Investment vs. Speculation: Capital Gains Tax Rates

The US has a spending problem.  The US also has a revenue problem.  Anyone who believes it’s one or the other and not both is not being intellectually honest.  Our government spends too much on many of the wrong things and has unfunded liabilities in the trillions of dollars for health care and social security.  At the same time, the wealthiest people in the country enjoy the lowest tax rates in decades and over 50% of the population pays no income tax at all.

On the tax side, I see four main problems.  First, the wealthiest are not paying enough.  Second, too few people are paying income taxes and the taxes they do pay, like payroll and sales tax are regressive.  Third, the tax code is far too complex and doles out favors to political contributors.  Fourth, the tax code does not distinguish between investment and speculation.

I’ve blogged about all four problems before, but I want to focus on the fourth problem: capital gains taxes are completely out of whack.  The left focuses on raising income taxes and letting the Bush tax cuts expire so that “the wealthy pays their fair share.”  But they are ignoring that the majority of wealthy people earn their income from capital gains: investing in companies, stocks, property, fine art or anything else they can buy and later resell at a higher price.

Capital gains are broken into two levels, short term capital gains and long term capital gains.  Short term capital gains are things that you buy and hold for less than a year before reselling them.  Short term gains are taxed as normal income, 35% for top earners.  Long term capital gains are things that you buy and then sell after more than a year and are taxed at a 15% rate, a 43% reduction from the normal income rate.

This discrepency is why people like Warren Buffett pay a lower overall rate than his secertary.  I believe that investment is the engine that drives growth and ultimately creates jobs and innovation in our economy, but I believe that one year is way too short of a window.  I would change the capital gains system so that it encourages real, long term investment, not speculation.  Here’s what I would change:

Years                    Rate

0-1                   Normal Income (35%)
1-2                       30%
2-3                       20%
3-4                       15%
4-5                       10%
5-6                       5%
7+                        0%

I want to incentivize people to invest for the long term, not speculate in the short term.  I want to make it more risky to play in the casino that has become our economy and make it more attractive to look for real value, for real innovation and for real job creation.  This system would raise revenue by raising rates on the highest earners, those who are speculating right now.  It will impact the real rich and will actually change the system instead of just raising income taxes, which won’t affect the truly rich.  For example, 1400 millionaires didn’t pay a penny of income tax in 2009 because they didn’t take a salary.  It was all capital gains.

Congress should differentiate between speculation and real investment and push people to invest long term, not short term.  It’s a fix that I believe makes sense and could gain bipartisan support in Congress, but so far, both parties are looking at the red herring that is the income tax rates.  True long term investments are in startup companies, publicly traded companies you truly believe in, alternative energy that pays off in 5-6 years, new buildings, etc. Fix capital gains, then move onto the other three problems.

PS – An added loophole that defies logic?  Hedge fund managers have been allowed to take billions in profits and income as capital gains instead of normal income, saving them billions in taxes.