their jobs; he just told them to be honest about it."

I don't see where John the Baptist took any position on the collection of taxes. His focus was on the character of a particular tax collector. We need not place the burden on John to require him to command Matthew to stage a revolt against the Romans a) if the tax rates were oppresive or b) if taxation in general was unjust. There is no indication that he is concerned with the politics of the issue. His concern was with Matthew's repentance for his own excesses.

B. Prokop said...
This comment has been removed by the author.
B. Prokop said...

Interesting point, Mike. I'm not sure there's a lot of difference in what we're saying, however. The Baptist similarly did not tell the soldiers to drop their arms and give up being soldiers. If we were to take the pacifist theologians seriously, we should have expected at least some condemnation of the military profession. In the same vein, given that John did not condemn outright the collection of taxes, I (I believe reasonably) believe he saw no problem with their collection per se.

This goes right along with my posting on another thread of Luke 12:13-14, where Jesus Himself declines to take sides in a property dispute. I take scripture seriously, and believe there is a consistent theme here of "Don't use God as your backbencher. He's not going to take your side. It's up to you to be on His side."

parbouj said...

Part of the answer is that the money used to invest has already been taxed once at the normal income tax rate, generally.

Sure, but the investment tax isn't on that money, but on money earned from the investment. If I invest 10 dollars (that I already was taxed on), and earn 20 dollars (so have 30 dollars in the account), I am taxed for the 20 additional dollars, not for the 10 that I already paid for.

(Though I realize there are actually many tax-code wrinkles that make this example not perfect in real life).

Tony Hoffman said...

I've always wondered about this one as well. It especially annoys me in that many wealthy conservatives I know think that people are poor because they're lazy, but these same conservatives work less and enjoy more free time than most of the poor folks I know.

I think the question really has two parts; why is this tax law in place? and what is the economic justification used to perpetuate something that appears so obviously unjust?

The answer to the first question is, I think, straightforwardly about money and politics (them with the gold make the rules).

There might also be a correct, complex and counter-intuitive justification for low taxation on investment being a positive effect on economic development, but I doubt it. I could certainly make an argument that high taxes on labor make it (too) difficult for poor people to enter the workplace legitamately, raise tax revenue, etc.

As for money "working" I find the whole argument to be patently untrue. (I agree that investing money is risked, but that's not the same thing.) I could see where money follows the best return on investment, and this being a good gauge for funding activities that are productive, but buying stock in a company is not putting working money into that corporation's hands. No, after the initial investing, corporations don't "spend" shareholder investment; when I buy a share of GE, GE does not have another $16.00 to spend. In fact, if there were no buyers at all for GE and its stock price dropped to zero, GE would continue to operate tomorrow, the difference being that the market no longer thinks it has any value. (I know that GE would find it harder to raise funds with no stock valuation, but that's not the same thing.) My point being that it appears that what most people think is "putting money to work" -- investing in stocks -- is really just placing bets on a company's future valuation.

SteveK said...

The rich do make the laws so there is a bias in the laws. The tax law is imperfectly balanced and the taxpayer can see the imbalance. If the taxpayer has the means, they take advantage of that imbalance. Sans a flat tax, I don't think there is a way to make the system perfectly balanced and equal.

So, like the gambler who see a flaw in the house odds (arbitrage), he places his money on the bet that will make him money relative to his neighbors. When the house changes the rules in an attempt to even the odds, the taxpayer moves to something else.

Anonymous said...

Investment income is taxed lower than income from labor because if you tax investment income too high, investors will take their investment away, investing it elsewhere or investing it in something difficult to tax. That isn't good for anyone.

Mike Darus said...

Government acutally goes one step further to incentivize investment in local governments throuth tax free bonds.

Anonymous said...

"Investment income is taxed lower than income from labor because if you tax investment income too high, investors will take their investment away, investing it elsewhere or investing it in something difficult to tax. That isn't good for anyone."

Only if there are enough low taxed investment alternatives, and if supervision by tax authorities is poor.

For example MY incomes are NOT taxed lower. I pay more than 10 % higher tax rates for my labor than investment incomes.

It is just about political decisions. If they favor rich people, then investment taxes are very low. And if they favor something else, then it has also consequences in taxation.