Replying to Remarkl:

Thanks for your observations. You raise some cogent points. I cannot fully answer them all in a short comment box, but I hope to find the time to return to the subject in a future post to add some detail. Here are some short, preliminary replies.

(1) You are right, I could have found a better example than the silly one about a contract with my wife. I should have focused on realistic and common ways in which corporations transform ordinary income into capital gains in order to get the capital gains (CG) tax break.

Paying executives with stock options rather than raising their salaries or giving cash bonuses is a good example. (The tax advantages are discussed here for anyone unfamiliar with them: https://www.investopedia.com/managing-wealth/get-most-out-employee-stock-options/ )

Note that the stock option version of the CG break is not available to contractors, consultants, or advisors, even if they contribute as much or more to the company’s success as its own execs. If the execs knew enough to run the business well themselves, they wouldn’t hire consultants anyway. So this violates the principle of taxing similar income in similar ways.

(2) The carried interest rule is the tip of the iceberg. Yes, getting rid of it would be nice, but a razor is not enough. A more fundamental reform of the treatment of capital gains is needed.

(3) You say, “ The inflation-based problems that the cap gains break does not solve are not reasons not to recognize its salutary effect on the kind of income it helps.” I disagree. To extend your comparison to chemo, the problem with the CG preference is that it kills healthy and malignant cells at random and ends up doing more harm than good.

I do agree that not as many people make the inflation argument for the CG break as used to be the case when inflation was higher. But the fact that inflation is now reliably low, and seems ready to remain so for the indefinite future, strengthens the case against the CG break. To overwork your analogy to an extreme, we are now giving strong chemo to a patient who has almost no malignant cells that need to be killed.

(4) You say, “ The first major argument for the capital gains break is that it subsidizes risk-taking. In effect, employees pay capitalists for creating jobs for them.” The argument that corporate executives are godlike “job creators” who deserve to be pampered and showered with tax breaks is just political hot air. The CG tax break does not reward job creating except by accident. It gives the same tax break to a an exec who boosts profits by downsizing as one who does so by expanding. It gives the same break to someone who buys a company to strip its assets in a way that destroys jobs and communities as it does to someone who builds a successful new firm that creates jobs.

You yourself say that there can be too much risk taking, or too little. The CG tax break almost guarantees that there will be too much.

Thanks again for you thoughtful contributions to the discussion!

Written by

Economist, Senior Fellow at Niskanen Center, Yale Ph.D. Interests include environment, health care policy, social safety net, economic freedom.

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