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A public policy blog from AEI
It just kind of bugs Michael Kinsley, at a gut level, that the US tax code gives a preference for investment income. Kinsley in his Bloomberg column:
Critics of the capital-gains tax are absolutely correct when they say that a tax on capital hurts our economy by reducing the incentive to save and invest. They say the same thing about the tax on investment interest, and they’re right about that, too.
Unfortunately, this is true of every method of taxing capital, just as any tax on labor reduces everybody’s incentive to get up in the morning and go to work. When you tax something, you discourage whatever it is you’re taxing. That is the tragic nature of taxation.
For me, the argument more or less ends when Kinsley concedes investment taxes hurt economic growth. We should want the tax code to be as neutral as possible. Right now, the tax code penalizes savings and investment as opposed to consumption, though that is somewhat offset by the capital gains preference. I don’t think Kinsley gets that. As AEI’s Alex Brill and Alan Viard explain:
We can illustrate this penalty with a simple example. Consider two individuals, Patient and Impatient, each of whom earns $100 in wages today. Impatient wishes to consume only today and Patient wishes to consume only “tomorrow,” which is many years in the future. Saving yields a 100 percent rate of return between today and tomorrow. With no taxes, Impatient consumes $100 today. Patient saves the $100, earns $100 interest, and consumes $200 in the future.
What happens with a 20 percent income tax? Impatient pays $20 tax on his wages today and consumes the remaining $80, which is 20 percent less than in the no-tax world. Patient also pays $20 tax and saves the remaining $80, earning $80 interest. However, $16 tax is also imposed on the $80 interest. That leaves Patient with $144, which is 28 percent less than in the no-tax world, compared to a mere 20 percent reduction for Impatient. The income tax imposes a higher percentage tax burden on Patient solely because she consumes later. The income tax’s penalty on saving causes an inefficient distortion of consumer choice and lowers the accumulation of national wealth and the long-run rise of living standards.
Eliminate that penalty and faster economic growth, more jobs, and higher incomes would likely be the result. I should also note that the US integrated tax on capital gains is extremely high both on an absolute and comparative level. When someone pays a capital gains tax, that income has already been taxed previously. No inequitable free lunch here:
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