Is Capital Gains Tax Law Biased Against Low Income Investors?
Paul Caron at Taxprof blog points us to capital gains
Is Capital Gains Tax Law Biased Against Low Income Investors?
Min Dai (National University of Singapore, Department of Mathematics), Hong Liu (Washington University, Olin Business School) & Yifei Zhong (University of Oxford, Mathematical Institute), Is Capital Gains Tax Law Biased Against Low Income Investors?:
The current capital gains tax law stipulates that the tax rate for short-term investment (gains and losses) and long-term losses is equal to an investor’s marginal ordinary income tax rate, which implies that this rate for low income investors can be significantly lower than that for high income investors. In an optimal consumption and investment model with asymmetric long-term/short-term tax rates, we show that even though capital gains tax rates for low income investors are always lower than those for high income investors, the current capital gains tax law is significantly biased against low income investors in the sense that these investors are willing to pay a substantial fraction of their initial wealth to gain the same capital gains tax treatment as high income investors have. The main reason is that investors have the option of realizing capital losses at the (higher) marginal ordinary income tax rate and realizing capital gains at the (lower) long-term tax rate and the value of this option is significantly lower for low income investors than that for high income investors. This result is robust to various changes in model parameter values. Raising capital gains tax rates for low income investors to the levels for high income investors would reduce the bias and substantially increase stock market participation by low income households. With regard to the optimal tax realization strategy, in sharp contrast to most of the existing literature, we show that it can be optimal to defer short-term capital losses beyond one year and to realize short-term gains.
Raising capital gains tax rates for low income investors to the levels for high income investors would reduce the bias and substantially increase stock market participation by low income households.
This is absurd. The implicit underlying assumption is that low income households want to participate, but are currently detered from stock market participation by a capital gains tax structure that they probably have no awareness of (if for no other reason than – why the hell would it even be on their radar screen?) and likely would not understand. (I had to read the excerpt twice – which was no fun at all – to get the point. And I’m not sure I got it right.)
People are not going to respond to incentivs or disincentives unless they are in some way relevant to the current conditions of their miseable existances.
Gee – can you think of any other reason why low income households are not speculating in the stock market? No fair pointing out that it’s a stacked deck and that the 1, 5, and 10 year returns are all negative.
(Refraining from using explitives,)
JzB
From what I can tell, lower-income households are only worse off in a relative sense, i.e. ignoring absolute levels of taxation and only comparing short- to long-term capital gains tax rates.
I don’t think they are using low income households with the same reference you and I would use. I think they are referring to the quintels of the top 10%.
Of course the whole issue I have with any discussion of the stock market, investment and Average American is the concept I was taught by anyone who was invested in the stock market while I was in high school: Never invest any money in the market that you can not afford to lose.
Funny how that bit of language has been removed from public speak, just as has rat race.
The financial class real was successful in that they change the concept about stock market and risk from the prior warning to the stock market being as safe as your bank. That was their major achievement and key to what allowed the crash.
In case it isn’t clear that the wealthiest Americans have all the tax advantages try this article from the NY Times yesterday:
http://www.nytimes.com/2011/11/27/business/estee-lauder-heirs-tax-strategies-typify-advantages-for-wealthy.html?_r=1&scp=1&sq=ronald%20lauder%20taxes&st=cse
Try to keep this in perspective. In order to pay the government’s annual bill requires tax receipts regardless of how huge or small that bill may be. The less Lauder and his ilk pay on their annual wealth increase the more the rest of us have to pay to make up the loss.
Actually, the biggest drawback for lower income capital gains investors is the limitation on capital losses. If one is limited to offsetting $3,000 of income against capital losses, one needs a good deal of capital gains to actually realize the losses.
I remember around 2001 I had over $100K of capital losses–I still haven’t had enough gains to offset these losses, so I was paying tax on income while losing on my investments for years. The truly wealthy own enough stocks to effectively utilize their capital losses annually by taking gains off the table. The less wealthy can get stuck in a hellhole of paying taxes while losing money net each year, because of the mismatch between capital losses and ordinar income.