Taxing Capital Income Is Unfair

By Bernie on 29 Nov 2012

Based on the past election I would guess that the majority of Americans have no idea what Socialism is, nor do they have the slightest bit of knowledge about economics.

Last February, Scott Sumner, an Economics Professor at Waltham’s Bentley University, wrote an excellent piece in the Economist, explaining why the proper tax rate on capital income should be zero:

ONE of the most basic principles in economics is that the taxation of capital income is inefficient. Taxes on interest, dividends, and capital gains represent a sort of “double taxation”, of wage income. For some reason many people have difficulty grasping this concept, and one often sees even Nobel Prize-winning economists talking about “income inequality” using data that includes both wage and capital income. This makes about as much sense as adding up blueberries and watermelons and calling it the “number of units of fruit”.

To see why this is so, consider twin brothers who each make $100,000 in wage income. Most people would regard these two people as equally well off, even if one freely chose to consume his income now, while the other chose to consume later. But not advocates of the income tax. They insist the more patient twin brother is “richer” and deserves to be taxed at a higher income tax rate. For instance, compare a 40% wage tax with a 40% income tax. Under the wage tax (sometimes called a “payroll tax”) the spendthrift brother is able to consume $60,000, which is 40% less than in a no-tax economy. Now assume the thrifty brother invests the after-tax wage income for 20 years, and sees the money double to $120,000. Then he can consume $120,000 20 years in the future, which is also 40% less than the no- tax consumption level. This sort of tax is neutral with respect to saving and investment; it's essentially a flat rate tax on consumption, whenever it occurs.

But that's not good enough for proponents of taxation of capital income. They want the thrifty brother to pay a 40% income tax on the $60,000 in capital income, leaving him with only a net gain of $36,000. Now the thrifty brother can only consume $96,000 in 20 years, thus he essentially paid a 52% tax on his consumption (as he would have consumed $200,000 in a no-tax scenario). The mistake people make is forgetting that the present value of $120,000 worth of consumption 20 years in the future is the same as $60,000 today. And in a sense that should be obvious, as both brothers are free to spend their money when they choose in the no-tax situation, so obviously the thrifty brother would not be economically “better off” merely because he chose a different year to consume his income. Both are equally “wealthy”, where wealth is the present value of lifetime consumption.

If a picture is worth a thousand words, then a video is worth a million (with a tip of the turban Hat Tip to Xanthippa's Chamberpot):

YouTube, Economist Steven Landsburg Discusses Incentives and Taxes

While Obama likes to talk about the wealthy paying their "fair share," the truth is that taxing the wealthy is unfair to wage earners. If taxes on dividends and other forms of capital formation were reduced to levels of the 1920s, average wages and real incomes would be about 17 percent higher.

The American Magazine, Don’t Raise Capital Gains Taxes

taxing capital income is unfairIncreasing taxes on capital income goes against current economic thinking on how to finance government spending. Indeed, taxing capital income ultimately hurts the very people it was supposed to help. It reduces investment, which reduces the amount of capital in the economy. A lower capital stock reduces economic growth, productivity, job creation, and wages.


A growing number of economic studies conclude that raising taxes on capital income leads to a substantial drop in capital formation. America’s capital income tax rates are about twice as high today as they were in the 1920s, and capital formation rates are much lower today than they were then. Economists use the “capital-output” ratio—the ratio of the capital stock to gross domestic product—to compare rates of capital formation over time. The capital-output ratio was almost 90 percent higher in the 1920s than it is today.

What would happen if the United States returned to the capital income tax rates of the 1920s? Its capital stock would be about 50 percent larger, and average wages and real incomes would be about 17 percent higher.

Taxing the rich more, hurts everyone who is not rich.

Anyone may republish this article for non-commercial use without asking my permission. I make it easy, see details here.

Related Posts with Thumbnails
If this is your first time here, please read my Comment Policy HERE.

comments powered by Disqus



Email Me

FAQ/About Me


Site Policies


My Articles in Danish

Follow Me:

Special Offer For My Muslim Readers: Please subscribe to Planck's Constant Blog. We guarantee a 100% increase in your intelligence.

subscribe to my Feedvia RSS Feed

subscribe to comment Feedvia my Comments Feed

Visit my Pinterest pagevia my Pinterest Feed


Shameless Advertising

This is what Bernie is Reading Now

For Previous Books Click Here.

Buttons & Widgets

Older Buttons

View My Stats

Blogs That Link to Me:

A collection of things...
Always on Watch
Americans Stand with Israel
Animal Magnetism
Apropos of Nothing
Bare Naked Islam
Basil’s Blog
Blazing Cat Fur
Blogging for a free world
Celestial Offerings
Cmblake6's Weblog
Commonsense & Wonder
Conservative Thoughts
Cosmic Cogitations
Cristy Li
Daily Blasphemies
David Drake
DragonLady’s World
Elder of Ziyon
Empyreum Cœlum
Fausta’s Blog
Fiery Spirited Zionist
Gates of Vienna
Gummihund/ Rubberdog and a proud Orangutan
Hard to Swallow
Hodjanernes Blog
Infidel Bloggers Alliance
Intergalactic Source of Truth
Iron Burka
Israel Matzav
Jewish Preppers
Leather Penguin
Maggie’s Notebook
MFS - The Other News
Monkey in the Middle
My Gripes of Wrath
My Newz 'n Ideas
News on the March
Nicholas Hunter Folkes
No Apology
nothing to laugh at
Oswald Bastable’s Ranting
Outside the Camp
Perigo Islâmico (In Portuguese)
Pirate's Cove
pislamonausea Central
Project 2,996
Prune Juice Media
Ramrock's Blog (In Spanish)
Right Nation
Right Pundits
Right Truth
Rosemary’s Thoughts
Sherryx’s Weblog
Silicon Valley Redneck
Simply Jews
Smooth Stone
So Far, So Good ...So What!
Squid Thoughts
Stop Islamic Conquest
Sunday Morning Coffee
Tales of a Wandering Mind
The Amboy Times
The Astute Bloggers
The Christian Defender
The Infidel Task Force
The Lunatic's Asylum
The Mindset
The Old Curmudgeon
The Political Commentator
The Right Nation
The Sandman
The Sassy Tn’T PoLITicallY InCorrect
The Tao of Torah and Rebbi Nachman.
The Unreligious Right
Theo Spark
Third World County
Thoughts From A Seared Conscience
Thunder Pig
usa stands with israel
Veritas Universalis
Western Civilization and Culture
wine women and transcendence
Working the Web
Xanthippa's Chamberpot
Zilla of the Resistance