Obama on Taxes

Roger Simon points out Obama’s confusion and evasiveness on the subject of taxes. There’s no mystery about why cutting the capital gains tax raises more revenue and why, correspondingly, raising the tax would bring in less revenue—both of which effects are well-confirmed empirically. Cutting capital gains taxes raises the after-tax value of stocks. Stocks therefore rise, producing more capital gains. Realizing capital gains is usually voluntary, furthermore, so the cut in rates makes people more willing to realize and pay taxes on the gains. If we raise the capital gains tax rate to 28%, stocks will fall—thus, fewer capital gains and more capital losses—and people will be less willing to sell stocks that have increased in value, lowering capital gains collections and keeping investments locked into suboptimal uses, lowering economic growth, which in turn lowers the value of stocks, etc.

But isn’t it unfair to tax wages at a higher rate than capital gains? No, because capital gains result from earlier investments. I already earned and paid taxes on the money I used to buy the stock or house, which has since increased in value.

That increase, of course, is judged in nominal terms. I’d be more open to the idea that capital gains and ordinary income should be taxed similarly if the tax applied only to real gains.

Let’s take the value of my house as a test case. I bought it in 1983 for $129,950. It’s now assessed at $307,000, a 136% increase. (For simplicity, let’s ignore improvements and the one-time exclusion, etc., which might apply here but wouldn’t on a stock purchase or other kind of capital gain. Also, let’s ignore the fact that I had a mortgage, that I would otherwise have had to pay rent, etc.) If I were to sell it and pay capital gains taxes on it, at the 15% rate I would owe $26,558. At 28% I’d owe $49,574. But almost all these gains are due to inflation. In current dollars, my purchase price was $273,753, making my real capital gain, in current dollars, $33,247—a 12% increase that took 25 years to achieve. But I would have to pay most of that in capital gains, leaving me with a real net gain of 2%. At 28%, I’d be paying more than $16,000 more in taxes than I had in real capital gains, thus losing, net, 6%.

What if capital gains were taxed as ordinary income, but adjusted for inflation? Then I’d be paying 30% of $33,247, or $9,974. Of course, Obama wants to reverse the Bush tax cuts, so raise that percentage to 33%. The bill would then come to $10,972, which is still a lot less than $26,558. So, on long-term investments, paying capital gains taxes at the ordinary income rate, but only on real gains, would be much better than the current 15% rate. But nobody’s proposing anything like that.

Here’s the broader point. Obama promises not to raise taxes on anyone earning less than $250,000 a year, even though he’s committed to policies that would have that effect and committed to spending priorities that would necessitate it. He’s caught in the standard trap facing Democratic candidates. Their policy priorities require a significant middle class tax increase; there’s no way to pay for them without it. But admitting that is electoral suicide. So, they have to dissemble.