Taxing Capital v. Taxing Labor

Here’s a question… its bothered me for a long time. Its definitely not an original question – I’m sure you’ve all heard it asked before. But here it is again: Why should the tax on capital be lower than the tax on labor?

At its most basic, taxing capital at a lower rate than labor is a message society is sending. The message is – we value (or at least are trying to encourage) capital more than we do labor. This might make sense if there were a shortage of capital, or a big surplus of labor, but I don’t think that is the case.

Consider the last decade or so, we’ve seen periods of time where the return on capital has been very low. Real interest rates have never been particularly high in the US anyway, so a shortage of capital has never been a problem here at least since the end of World War 2. I understand that in Japan, real interest rates were actually negative for quite a while, so the US is probably not a special case among big economies. Wouldn’t this imply that capital is cheap and easy relative to the demand for capital in large prosperous economies?

On the other hand, consider the supply and demand for labor. Sure, there is unemployment in the US, and it may even be higher than official figures indicate . But when was the last time labor could be had for free or near free on anywhere near an economy-wide scale, when the economy you’re talking about is the size of the US or Japan? Doesn’t this imply that labor should be valued more, not less highly than capital? Furthermore, as society becomes wealthier, the ratio of capital to labor increases. The scarcity of labor to capital will, if anything, increase.

There are a few other reasons why labor should be taxed no higher, if not at lower rates, than capital:

1. The income to labor accrues to the person who actually produced the labor. Capital on the other hand, can be inherited, stolen, or otherwise fraudulently obtained. Therefore, when you reward labor, you’re rewarding the “right” person, which may not be the case when you reward capital.
2. As an individual becomes wealthier, his or her ratio of capital to labor increases. Taxing labor at a higher rate than labor in effect means imposing the highest taxes on those with the least ability to pay.
3. Capital can be accumulated, labor cannot. (One can work only so many hours a day, and this does not increase substantially with age – if anything, it decreases.) Taxing capital at lower rates than labor can lead to increased inequality; while equality of outcomes is not desirable in a capitalist system, excessive inequality can cause problems as well.