March 1, 2015

Is It Fair to Tax Capital Gains at Lower Rates than Earned Income?

Scott Sumner

Ralph G. Hawtrey Chair of Monetary Policy
Summary

Scott Sumner and Leonard E. Burman of the Urban-Brrokings Tax Policy Center discuss capital gains tax and the appropriate level of taxation on these gains. They address the broader question that divides experts: Are capital gains so different from earned income that they should be taxed at a different rate?

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Capital gains—and how big a bite the government should take out of them—have become a major point of contention in the past couple of months.

In January, President Obama proposed tax changes designed to raise some $320 billion over 10 years, largely through higher levies on high-income Americans. The revenue would be used to cover $235 billion in tax breaks, mostly for moderate-income workers, along with other initiatives.

Among the changes he proposed: boosting the capital-gains rate to 28% for the top 1% of taxpayers, up from the current 23.8%, as well as a new capital-gains tax on many inheritances.

The GOP fired back that taxing investment income would harm economic growth by discouraging business investment and thereby hurt workers’ incomes.

All of which points to a broader question that divides experts: Are capital gains so different from earned income that they should be taxed at a different rate?

Below, two experts tackle that question. Scott Sumner is professor of economics at Bentley University and the Ralph G. Hawtrey chair of monetary policy at the Mercatus Center at George Mason University, where he is director of its program on monetary policy. Leonard E. Burman, director of the Urban-Brookings Tax Policy Center and the Paul Volcker chair in behavioral economics and professor of public administration and international affairs at Syracuse University’s Maxwell School, is author of “The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed.” They can be reached at reports@wsj.com.

YES: It Makes Sense for Individuals—and the Economy

By Scott Sumner

To many people, investment income should obviously be taxed at the same rate as labor income. After all, income is income, right?

But it’s not that simple. There are compelling reasons to treat capital gains differently than other earnings.

For one thing, taxes on investment earnings effectively double-tax that income. Labor income is taxed when it is earned, and investments are generally made out of after-tax earnings—so capital-gains levies represent another bite out of an investor’s money.

In effect, the system punishes those who put their money to work. Raising the capital-gains tax rate would just make the punishment that much more drastic.

This question doesn’t simply affect people who invest—it affects the entire economy. Investment capital is one of the most important drivers of economic growth, and the promise of big capital gains are an important inducement to get people to put money into critical but risky fields like biotechnology. If we want more inventions, or a faster cure for cancer, then we should have lower capital-gains taxes.

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