Put Capital Gains Taxes on the Table!

Like Greece, the US is currently facing the issue of “who will pay” for our sovereign debt crisis. So far, I haven’t come across the suggestion to put the capital gains tax on the table. Here are three reasons I feel capital gains taxes should be increased right now to be at parity with ordinary income taxes.

(1) Capital gains were saved by the bailout

The stock market is not the only wealth-building game in town, but through IRS tax breaks, it has become the biggest one! In addition to individual investors, the stock market also serves institutional investors such as mutual funds, banks, insurance companies, hedge funds, and pension funds. These are the institutions that benefited most from the taxpayer funds spent on the bailouts and the stimulus during the recent financial crisis. Those who are better off financially in this country have the most to be thankful for. Their comfort would have diminished greatly if these big institutions hadn’t been saved!

Here is an example of disparate results of the financial crisis. Older people who depended on interest from government bonds and dividends form holding stocks were out of luck. Interest rates declined to near zero. Older people on fixed incomes made no income on interest and dividends, and hence the government collected no ordinary income taxes those kinds of investments.

For example, Wall Street Journal’s “Rejuvenated Banks Raise Dividends,“ quotes an investment bank, Keefe, Bruyett and Woods, Inc. “Nearly 300 banks had reduced or discontinued their dividends since 2008, saving the industry nearly $100 billion in shareholder payouts…” It has been both working people and less-well-off older people who have lost their income during the recession. Meanwhile, those who are continuing to enjoy betting in the stock and bond markets still get profits and tax breaks on their capital gains.

Is it too much to ask for the wealthy to put their (15% maximum) capital gains tax rates on the table as we face a huge budget deficit that, in large part, was caused by the stimulus and bailout monies needed to save their Wall Street banks?

(2) Capitals-gains-tax breaks skew entrepreneurship

If you’ve ever played Robert Kiyosaki’s Rich Dad Poor Dad Cashflow board games, you’ve seen that investments in stocks and bonds are part of the sustainable wealth chain. A player amasses a certain amount of cash flow, or residual income, i.e., income that exceeds monthly expenses, from these investments. But the real wealth in the game comes from the “big deals” section of the deck where you can become an owner of real property and/or businesses.

If you’ve read Kiyosaki’s recent books such as The Conspiracy of the Rich, you’ll note he now discusses “derivatives” in the form of intellectual property, licensing, and leasing. These legal vehicles are major wealth builders for the Kiyosaki family. All of these kinds of derivatives that offer ways of accumulating enough money to sustain oneself without a job are heavily favored by the US tax code. That is why speculation is such an effective wealth-building technique.

The thing is, there is another way to build wealth. That is by building a small business that offers some kind of service or product that others need or want. And here the tax code is not only not helpful; it is perfectly antagonistic.

The federal government drives US small businesses with one foot on the gas while the other is on the brakes. The work of the US Small Business Administration (SBA) is admirable. But it a drop in the bucket compared to the draconian taxes collected by the IRS on solo and small (non-incorporated) businesses. Especially onerous is the double SE tax (similar to the FICA tax paid for employed people, half of which is paid by the employee and the other half by the employer.)

Sole proprietors, who work in their business as well as own it, are not two people; their tax rate should not be 100% higher than that paid by an employee. Furthermore, sole proprietors who hire others should have the employer portion of their payment of the SE taxes for their employees prorated until they reach a size where they gain enough efficiency through division of labor and increasing returns to scale to be able to afford to pay full SE taxes for their employees and ultimately, for themselves too.

Taxes are a major reason so many small businesses fail within the first three years. Yet while sole proprietors and small (micro) business owners struggle to pay taxes each year, large corporations and those who buy and sell their stock and bonds are growing fat off of the capital gains tax break.

Capital gains tax rates are dampening job creation

Large corporations are growing profits like crazy. But they are not doing this by hiring more workers! Rather they are increasing the “efficiency” of the workers they have. They are also rushing to to find mergers and acquisitions opportunities abroad so that they do not have to bring home their cash earned overseas and pay US taxes on it! (Source: Financial Times, Tax fears prompt M&A Rush, May 15, 2011 p. 15)

Sole proprietors and small (micro) businesses are the ones who create the most jobs in this country, but without the incentive of customers who can afford to pay for their products and services, job creation has stalled. This is why the current cuts in unemployment benefits in many states for the workers laid off in the recession will have such a large impact on the economic recovery. Unemployment checks go directly towards funding local services and businesses.

It is a myth that large corporations are “job creators”. Large corporations are exporting American jobs abroad in droves. They are diminishing the wages of American workers by pushing for union-busting legislation. And they are using their large cash reserves to buy each other out (and thus, lay off more Americans!), to buy back their own shares (profiting their large shareholders), and speculate in the new financial derivatives that are making a comeback at the investment banks on Wall Street and elsewhere in the world.

Small, local entrepreneurship is being stifled in favor of investment in the financial markets. Large amounts of capital is accumulating in the hands of those who create nothing of necessity for society. And clearly they have had and still have too much capital to play with. Witness some of the risky derivatives that are making a comeback right now.

The bottom line

American workers in unions have generously offered to share the burden that the financial crisis left. But this just isn’t right. Our government, that is we taxpayers, “socialized” the private debt of large corporations during the financial crisis to prevent the markets from collapsing. And now our governments have huge amounts of debt. Surely those who benefited the most from the bailout and stimulus programs should pay the most for restoring the economy. It will be years before we even know how much their actions will cost the federal government agencies who bailed them out.

Here’s why I suggest we put capital gains tax rates on the table. It’s way past time to (1) stimulate real economic growth and employment instead of gambling on corporate stock and bond market gains and losses (2) encourage sole proprietors and small business owners to create more jobs for others, and (3) make taxes fairer to all Americans.