[kenrexford]

There seem to be a lot of morality and incentives and the like discussed here, but my original question had to do with mathematics, more. Whatever the policy concerns, it still seems to be a matter of basic math, unless I am missing something that no one has yet pointed out, that a dollar earned by a person in business for themselves is taxed at the individual income tax rate, whereas a dollar earned by a corporation is taxed at the corporate rate and then again at the capital gains rate, which means taxed twice.

This seems somewhat like the fallacy of claiming that a person pays, for instance, 20% income tax. We know that if they make $100K, then they "really" made about $107.5K (or whatever the tax "paid by the employer" is). So, as a starting point, "20%" really is about 18.6%+6.9% = 25.5%. But, against the 18.6%, the person then gets deductions and the like, reducing that amount down. But, it is not 20% unless the math is lucky at ending at that point. Of course, we can call a large portion of this mandatory contributions to retirement, but that seems like a joke to some degree. Even that amount, though, is calculated errantly.

[barmar]

 kenrexford, on 2012-January-30, 08:12, said:

There seem to be a lot of morality and incentives and the like discussed here, but my original question had to do with mathematics, more. Whatever the policy concerns, it still seems to be a matter of basic math, unless I am missing something that no one has yet pointed out, that a dollar earned by a person in business for themselves is taxed at the individual income tax rate, whereas a dollar earned by a corporation is taxed at the corporate rate and then again at the capital gains rate, which means taxed twice.

First of all, the CGT only applies if an investor sells their shares. Many investors just sit on their shares for years, so the government never gets any of it.

Second, when the corporation pays taxes, it reduces the company's net worth. Analysts should take this into account when valuing the company, so it should reduce the capital gains.

There may still be some double taxation. Who ever said there wouldn't be? If you pay sales tax on supplies and raw materials, and then there's sales tax on the products you produce, that's also double taxation -- the government could get a piece of every step in the supply chain.

[phil_20686]

 barmar, on 2012-January-30, 09:20, said:

First of all, the CGT only applies if an investor sells their shares. Many investors just sit on their shares for years, so the government never gets any of it.

Second, when the corporation pays taxes, it reduces the company's net worth. Analysts should take this into account when valuing the company, so it should reduce the capital gains.

There may still be some double taxation. Who ever said there wouldn't be? If you pay sales tax on supplies and raw materials, and then there's sales tax on the products you produce, that's also double taxation -- the government could get a piece of every step in the supply chain.

In most countries you can get your sales tax back on raw materials if they are included in something you build, so you only pay the value added.

Also, no matter how long you sit on your shares, the government gets its share as soon as you liberate your asset for cash. Even if it has to wait for you to die its irrelevant whether they sit it on or trade it often. In practice, due to the inflation, the government gets slightly less if you sit on it for years, compared to if you trade frequently, but its not a big difference.

[phil_20686]

 kenrexford, on 2012-January-30, 08:12, said:

There seem to be a lot of morality and incentives and the like discussed here, but my original question had to do with mathematics, more. Whatever the policy concerns, it still seems to be a matter of basic math, unless I am missing something that no one has yet pointed out, that a dollar earned by a person in business for themselves is taxed at the individual income tax rate, whereas a dollar earned by a corporation is taxed at the corporate rate and then again at the capital gains rate, which means taxed twice.

This seems somewhat like the fallacy of claiming that a person pays, for instance, 20% income tax. We know that if they make $100K, then they "really" made about $107.5K (or whatever the tax "paid by the employer" is). So, as a starting point, "20%" really is about 18.6%+6.9% = 25.5%. But, against the 18.6%, the person then gets deductions and the like, reducing that amount down. But, it is not 20% unless the math is lucky at ending at that point. Of course, we can call a large portion of this mandatory contributions to retirement, but that seems like a joke to some degree. Even that amount, though, is calculated errantly.

This is not a correct statement. It depends very much on what sets the price for that particular piece of labour. If you are a stellar CEO in a global environment, then competition between different countries sets the price and it is the after tax salary that is important, basically, as that is what you will use in deciding where to work (+plus other non economic factors).

If the wages are set by competition between companies putting downward pressure on the wages to make the product cheaper, then the payroll tax, will matter as its the pre tax salary that is important in deciding whether your widgets are competitive with widgets from china. This is why tax incidence is very complicated. There is only one fundamental truth in tax incidence that is easy to understand, and that is that all taxes are paid by people. Corportation tax falls on people, sales tax falls on people, its just a question of whom. Corporations do not pay tax, either the employees pay tax, or the shareholders pay tax, or the consumer pays tax etc. All taxes are paid by people.

[Cthulhu D]

It's difficult to argue against the Norwian approach for a CGT. 28% rate with shielding for the average return of 3 month treasury bonds over the period (so if bonds are 3% (risk free rate) and you get 15%, you get taxed 3.36%. Most methods of taxation that operate on capital investments (e.g. share dividends) have the same tax rate and shielding principle applied. Dividends are not double taxed.

This clearly makes more sense than the fixed rates or the US double taxation of dividends.

They are also forbid the US practice of carried intrest being taxed as capital gains which makes sense.

Pensions are managed seperately and income tax is somewhat higher!

[barmar]

What's the "carried interest" thing? I've heard about it in reference to Romney and Bain Capital, but I don't know what it is. It allows dividends to somehow be turned into capital gains?

[kenberg]

 barmar, on 2012-February-03, 12:10, said:

What's the "carried interest" thing? I've heard about it in reference to Romney and Bain Capital, but I don't know what it is. It allows dividends to somehow be turned into capital gains?

You are not alone in your ignorance. But then I'm the guy who, when in college and invited to accompany a group to see the Monet exhibit, said who's Monet?


Also, my knowledge of capital gains is miniscule, but I approach questions like Ken's this way: A lot of people, especially a lot of people with money, engage in activities that lead to paying a capital gains tax. Still, they do it. So I suppose it's not such a tough deal. This seems like a better approach to the question than attempting to apply mathematics or, especially, logic.

[blackshoe]

I dunno from capital gains, but it seems there must first be capital, which I suppose is money, or machinery, or buildings, or something used to produce goods or services. If the capital increases in value, you have a capital gain. If it decreases, you have a capital loss. I'm sure it's not that simple, but it seems the place to start.

[barmar]

 kenberg, on 2012-February-03, 20:03, said:

Also, my knowledge of capital gains is miniscule, but I approach questions like Ken's this way: A lot of people, especially a lot of people with money, engage in activities that lead to paying a capital gains tax. Still, they do it. So I suppose it's not such a tough deal.

Of course. They do it because capital gains tax is LOWER than ordinary income tax (it's less than half if you're in the top tax bracket). So if they have a choice between receiving the same amount as interest/dividends or capital gains, they choose the latter.

Capital gains is very simple: You buy something for $N, you later sell it for $M dollars. The gain is M-N, and you pay tax on this. There are a few complications: if you sell less than a year after buying, it's short-term gain and is taxed as ordinary income; if you sell at a loss and purchase replacements within a month, you don't get to use the loss to reduce your tax immediately (this is the "wash sale" rule).

[barmar]

 blackshoe, on 2012-February-03, 22:05, said:

I dunno from capital gains, but it seems there must first be capital, which I suppose is money, or machinery, or buildings, or something used to produce goods or services. If the capital increases in value, you have a capital gain. If it decreases, you have a capital loss. I'm sure it's not that simple, but it seems the place to start.

Capital is just money. You don't have a capital gain or loss until you sell something, depending on whether the amount you received is more or less than what you originally spent.

[kenberg]

 blackshoe, on 2012-February-03, 22:05, said:

I dunno from capital gains, but it seems there must first be capital, which I suppose is money, or machinery, or buildings, or something used to produce goods or services. If the capital increases in value, you have a capital gain. If it decreases, you have a capital loss. I'm sure it's not that simple, but it seems the place to start.

This is about what I know, and probably my knowledge will never extend further.

When Becky and I got married sixteen years ago she, through various complexities of life rather than any desire to join the investment class, owned a townhouse that she rented out. I had always done my own income tax paperwork (I started young, my father had a stroke when I was thirteen and I did the family taxes) but suddenly things became way more complicated. I'm not one of those guys who gives his wife instructions about how to live, but when she decided to sell the damn townhouse I was delighted.

Someone, I can't recall who, said that "tax rules turn a man's life into a business. A man's life should not be a business". I agree. I put a high value on simplicity (I avoid conventions such as kickback that have a list of rules attached) and most of these maneuvers to avoid taxes have always seemed like too much of a pain in the rear end, whatever their financial advantages.

[PassedOut]

 barmar, on 2012-February-04, 02:31, said:

Of course. They do it because capital gains tax is LOWER than ordinary income tax (it's less than half if you're in the top tax bracket). So if they have a choice between receiving the same amount as interest/dividends or capital gains, they choose the latter.

Capital gains is very simple: You buy something for $N, you later sell it for $M dollars. The gain is M-N, and you pay tax on this. There are a few complications: if you sell less than a year after buying, it's short-term gain and is taxed as ordinary income; if you sell at a loss and purchase replacements within a month, you don't get to use the loss to reduce your tax immediately (this is the "wash sale" rule).

As Barmar said, first you need some money to invest. Once you've accumulated some savings, though, you can multiply those savings quickly via capital gains.

For a simple example, suppose you put down $20,000 on a rental property that costs $100,000. The rent from the tenant pays the mortgage, taxes, and maintenance, plus a small profit for you each month. After a year, you sell the property for $120,000, realizing a capital gain of $20,000, reduced to $17,000 because of the 15% tax.

But the principle balance on the mortgage had gone down to $75,000 (paid by the tenant), so your $20,000 has become $42,000 in one year. If the capital gains tax were 25% instead of 15%, your $20,000 would still have become $40,000 -- not a bad return.

When I was young (1970s and early 1980s) the holding period for capital gains treatment was longer and the tax rate was higher, but the strategy outlined here worked well for me nevertheless.

[hrothgar]

This whole "double taxation" argument is farcical.

Back when I was teach economics 101, the concept of the "incidence of a tax" was a standard part of the curriculum.
The incidence of a tax describes how the effects are of a given tax are distributed between consumers and producers...

Guess what... The exact same principles applied to corporate income taxes.

If I go and levy income taxes on a company, the incidence of the tax isn't restricted solely to capital owners.
It ripples across the system and, guess what... One of the things that it impacts is wages.

So guess what? When workers are paying income taxes on their wages...
They're getting taxed "twice" as well.

The difference is that they aren't acting like pissy little shits and complaining about grand conspiracies against job creators.

[blackshoe]

 kenberg, on 2012-February-04, 07:59, said:

I put a high value on simplicity (I avoid conventions such as kickback that have a list of rules attached) and most of these maneuvers to avoid taxes have always seemed like too much of a pain in the rear end, whatever their financial advantages.

That's why the rich hire accountants, to do the maneuvers for them.

[phil_20686]

 hrothgar, on 2012-February-04, 08:36, said:

This whole "double taxation" argument is farcical.

I agree that it's farcical, but mostly because I don't think we know with any certainty at all how the tax incidence from corporations tax (or sales tax) falls. I suspect it varies widely by industry, and possibly even by compnay within an industry.

Here is one illuminating thought experiment.

Suppose companies Avalon and Utopia are in direct competition in the making of widgets. They are in different countries under different tax structures. Due to a technological advantage, Avalon can make widgets for half the price of Utopian widgets. However, they choose to sell them at 10% below the Utopian price, because they judge this to maximise profit and market share until Utopia catches up. Suppose the country of Avalon raises its capital gains tax, this will not effect the price at wich avalon sells its widgets, as it is not cost constrained. Thus the tax will eat directly into shareholder profits. Suppose instead that the Country of Utopia raises its capital gains tax. Because it is making widgets as cheaply as possible, it must necessarily raise its prices, and as a result the tax will fall entirely on consumers of Utopian widgets.

I think that this kind of scenario illustrates the plausibility that the incidence might be different even for similar companies in the same industry.

[awm]

I don't really understand what Phil's example has to do with capital gains.

A change in capital gains tax doesn't change the company's costs or the company's revenues (these might be effected by the corporate income tax rate, but they are not capital gains). Companies do not necessarily pay out most of their profits as dividends, and even if they do, dividends are not necessarily taxed at the capital gains rate (in the US it depends on a lot of things). The company's stock price is an amalgamation of total assets, projected future assets, and projected future dividends. In fact things only peripherally related to the company (i.e. economic "confidence", what's going on overseas, the latest jobs numbers) often have huge effect on the stock price.

Even if we assume that these companies pay out all their profits to investors and this is taxed at capital gains rates, it's not obvious what the investors will do about an increase in capital gains tax. The amount of revenue that the investors get at a 15% capital gains rate is (0.85)P where P is the profit margin. The revenue that investors get at a 25% capital gains rate is (0.75)P. Since the company's pricing policies are presumably already optimized to maximize P there is no particular reason for any change in corporate strategy due to the capital gains rate.

Now what might happen, is that investors realize that their dividend just dropped about 11%, and this might lead to an up-to-11% decline in the company stock valuation (assuming there is no reason to expect future change in capital gains rate). The quicker investors (i.e. those skirting the insider trading laws, i.e. the US congress) will sell off their holding before the general market reaction. Other investors may get left holding a stock that suddenly dropped in value. The devaluation of the stock might indirectly effect the company if they need to raise some money or valued employees leave because their stock options are worthless... but then again it might help the company to embark on a stock buyback or the like. The "losing" investors can also write off the capital loss (stock valuation drop) against their capital gains, which might make the whole thing closer to a wash.

It certainly seems to me like most of the effect of raising capital gains tax will be that wealthy investors pay more taxes. Note that retirement funds in the US anyway (think Roth IRA and the like) are mostly shielded from taxation (as are capital gains by low-overall-income people). Investors may look for other places to invest their money, but most alternative investments in the US are already taxed at capital gains rates (or above!) and the government generally does not allow US citizens to dodge taxes by investing overseas (i.e. if US tax rate is more than what they pay, they still have to pay the difference to the US government).

[barmar]

I found a decent summary of carried interest at Wikipedia. Basically, if you're a private equity fund manager, the fund periodically pays out a portion of its profits to you, in lieu of a regular salary. Since this is considered a return of the capital that the manager put into the fund in the first place, it's taxed at capital gains rate, rather than as ordinary income.

[phil_20686]

 awm, on 2012-February-04, 17:07, said:

I don't really understand what Phil's example has to do with capital gains.

Apologies, the thought experiment is about sales tax. It was meant to demonstrate the plausibility that the incidence of a tax can vary even among similar companies.

I could not think of a simple example for capital gains.

[Cthulhu D]

 barmar, on 2012-February-05, 00:11, said:

I found a decent summary of carried interest at Wikipedia. Basically, if you're a private equity fund manager, the fund periodically pays out a portion of its profits to you, in lieu of a regular salary. Since this is considered a return of the capital that the manager put into the fund in the first place, it's taxed at capital gains rate, rather than as ordinary income.

Yeah the US practice of carried interest is ludicrous - capital gains has a favorable tax regime because it's an investment and at risk. However carried interest is essentially a performance bonus that is taxed at capital gains rates rather than salary rates. It's a pretty stupid loophole.

[kenberg]

 Cthulhu D, on 2012-February-06, 06:19, said:

Yeah the US practice of carried interest is ludicrous - capital gains has a favorable tax regime because it's an investment and at risk. However carried interest is essentially a performance bonus that is taxed at capital gains rates rather than salary rates. It's a pretty stupid loophole.

This appears to be a fine example of using words to make the true meaning as opaque as possible. From the Wik article:

Quote

In a hedge fund environment, carried interest is usually referred to as a "performance fee". Hedge funds, because they invest in liquid investments, often are able to pay carried interest annually, if the fund has generated a profit for its investors.

"Performance fee" seems closer to the truth, maybe "bonus" would be even better. "Carried interest" appears to have no relationship to what actually occurs (indeed no obvious meaning at all), but it is suitable vague so that taxpayers, who might object to others getting getting a special tax break on their bonus pay, let this slide because they have no idea what is being done.