More on Capital Gains vs Ordinary Income

There have been some excellent recent diaries about the issue of income being taxed at 15% (capital gains) vs. as ordinary income.  With everything going on this week regarding the Meirs and Taylor hearings, the Moyers broadcast, vote in the House to bring our troops home, and the Home Run Derby, this shouldn't get lost...

bonddad1

FoundingFatherDAR1

FoundingFatherDAR2

In Friday's NYT there were two items that caught my eye, a front page story about tax loopholes and Paul Krugman's editorial in which he states:

"A couple of weeks ago, Warren Buffett pointed out that he pays on average federal income tax of 17.7 percent while his receptionist pays about 30 percent"

More below....

Yes, there are only 2 things that are certain, death and taxes.  And the govt needs tax income to help pay for all those things we like such as defending our country, National Parks, the CDC, the FDA, the USDA, the CPB, Social Security, Medicare, Head Start, etc........as well as those things we don't like such as spending $10B a month in Iraq.  We may not like paying taxes, but we have to.  With that being said we would like the tax system to be fair.  In the early 1900s the tax system wasn't so fair.  I'm no tax expert, but I have to believe that the excesses of the Guilded Age where part of the reason that the Federal Income Tax system was implemented.

We have now reached a point in our history where the tax code seems to be skewing again.  There is the influence of the Alternative Minimum Tax, which now hits more and more Americans, Bush's tax cuts for the wealthy and a new one for me, the loophole that allows certain income to be charged at the rate for Capital Gains, 15%, rather than the higher rates for ordinary income.

In Friday's NYT one of the front page articles was "Tax Loopholes Sweeten a Deal for Blackstone"

NYT Blackstone

The article states:

"The Blackstone Group, the big buyout firm, has devised a way for its partners to effectively avoid paying taxes on $3.7 billion, the bulk of what it raised last month from selling shares to the public"

Further:

"Lee Sheppard, a tax lawyer who critiques deals for Tax Notes magazine and has studied the Blackstone arrrangment, said it was a reminder of the disconnect between the tax debate in Congress and how the tax system actually operates at the highest levels of the economy"

'These guys have figured out how to turn paying taxes into an innuity' Ms Sheppard said.'

Inside the paper there is a good visual showing how it all works.

Paul Krugman's excellent editorial is "An Unjustified Privilege"  Paul states:

"So fund managers get to pay a low tax rate that is supposed to provide incentives to risk-taking investors, even though they aren't investors and they aren't taking risks"

and

"The immediate response should be, what risk-taking? To repeat: the fund managers aren't entrepreneurs; they aren't putting their own assets on the line"......other Americans also earn their pay, but they don't get special tax breaks.  Plus we are talking about a lot of lost revenue due to the loophole - revenue that could for example, be paying for the health care of tens if not hundreds of thousands of children"

He closes with a plea to those Senators on the fence to do the right thing and close this loophole.

Thanks bonddad and FoundingFatherDAR for your leads on this story.  Please continue the good work!

•  Tips? (What IS the tax rate on tips?)

  by TomFromNJ on Sat Jul 14, 2007 at 08:10:28 AM PDT

  •  tips are taxable

      only if you have more than $20.00 in tips a month. So what is the cash value of these kind of tips?
      To the extent tips are taxable it is as ordinary income, and since it is pay for work, it is subject to Social Security and Medicare taxes. Of course sometimes people have tips they do not report, and don't pay any taxes at all.

    by Zack from the SFV on Sat Jul 14, 2007 at 11:13:22 AM PDT

•  Well I Am Not A CPA

  But I work for two of them and I can tell you if you can afford to use a good one (which I do) you pay a heck lot less in taxes cause there are many, many loopholes.

  by webranding on Sat Jul 14, 2007 at 08:13:07 AM PDT

  •  There are "loopholes" and there are

    "let's create our own loophole by interpreting the tax law the way it was not intended to be interpreted."  (Sort of like Cheney's "interpretations" of the Constitution.)
     I am (or was) a CPA.  But I got out because I became so disgusted at what the big players were pushing as "legitimate" interpretations of long established law.

    by FoundingFatherDAR on Sat Jul 14, 2007 at 11:03:59 AM PDT

•  Leona Helmsly spoke truth:

  "only little people pay taxes".  Unfair, unjust, sad, downright criminal, etc.  But true.

  by Lying eyes on Sat Jul 14, 2007 at 08:21:46 AM PDT

•  Sit by the pool, pay less taxes

  than people who go to work every day. Investors and trust fund babies are taxed (percentage wise) less on cap gains than most wage earners are on their income. 15 percent versus 28 percent and higher.

  When John Edwards said this during the 2004 campaign, I sat up and took notice. And I loved it!  

  Jim Webb won over voters here in VA with similar speeches.  

  Even conservative fanatics see how unfair this is.  

  by redding888 on Sat Jul 14, 2007 at 08:38:35 AM PDT

  •  Go Edwards

    Yes, the more I see and read about Edwards the more I lean toward him in '08.

    by TomFromNJ on Sat Jul 14, 2007 at 09:23:17 AM PDT

•  Bush says:

  "You know what else I think? You know what else I think when they say, tax the rich? Most rich people are able to avoid taxes, and if you can't raise enough money from taxing the rich, guess who pays the taxes? Yes, you do."
  -- Dubya explains his tax priorities by portraying the concept of taxing the rich as a pipe dream. I guess we might as well drop their rate to 0%. Albuquerque, New Mexico, Aug. 11, 2004

  "The really rich people figure out how to dodge taxes anyway."
  -- Dubya tries to find more reasons not to tax the rich, Annandale, Virginia, Aug. 9, 2004

  http://www.dubyaspeak.com/

  by Crazy like a fox on Sat Jul 14, 2007 at 08:51:18 AM PDT

•  this is the problem, no disrespect to Bonddad

  he might not disagree with me that much, but I felt his article didn't go far enough in looking at capital gains and their relationship to entrepreneurs.

  The problem with captal gains is far greater than loopholes.  The problems is that in all likelihood (I have no data, this is just an educated guess) the vast majority of capital gains taxes are paid for gains that didn't really contribute directly to innovation and cpital development.  If I make money buying and selling a publicly traded stock after the IPO/secondary, that is not the same as investing in a private startup company.  It does not have the same benefits to the economy and in my opinion it should be taxed like ordinary income.

  I fully understand that the capital markets are complex, and that there is no one place where you draw the line.  If people drive up the price of a stock, it DOES help the company in a variety of ways.  But I don't think it deserves the same preferential treatment as real venture capital.  That's to say nothing of the preferential treatment for things like real estate and nonrenewable resources, both of which have legitimate justifications that have been bastardized by partnerships and other formations that defy reasonable arguments.

  Now, the related argument to all this is that we want to encourage long-term savings, so long term capital gains should be taxed lower.  On the surface that makes some sense (although a year is nowhere near long enough).  But I can't accept the corellary, which is that encouraging savings is MORE important than encouraging wages.  We are a much more productive society if we focus on the latter.

  So while I almost always agree with bonddad, I don't think we completely agree on this issue.

  by eparrot on Sat Jul 14, 2007 at 09:09:17 AM PDT

  •  "savings" vs "investments"

      If the idea were just to encourage savings then any kind of interest or dividend income would be entitled to the lower capital gains tax rate. The law now is that only longterm capital gains (income from sale of assets held over one year) and "qualified dividends" (dividends from stocks held more than two month, more or less) are taxed at the maximum rate of 15% (or 5% for people in the lower brackets).
       I have many senior citizen clients who pay more tax on the same amount of income because they have their income from interest income rather than CGs and QDs.
    It seems kind of arbitrary, but as a tax geek you have to follow the rules as they are now. If people are especially tax-averse there are ways of reducing your tax burden, like putting money in tax-exempt muni bonds. Another thing is to think before you sell any stocks or mutual funds to maximize longterm rather than shortterm gains.

    by Zack from the SFV on Sat Jul 14, 2007 at 11:32:17 AM PDT

•  100% agreement

  Income is income.  You earn it if you do something that is valuable to other people.

  The government should be entirely neutral as far as how income is earned.   Capital gains, dividends, wages should all be taxed at the same rate.  

  by caldreaming on Sat Jul 14, 2007 at 09:41:38 AM PDT

•  A Couple Points...

  First, only long-term capital gains (i.e. assets held for longer than 1 year) get taxed at a lower rate. Short term capital gains get taxed at the same rate as wages. The rationale here is that over time, inflation eats away at the $ value of the asset, say stock shares. Assume a $100 share of stock increased in value 5% a year and assume the inflation rate was 5% a year. After 5 years, the stock is at $127 but has the exact same purchasing power as it did five years before. Yet, if it's sold, the seller pays capital gains on $27 in "gain" that really didn't occur in terms of purchasing power. Now rather than do some complex inflation-adjusted gain calculation, it's simpler to just reduce the tax rate on long term gains.

  BTW, there's a similar rationale for the estate tax where heirs get to "step up" their tax basis in an inherited asset in exchange for paying the estate tax. It makes things simpler for everyone yet retains a degree of tax fairness.

  by Ian S on Sat Jul 14, 2007 at 10:30:37 AM PDT

  •  The current issue re: CG vs. OI has to do

    with a quirk in the partnership rules as they are applied to managing partners in investment partnerships.  What they're doing is waiving a magic wand and somewhat arbitrarily claiming that what would normally be treated as ordinary services income gets to be treated as CG.  That's a different issue than what you're talking about.  

    by FoundingFatherDAR on Sat Jul 14, 2007 at 11:11:40 AM PDT

    •  this is the same as corporate executives getting

        stock options instead of salary for their compensation. They sell later on and pay CG rates rather than ordinary rates. This can add up to big money; the year a Disney exec got over $500m in options he saved $45 million in taxes because the rate dropped 8% that year from 28% to 20%.
         Besides giving gigantic tax breaks to people who don't need breaks, it is a way to put the federal government in such debt that we can't make enough progress. The last time the Democrats got in power their big priority was to start paying off the Reagan-Bush debt. Now the Greedy Old Party is back to the borrow and spend so we will be stuck again in the position of having to pay off their excesses.

      by Zack from the SFV on Sat Jul 14, 2007 at 11:46:46 AM PDT

      •  ISOs are subject to AMT.

        by FoundingFatherDAR on Sat Jul 14, 2007 at 12:20:29 PM PDT

    •  Yes, I Agree...

      that this is an absurd loophole but a number of the comments had generalized the outrage to all capital gains. I probably should have attached my comment to caldreaming's immediately above mine.

      by Ian S on Sat Jul 14, 2007 at 11:52:23 AM PDT

•  Thanks for the plug.

  And for highlighting the latest NYT article.

  by FoundingFatherDAR on Sat Jul 14, 2007 at 10:59:34 AM PDT

  •  No Problem.

    Glad this stuff gets in print occasionally.  Also have to thank Krugman.

    by TomFromNJ on Sat Jul 14, 2007 at 07:01:04 PM PDT