We have many serious tax policy issues in this country. I'm going to examine one small section of the picture, the period for long term capital gains, and propose some simple policy changes that would help fix it.
This issue is a way to address real revenue problems in our country with a policy solution that would be hard for Republicans to successfully argue against.
I doubt many will read this, but for those who do, thanks for reading and I hope you find it interesting and/or insightful.
(A quick note: The links to laws and regulations in this diary are not necessarily to the most current version of the law/regulation in question. In fact some of them have guaranteedly changed slightly from the version linked to. Do not rely on these links for legal purposes and remember that none of this is legal advice, it is merely educational, and no attorney-client privilege is formed by you reading this diary or interacting with me in the comment boards).
First, some law. Federal tax laws are set forth in Title 26 of the U.S. Code. This title is commonly referred to as the Internal Revenue Code or "IRC". I'll be using IRC in this diary as shorthand.
IRC § 1(h) provides special (lower) tax rates on "net capital gains". Net capital gains is a term of art defined in IRC § 1222(11) as "the excess of the net long-term capital gain for such year over the net short-term capital loss for such year." IRC § 1222 provides many other definitions which, in sum and substance, are that a long-term capital gain is a gain on the sale (or exchange) of a capital asset held for more than one year; a long-term capital loss is a loss on the same; short term gains and losses are the same except they are for capital assets held for not more than one year; and nets for each (i.e. long-term and short-term) are the excess of the gain over the loss or vice-versa (e.g. net long-term capital gain is the excess of the long-term capital gains for a taxable year over the long-term capital losses for such year).
What constitutes a capital asset took up probably two weeks of my personal income tax class in law school so I'm not even going to attempt to get into that (go read IRC § 1221 and the regulations (e.g. 26 CFR 1.1221-1, 26 CFR 1.1221-2, and 26 CFR 1.1221-2T), revenue rulings, court cases, and other interpretive materials thereunder if you are so inclined). For most of us it means stocks and bonds and hedge funds (there are special rules for houses which I'm sure some of your know about as well).
So if I go out and buy stock tomorrow and sell it exactly one year from now for more money, it's treated as ordinary income and taxed at my regular tax rate. If I hold it for one day more, I get to treat it as special capital gains taxes and pay only 5% or 15% (depending on the circumstances) on it. If I hold it for 10 years, I still have to pay 5% or 15% on it. Ditto for 20 years, 30 years, etc.
The purpose of special tax rates for capital gains is to encourage people to invest their money in things like companies in order to give those companies more money (i.e. capital) to invest in infrastructure, expand business, hire more employees, and help expand our economy. There's the argument that people would invest anyways, but that's for a different day, a different diary, and, given the fact that capital gains have been a part of our tax laws for almost 90 years, probably a different generation. There is logic behind the idea that if you give people incentives to invest their money and keep it invested, they are more likely to do so and thus help the economy.
The problem is this: why just one year and a day? A typical car loan is for 3-4 years. Mortgages tend to be between 15 and 30 years. Most loans, which is what a capital investment essentially is, are for much longer terms and in general the longer the loan, the lower the interest rate. Credit cards have higher rates because the loan period is typically shorter and, if you pay off your balance (i.e. your loan) in full at the end of each month, you incur no cost at all. In other words, you are basically able to borrow money for free for up to 30 days provided you pay it all back at the end of that period. If not, you pay interest on your outstanding balance until you have paid it all back. But I'm digressing.
Capital gains rates are supposed to encourage companies to expand by providing them with a level of security that investments made in the company by individuals will likely be maintained for a minimum period of time due to the favorable tax consequences of maintaining the investment for that minimum period of time. But what security is provided by a period of only a year and a day? And thus what incentive to invest in infrastructure and hire new employees?
I posit that the security is minimal because the time period stinks. How likely are you to make long term improvements and investments with a loan that might only last for one year and a day? This is the question that small to mid-sized businesses face when potential investors come knocking.
If we enacted a law that gradually increased the time period for long-term capital gain status from a year and a day to five years, I believe that we would encourage businesses to invest more in their own growth and expand their workforces because it would significantly increase their confidence that the money invested in them today will not be gone tomorrow.
I leave it to the economists to determine whether three years, five years, ten years, or some sliding scale system would best encourage growth. But the one year and a day system as it stands stinks. It provides no real security to the investees while providing huge, disproportionate benefits to the investors. If we wish to reward long-term investments, that's fine. But a year and a day is not a long-term investment.