## Monday, 1 November 2010

### Steve Landsburg fallacy re. Capital Gains tax as a double tax on income.

This is Steve Landsburg on Capital Gains Tax-

The New Yorker arrived today, leading off with this letter to the editor about income tax rates:
…The very rich pay at significantly lower rates, because most of their income consists not of compensation for services but of capital gains and dividends, which are capped at a fifteen per cent rate.
This is wrong, wrong, wrong, wrong, wrong, wrong, wrong, and you can’t begin to think clearly about tax policy if you don’t understand why. Even if capital gains taxes were capped at one percent, income subject to those taxes would be taxed at a higher rate than straight compensation. That’s because capital gains taxes (like all other taxes on capital income) are surtaxes, assessed over and above the tax on compensation.
It always pays to think through stylized examples. Alice and Bob each work a day and earn a dollar. Alice spends her dollar right away. Bob invests his dollar, waits for it to double, and then spends the resulting two dollars. Let’s see how the tax code affects them.

First add a wage tax. Alice and Bob each work a day, earn a dollar, pay 50 cents tax and have 50 cents left over. Alice spends her fifty cents right away. Bob invests his fifty cents, waits for it to double, and then spends the resulting one dollar.
What does the wage tax cost Alice? Answer: 50% of her consumption (which is down from a dollar to fifty cents). What does it cost Bob? Answer: 50% of his consumption (which is down from two dollars to one dollar). In the absence of a capital gains tax, Alice and Bob are both being taxed at the same rate.
Now add a 10% capital gains tax. Alice and Bob each work a day, earn a dollar, pay 50 cents tax and have 50 cents left over. Alice spends her fifty cents right away. Bob invests his fifty cents, waits for it to double, pays a 5 cent capital gains tax, and is left with 95 cents to spend.

Landsburg assumes all income is earned and taxed.
Let us suppose the following- income is taxed at 50% and Capital Gains at 20%. I have a choice between earning \$100 by working for my Dad renovating a house he has bought for \$1000 which he can later sell for \$1200 or else receiving a 50% share in the Capital Gain.
How much tax do I pay if I take my reward as earned income? Answer \$50 leaving me \$50 disposable income. How much if I go into partnership with my Dad and take my reward as a Capital Gain? Answer \$20 leaving me with \$80 to spend.
What if I'm an orphan with no capital or access to credit such that I could get into the business of property development not as a paid employee but as a speculator entitled to capital gains?
Well, I'm shit out of luck. My supply of labor will tend to be inelastic meaning that the Taxman will tend to slap a higher tax on me simply because only when supply is inelastic will a higher tax rate yield more revenue.
Now you may argue that to take income as Capital Gains involves a risk- so we are comparing apples to oranges. The answer to this is that workers and self-employed contractors are just as likely to get stiffed- i.e. not paid- and more likely to suffer prolonged hardship than a capitalist who can simply walk away from a project if the market turns against him. Indeed, the bigger the capitalist the more likely this is because his portfolio would be diversified and protected against a down-side by positions on the options market.
If capital is more elastic in supply- as with globalized financial markets it is bound to become- capital gains will always be more lightly taxed especially when you consider that economic rents tend to become quasi rents and disappear in the long run even w.r.t Land.
A situation where a country, like America, is heavily indebted to foreigners is one where taxes on capital have to be globally competitive and are under downward pressure. Since labour is not as geographically mobile and elastic in supply, taxes will have higher incidence on workers rather than those who can derive part or all of their sustenance from inherited or acquired wealth.
Taxation is really about elasticities. If you can transfer your domicile without impacting on earnings, you escape tax and, sooner or later, Tax authorities will recognize this power of yours and negotiate a sweetheart deal with you.
That's what happened to the super-rich and that's why enormous sums of money are being poured into this Tea Party bull-shit. It's also the reason why Landsburg is spending time talking to stupid people on his blog. He knows they are stupid. He knows he's talking through his arse. But, there's a big Capital Gain in it for him so screw all youse.

If Landsburg is involved in his own tax-planning, it is unlikely that he can be utterly ignorant of the numerous advantages to preferring to realize a capital gain at a convenient time rather than maximizing taxable income in the time period where an economic activity occurs.
Frankly, if Landsburg's arguments were true then all the Tax Accountants and Trust lawyers and so on would be out of a job.
Why is Landsburg peddling this ignorant shite? Is he stupid? Mencken said 'no one ever lost money underestimating the intelligence of the American public.'

#### 1 comment:

Anonymous said...

The British Chancellor George Osborne (a right wing Conservative) said the CGT regime was "one of the most chaotic areas of tax" inherited from the Labour government and that he endeavoured to "balance the competing demands of fairness, simplicity and competitiveness" in the reforms. Although not referring to him by name, he evoked the spirit of private equity boss Nicholas Ferguson when he said: "Some of the richest people in this country have been able to pay less tax than the people who clean for them."

He said the existing system had encouraged people to avoid paying tax by exploiting "the wider gap between the rate of capital gains tax and the top rates of income tax."
The U.K CGT top band is now 28% and would be higher if Private Capital weren't so mobile across borders.