INTRODUCTION-- WHAT ARE CAPITAL GAINS?
With all the recent talk about Mitt Romney's taxes and the impending "fiscal cliff," I realized that I, as well as many people, had only a rudimentary understanding of the taxation of capital gains. Indeed, I feel many retain some misinformation on the topic.
Long-term capital assets receive preferential tax treatment under the Internal Revenue Code. Long-term capital assets are any property held for more than a year EXCEPT for property that is the normal source of business income (e.g. inventory held for sale, business equipment, office space, etc.). Perhaps the most familiar form of capital gains are those associated with stock in companies. For those realizing capital gains whose marginal tax rate is 15% or lower, they pay NO tax on capital gains (0%). For those in higher tax brackets, capital gains are taxed at a maximum rate of 15%. However, the rates on capital gains are slated to go up to 20% on December 31, 2012 unless Congress does something to change it (part of the "fiscal cliff").
PROS & CONS OF PREFERENTIAL TAX TREATMENT ON CAPITAL GAINS
Justifications advanced for the preferential treatment of long-term capital assets are generally threefold:
1. Part of the gain realized on the sale of capital assets represents inflation. Thus, although the market price of property increases after ten years, the true value has not after factoring in inflation. Taxes should be lower on capital gains to take inflation into account.
2. Lower taxes on capital gains incentivizes responsible savings.
3. Preferential tax treatment of capital gains makes for mobile capital and more efficient markets. Lower taxes on capital gains makes it easier for investors to take money out of stagnant or failing companies and put it into more promising businesses. Lower capital gains taxes helps socially beneficial or popular enterprises raise capital.
But, there are strong counterarguments too:
1. Differentiating gains and losses as capital or ordinary requires complex and hard to understand regulations. The administration of preferential treatment of capital gains, this argument goes, is too expensive and cumbersome to be worth it. Opponents of lower taxes on capital gains argue that there are better ways to accomplish the purposes of favorable capital gains treatment. For example, tax bases can be adjusted for inflation.
2. The strongest repost of opponents is that favoring capital gains is just not fair. Only those with lots of capital with which to invest have capital gains. In 2010, the top 1% of income earners realized over 70% of the capital gains.
SOME SUGGESTIONS FOR CHANGE
Regressive Capital Gains Tax: Clayton Christiansen of the Harvard Business School, and others, suggest taxing capital gains regressively over time. In other words, the longer you hold on to an investment, the lower the tax rate should be on that investment. He believes that the relatively minor loss in tax revenues for the government ($38 billion in 2012) are well worth the increase in capital available for job creation and innovation. Indeed, many or probably most economists agree that lower capital gains increase revenues in the long run through quickened economic growth. But, this notion is challenged. The true effects of high and low capital gains rates are hard to measure because there are so many other historical factors that affect the state of the economy. Evidence seems to support and deny the benefits of low taxes on capital gains.
No Capital Gains Tax: There are many voices calling for the government to stop collecting taxes on capital gains entirely. This would have effects on businesses' choice of entity (i.e. pass-through entities like LLC or LPs may lose importance) which may require some legislative tweaking; but, would increase capital mobility and, in theory, make for a more efficient market.
No Preferential Treatment for Capital Gains: Another option would be to tax all gains at the ordinary rates. Whether a gain is realized on stock or through lending services, the tax on income would be the same. This would raise government revenues and make for more equality and result in more fairness. After all, why should income from labor be taxed more than income from investments in big corporations.
Comprehensive Change: Perhaps my idea would be to alter the entire structure of the Code. I would widen the base and flatten the taxes for all but those making more than $5 million per year except for income from patent and copyright royalties. The rate could then be steeper from there. I would do away with a number of counterproductive tax subsidies. I would cut spending and regulation. Perhaps I will elaborate my nascent tax plan in a forthcoming post.
The four traditional police powers of government are to protect public health, safety, welfare, and morality. In American law, the police powers are legitimate and even compelling justifications for government legislation and regulation. Usually, government exercises of the police powers can pass any level of judicial scrutiny. Within these realms, the courts do not challenge the legislature or executive branches in their capacity to regulate behavior and enforce social order.
However, some courts have explicitly rejected the power of government to protect citizens' morality. Courts began to embrace moral relativism in the context of pornography and indecency cases under the First Amendment.
In Cohen v. California (1971), the Supreme Court heard a case about a man, Cohen, who had been convicted under a California statute prohibiting anyone from "maliciously and willfully disturb[ing] the peace or quiet of any neighborhood or person . . . by . . . offensive conduct." Cohen had worn a jacket that prominently displayed the phrase "F*** the Draft" in a government building with children. Although the Court could have held narrowly on the unconstitutional overbreadth of the California statute, it articulated a broader ruling. The Court held that California cannot censor profanity in public places because "one man's vulgarity is another man's lyric." Such a holding seems to endorse an almost unlimited personal autonomy. It chants the selfish mantra, "you can do whatever you want, so long as you don't hurt anyone." Justice Burger, Justice Blackmun, and Justice Black dissented in part because they (correctly) asserted that we do not "live in a world so incapable of communication that it can be said that 'one man's vulgarity is another's lyric.'"
More recently, Justices Kennedy and O'Connor seem to have accepted moral relativism by asserting that the Court cannot rule on morality in cases dealing with abortion and same-gender sex (Lawrence v. Texas; Planned Parenthood v. Casey). But, I will keep the scope of this post to the First Amendment.
Judge Robert Bork criticized the Court's capricious admission of moral relativity in, among others, the Cohen case. He points out that moral distinctions stand at the very foundation of the law. If it were not for morality, law could be established in very few areas, "[a]fter all, one man's larceny is another man's just distribution of goods." Moral relativism as a formula for justifying and fashioning the law is totally vapid. A change in deeply entrenched and widely accepted moral environment is harmful.
One of the chief objections to Bork's critique of moral relativism in the judiciary is that, with Cohen, the Court was not dealing with regulations of Conduct like larceny, but speech, which has special status under the Constitution. This seems to me to be a widely accepted tenant of First Amendment theory. That, somehow, speech, as a right, is superior to other rights because it is memorialized in the First Amendment. First Amendment jurisprudence demonstrates a belief that the First Amendment enthrones speech and self-expression as higher than all other values save health, safety, and financial well-being of others. Since Judge Stone penned the famous footnote four of the United States v. Carolene Products case, rights specifically mentioned the Constitution have been blindly treated as superior to other rights.
I refute this notion. I believe most all of the founding fathers would heartily agree. The purpose of the First Amendment was not to give speech superior status relevant to other rights, but to declare the status of speech as a right where it had previously been treated only as a privilege in the law. Thus, speech is on no greater footing than other rights and must be balanced against other rights. Whether Cohen's "absurd and immature" form of protesting the Vietnam War can be regulated, I am not decided. However, the Court proceeded incorrectly, and in so doing, set dangerous precedent. Rather than proceeding on the assumption that no morality exists, the Court should have recognized the rights of parents to steer their children away from such indecency or the right of persons to function normally in society without having their moral sensibilities accosted. Then, the Court should weigh the rights of the speaker against the rights of the audience to come to a conclusion. Judicial consideration should take into account the justifications for free expression, asking: (1) Does the speech have a positive or negative affect on the marketplace of ideas, as a step to truth? (2) Does the speech have importance in checking government abuse or in sustaining a healthy democracy? And, (3) how important is the person's interest in autonomy and self-expression as compared with the opposing party's rights.
Although we may dispute the definition of moral good at the margins, there are certain ubiquitous virtues that should define the contours of the law. We may disagree about exactly what it means to be kind. But, virtually every society across time and geography values kindness and dishonors cruelty or selfishness. Rather than shun morality, Courts should sculpt the contours of the law around fundamental principles of morality.
Americans have the right to pursue a broadly virtuous life without being unduly burdened. While we can argue at the margins of what it means to be good; there is a central core in the American tradition of what it means to be virtuous: wise, courageous, kind, temperate, and transcendent. Our freedom of expression cannot be superior to the right to live normally without being exposed to a waterfall of profanity, lustful nudity, gratuitous violence, outright lies, and verbal abuse. Our policies must support virtue. Or, we will lose virtue. Benjamin Franklin understood well the results of a morally relativistic citizenry when he said, “Only a virtuous people are capable of freedom. As nations become corrupt and vicious, they have more need of masters.”
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