Tag Archives: capital gains tax

Krugman Versus Mankiw on Capital Income Taxation

This morning’s New York Times featured an op-ed from Paul Krugman titled “Wealth Over Work.” In the piece, Krugman warns that we are on a dangerous path towards an oligarchical society, where inequality is rampant and wealth accumulates in the hands of a small group of powerful elite. The government enacts policies that promote the accumulation of this wealth and living off of capital income over deriving income from working in the labor force.

While the inequality argument is certainly a relevant and important topic, Krugman’s finger pointing seems over the top to me. Krugman, in his typical fashion vilifies the GOP:

Despite the frantic efforts of some Republicans to pretend otherwise, most people realize that today’s G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about.

Some of his points are valid but there are two problems I have with Krugman’s argument:

  1. Krugman claims that one of the contributing factors to his claimed shift towards an oligarchical society is the favorable tax treatment capital income receives. Based on my experience studying taxes in Jim Hines’s government revenues class, this statement struck me as off. Taxes on investments such as capital gains and dividends are some of the most inefficient taxes a government can impose. I was happy to see that Greg Mankiw publicly called Krugman out on this on his personal blog. Mankiw points out that it is not class warfare that drives the rationale for lower capital taxes, but rather the fact that it is optimal economically. At its heart economics is about trade offs and governments are faced with a serious tradeoff when designing a tax system: the tradeoff between efficiency and progressivity. Capital taxes are extremely inefficient because capital owners can choose to not sell their assets very easily if they face the tax, distorting economic activity and producing dead weight loss, which is a net loss to society. Therefore having lower capital taxes if efficient. The tradeoff here is that the bulk of capital income goes to the wealthy and so a lower tax is also regressive. Our tax system corrects for this in other areas.
  2. My other problem with Krugman’s article is the borderline conspiracy theorist perspective he advances as to why this shift is occurring, “Why is this happening? Well, bear in mind that both Koch brothers are numbered among the 10 wealthiest Americans, and so are four Walmart heirs. Great wealth buys great political influence — and not just through campaign contributions. Many conservatives live inside an intellectual bubble of think tanks and captive media that is ultimately financed by a handful of megadonors. Not surprisingly, those inside the bubble tend to assume, instinctively, that what is good for oligarchs is good for America.” To me this argument sounds a little too extreme. Yes money can buy power and influence, but politicians ultimately must answer to all of their constituents in our democratic society and ultimately those well off can be heard. The adoption of Obamacare (which the Koch brothers strongly oppose) is one example of a the less powerful majority winning a battle.

Overall, Krugman provides a thought provoking piece but his points seem drastic and overblown, especially from an economic perspective.

Increase in U.S. Capital Gains Tax on Wealthy: Incentive to Donate?

It’s that time of the year when American earners start to fret about their personal wealth. The IRS began accepting returns for 2013 income tax season on January 31st yet again in the U.S., and the WSJ has made sure that its readers are aware of many of the upcoming changes to the tax code that have come this year. Since many of the new provisions only affect high-income taxpayers, most of us in Econ 411 will likely be unaffected (unless you have your own lucrative hedge fund or startup on the side). However, since we have progressive income tax rates, the tax code has a significant effect on the distribution of wealth in our country, so these changes are useful to consider when analyzing inequality (at least in terms of taxable income). Furthermore, there are a few loopholes that allow some high earners to maintain their advantages.

One of the biggest changes for those in the top income bracket (singles making more than $400,000 a year, or married couples making more than $450,000 a year combined) is the increase in the top tax rate for long-term capital gains and qualified dividends (on assets held for more than a year) from 15% to 20%. In addition, there is also a new “net investment income” tax, in which those that earn more than $125,000 (if they’re single, $250,000 for couples) in investment income will pay an additional 3.8% on their investment income. This essentially acts as an additional tax on capital gains and dividends.  On paper, these new taxes may appear to some politicians to be a step towards evening out the inequality in this country, but there are also a few loopholes that may prevent this from being a successful strategy.

One important loophole was illustrated in different Wall Street Journal article. The article suggested to the average taxpayer to donate stock or other financial assets to charity rather than give a monetary gift. It’s widely known that charitable donations can be deducted from a filer’s tax return, but there is an added advantage to donating your financial assets. If you donate stock to a charity, not only do you receive a tax deduction at the fair value of the assets, but you won’t have to pay the capital gains tax on that asset. Individuals can deduct contributions of capital gains assets up to 20% of their adjusted gross income. This means a wealthy taxpayer that typically gives away a large portion of their salary to charity could simultaneously avoid paying taxes on their investment gains by simply donating a portion of their financial assets to a qualified charity.

For example, say a wealthy bachelorette in the top income bracket with a salary of $1MM per year gives away $50k in cash to her favorite charity annually and, after saving steadily, she has an investment portfolio of $500k that generates 10% dividend return annually (assume this is in a high-yield ETF, with reinvesting dividends), so she normally gets $50k worth of investment income annually. This year, she wants to take her annual capital gains and dividends out of the fund and spend it on a vacation with her partner. These gains would be taxed at 20%, given the 2013 capital gains tax increase. This would mean that she would only get to keep $40k of this year’s $50k capital gains ($500k * 10% interest * (100-20% capital gains tax) = $40k). Between her charitable contributions and her capital gains after tax, she would have spent $10k this year (simplified to only these two items for illustration). If she instead decides to donate $50k of her ETF portfolio to her favorite charity, she escapes the capital gains taxes on this stock and her gains from her portfolio ($50k) cancel out her charitable donation ($50k). So far, she’s left with $10,000 worth of extra cash flow this year. Furthermore, since charitable contributions are tax-deductible, she gets to write $50k off her annual income when she pays her income tax. This means she’ll get to keep an additional $50k*39.6% (for the top tax bracket) ~ $20k, instead of paying this in tax. The overall effect is that she pays 20k ($50k – $20k income tax savings -$10k capital gains tax savings) in order to donate $50k to charity; it’s a strong incentive to donate!       – Keep in mind this strategy only works for philanthropists that would have originally donated to charity anyways.

Overall, while this part of the tax code is likely to have some sort of an effect on income inequality in the U.S. directly, the higher tax may also incentivize wealthy people to donate to qualified charities. In the end this might have a positive redistribution effect, assuming the money donated to these charities is used appropriately and responsibly. This would make an interesting topic to research, to investigate whether there was an impact on the capital gains tax rates and charitable giving.