Discussion in 'Economics' started by ShoeshineBoy, Apr 10, 2008.

  1. This is kind of a scary link, but I don't quite get the numbers. What does he mean, for example, when he says, "Even more worrisome is that the collision of a 28% tax rate on capital gains combined with inflation above 3% would raise the effective tax wedge on capital to nearly 60% – the highest in 17 years"? Can someone give a numerical example of what he's talking about?

    The Federal Reserve's efforts to reflate the financial system with negative real short-term interest rates may have a dire consequence: sharply higher effective tax rates on capital.

    History has not been kind to such episodes. The combination of a rise in the statutory tax rate on capital and rising inflation nearly doubled the effective tax rate on capital between 1986 and 1991. This period also witnessed a stock market crash and a recession. Bringing inflation and marginal tax rates down created a major pro-growth inflection point in the early 1980s. But this progress could be substantially undone if we allow easy money to once again collide with sharply higher tax rates on capital.

    Capital gains are not indexed to account for inflation, which means that in times of rising inflation, the effective tax rate on capital can rise significantly above the statutory rate. If inflation is high enough, effective tax rates on capital can rise above 100%. This was the story of the 1970s.

    The current effective tax rate on capital is around 30%, down sharply from the 60% rates seen as recently as the early 1990s. This drop has been occasioned by a long period of falling inflation and the reductions in the top tax rate on capital gains in 1997 and 2003. The result has been an extended period of economic growth, strong advances in productivity, falling unemployment and rising real wages and incomes for most Americans.

    But this positive trend may not last. The statutory capital gains will automatically jump to 20% from 15% in 2011 unless legislative action is taken to extend the current rate. Democratic presidential front-runner Barack Obama has stated a preference to raise the top rate on capital gains to as high as 28%, a near doubling of the current rate. Even more worrisome is that the collision of a 28% tax rate on capital gains combined with inflation above 3% would raise the effective tax wedge on capital to nearly 60% – the highest in 17 years
  2. pitz


    Exactly! If you bought gold in 2000 at $250/ounce, and you sold in 2008 at $1000/ounce, the tax code presumes that you actually gained something of value, and you'd be taxed on a gain of $750.

    Did you actually have any more gold than when you bought the coins in 2000? Of course not. But the way the tax code is written, the government, by way of inflation, can now confiscate pretty much your entire original $250/ounce investment in 2000. (assuming that gains in gold are taxed as ordinary income, and assuming that one is in a 33% tax bracket on ordinary income)

    Basically put, just for holding gold for the past 8 years, the government has an entitlement of a quarter of your gold, or 100% of your initial investment, for an effective tax rate of 100%.

    This is robbery, since gold itself didn't produce any income, nor did it provide any wealth. Isn't our tax system really supposed to only tax income? I mean, the person who bought gold in 2000 isn't any 'wealthier' today (measured in gold) than he was in 2000.
  3. pitz


    BTW, the most effective way for a business to hedge against this behaviour is through debt. Of course, most American businesses have been steadily reducing debt over the past decade, and reducing the duration of their debt obligations, so they have actually amplified their vulnerability to the sort of confiscation of wealth articulated in the article.

    As individual investors, we can hedge against this using debt. For instance, if you took out a 30-year loan to buy stocks, as inflation accelerates, the relative cost of servicing the debt obligation diminishes, which offsets the tax burden. But individual investors, of course, are not immune from the problems that arise on the balance sheets of the businesses they own. So you'd want to fund your portfolio with at least some short-term debt, in addition to long-term obligations.
  4. Great example - thx!
  5. Don't dividends work pretty well now, too? (From the shareholder standpoint...)