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Taxing the Rich for the Benefit of All (Even the Rich)

August 16th, 2011 . by economistmom

Warren Buffett performed a very civic duty when he wrote his op-ed in the New York Times pleading for the U.S. government to raise his taxes.  He makes two basic points:  (1) the rich can surely afford to pay higher taxes, and (2) their paying higher taxes would not prevent them from investing and hiring.

Bill Gale, speaking as a smart economist rather than famous rich person, goes further, explaining the historical evidence that low taxes grow the deficit more than the economy, aren’t effective at constraining the growth in government spending,  and have contributed to the dramatic rise in income inequality.  But instead of just endorsing Buffett’s idea that we could just raise marginal tax rates on the rich (what sounds like a version of the “millionaire surtax”), Bill suggests (in his op-ed on CNN.com) there are better ways to raise taxes, even if only on the rich, by broadening the tax base and rethinking our ill fated love affair with the Bush tax cuts:

There are, of course, better and worse ways to raise taxes. A general goal would be to broaden the tax base — reduce the use of specialized credits, deductions, loopholes and so on — and minimize the extent to which tax rates need to rise.

One good place to start? High-income households: Limit the rate at which itemized deductions can occur to 28%. This would affect only households in the highest income ranges, it would not raise their official marginal tax rate, and it would raise $293 billion over the next decade, relative to how much money would be raised according to current law, according to the Congressional Budget Office. This would be a small move in the right direction.

Of course, sticking to current law revenues — that is, either not extending the Bush tax cuts after their scheduled expiration date of 2012 or paying for any extension with a reduction in various tax expenditures — is even more important. Extending the Bush tax cuts would reduce revenues by about $2.5 trillion over the next decade, relative to current law. Counting net interest savings, it would cost $3 trillion. Letting the cuts expire could actually help economic growth since the lower deficits would more than offset the effect of slightly lower marginal tax rates, and it would be progressive. That would be a big move in the right direction.

So although Buffett tells us that we could start with our already-flawed income tax policy and just raise tax rates on millionaires and billionaires and score a net win for society as a whole (because deficits would come down and jobs would still be created–i.e., economic life would still go on), Bill Gale tells us that there are even better ways to “tax the rich” to produce an even bigger net benefit for all.

If the federal government could spend less of its money on tax cuts for the rich, it would have more available for some combination of: (1) deficit reduction (better for longer-term growth and current interest rates), and (2) fiscal policies more effective at encouraging near-term demand (better for jobs).  (It doesn’t have to be either-or.)

Maybe we can think of any new willingness to raise taxes on the rich as “growing up” economics rather than “trickle down.”

Are policymakers ready to grow up?

30 Responses to “Taxing the Rich for the Benefit of All (Even the Rich)”

  1. comment number 1 by: Underwriterguy

    Now that I know it is only the millionaires and billionaires, and not me, that are going to have a tax increase, I’m all for it. But someone needs to tell Obama that “rich” doesn’t start at $250,000.

  2. comment number 2 by: SteveinCH

    FWIW, the notion that increasing effective tax rates without increasing marginal tax rates is somehow better and that making a complex tax code more complex is a good thing seems really quite odd to me but then again, I’m not an economist.

    As for Buffett, he displays his customary ignorance of tax incidence currently and historically and props up the ridiculous focus on the top 400 HH data as if it is somehow relevant to the discussion.

  3. comment number 3 by: Vivian Darkbloom

    I’m with Gale on this one and, indirectly I suppose, Economist Mom. Raising marginal rates should be the last resort.

    And, Buffett seems to have forgotten that a good portion of that tax he incurs is paid on his behalf by Berkshire Hathaway. His effective tax rate is much higher than the rate he incurs on his individual income tax return. In this sense, SteveinCH, I don’t think his ignorance is historical (and probably not current, either) quite aside from the point that taxing the top 400 at higher rates won’t put much of a dent in the deficits. My guess is that his “ignorance” is willful,. Here’s Warren in a more lucid moment in a 1979 article he wrote for Fortune magazine:

    “Lower corporate income taxes seem unlikely. Investors in American corporations already own what might be thought of as a Class D stock. The class A, B and C stocks are represented by the income-tax claims of the federal, state, and municipal governments. It is true that these “investors” have no claim on the corporation’s assets; however, they get a major share of the earnings, including earnings generated by the equity buildup resulting from retention of part of the earnings owned by the Class D shareholders.
    A further charming characteristic of these wonderful Class A, B and C stocks is that their share of the corporation’s earnings can be increased immediately, abundantly, and without payment by the unilateral vote of any one of the “stockholder” classes, e.g., by congressional action in the case of the Class A. To add to the fun, one of the classes will sometimes vote to increase its ownership share in the business retroactively - as companies operating in New York discovered to their dismay in 1975. Whenever the Class A, B or C “stockholders” vote themselves a larger share of the business, the portion remaining for Class D - that’s the one held by the ordinary investor - declines.

    Looking ahead, it seems unwise to assume that those who control the A, B and C shares will vote to reduce their own take over the long run. The class D shares probably will have to struggle to hold their own.”

    http://www.valueinvesting.de/en/inflation-equity-investor-by-warren-buffett.htm

    Well, those first classes of shares did reduce their take, at least for a while. Having reported that, I must admit that Buffett’s phenomenal success has had much to do with his gaming of the tax code–he’s taken advantage of the tax code more than any other investor I can think of. He had the foresight and genius to understand that he could garner huge amounts of investable funds via premiums from an insurance company structure and defer tax on “unearned premiums”. His share of the earnings in such a structure are much greater than those he could have earned as an investment advisor of, say, a mutual fund. Perhaps he’s feeling a little bit guilty for the huge benefits he’s derived in the past from using the tax code to his enormous benefit, but this seems to have little to do with the (marginal) rate of tax on capital gains and dividends for individual investors.

  4. comment number 4 by: Brooks

    Steve,

    I’m surprised as your first paragraph. I mean, I know you have a flawed understanding of the nature of tax deductions/credits/exemptions vs. tax rate increases, but I would have thought that even you would see that reducing such subsidies is more conducive to (or less injurious to) economic growth, economic efficiency, and merit-based fairness than would be a tax rate increase of comparable size. And you seem fixated on the premise that anything that complicates the tax code further is inherently undesirable, regardless of other considerations, so much so that you’d apparently prefer a tax rate increase on that basis.

  5. comment number 5 by: Brooks

    Re: Buffet’s argument:

    - I find it odd that he (or anyone else) would make the straw man argument that investors won’t “refuse to invest because of the elevated tax rates on capital gains and dividends”, as if investment were all-or-none. Deciding on making an investment or not is a matter of weighing rewards vs. risks. Ceteris paribus (holding risk equal), there will be some worthwhile investments that will not be seen as worthwhile if the expected rewards are lower, as they would be — after tax — if tax rates went up. So at a higher tax rate, some investments will be forgone. Am I missing something, or isn’t this very basic economics?

    - I’ve now seen moron Michele Bachman and one or two conservative pundits making the idiotic rhetorical point that “If Buffet thinks he should pay more in taxes, he should just go ahead and send a check!” What idiocy. Obviously these people aren’t familiar with the concept of the “free rider problem” or the common sense underlying that concept.

  6. comment number 6 by: AMTbuff

    Buffett’s primary tax shelter is non-taxation of unrealized capital gains. This is a mismeasurement of true economic income (Haig-Simons income).

    I will take Buffett seriously when he calls for taxation of paper gains, for example applying “mark to market” gains reporting above $1M annual and/or $10M lifetime exemptions. Until then he is advocating taxing other people, not himself.

  7. comment number 7 by: AMTbuff

    Major revenue increases are premature. Voters first need to decide either to cut promised benefits to fit revenue or to increase revenue to fit promised benefits (although the latter option might last only 20 or 30 years).

    Although most partisans disagree with me on this, I believe that settling this fundamental question ASAP is much more important than which way it is settled. Only after the ideological direction is firmly set will our political system allow the fiscal gap to be closed.

    My dream 2012 match-up is Ryan vs. Obama. That contest would clarify voters’ intent to close the gap via benefit cuts or via tax increases. Either way, we could get on with it. No matter which side won the election, the American people would win.

  8. comment number 8 by: SteveinCH

    Brooks,

    Thanks so much for your empathy with my confusion. Allow me to clarify. The changes that Buffett talks about will have relatively little impact on marginal propensity to invest, particularly since, in an Obama like way, he’s entirely unclear about what he is suggesting. Is he suggesting an increase in the income tax rate? If so, it will have relatively little effect on people with incomes over $10 million, very few of whom have salary income at that level. Is he suggesting an increase in the capital gains tax rate? That might have some impact but the impact is not overlapping with the impact of capping deductions which relates to the income tax rate and not the capital gains tax rate.

    So, if you interpret Buffett as calling for an increase in the cap gains tax rate (which is the only way he would materially affect the $10MM plus crowd), my perspective is that it would have relatively little impact on the economy from a DWL perspective. As a consequence, I would not make a strong argument one way or the other about the effects and I’m not sure why a more complex solution is helpful (the Gale solution).

    Perhaps that helps explain and perhaps not. At, this point, afaic, you can stuff your snide comments where the sun don’t shine.

  9. comment number 9 by: SteveinCH

    My point on rates Vivian is that effective Federal income and payroll tax rates are higher for the 60th to 99.5th percentile of taxpayers than the were in 1970. If you add imputed corporate taxes in, the same applies from the 80th to the 99th percentile.

    In income and payroll taxes, the largest rate reductions (by far) have occurred at the bottom of the income distribution. It is this history that I think the man is ignorant of.

  10. comment number 10 by: Brooks

    Steve,

    I learned something new today, thanks to you. I had to look up “afaic”. By the way, the last place I’d want any snide comments of mine to be is “where the sun don’t shine”. As they say, sunshine is the best disinfectant, and my hope is that if I err in some assertion I will be corrected.

    Do you agree that taxing something more is generally likely to change behavior such that we end up with less of what is hit by that tax increase, ceteris paribus? If so, taxing work* or investment income is likely to result in less work and/or investment. By contrast, reducing a deduction or credit for purchasing or producing Product X is likely to reduce the excess amount of Product X above what we’d have without that subsidy. Do you disagree with any of the above premises, or are you saying you don’t think there’s an economic basis for preferring the latter scenario over the former?

    * There is, of course, the counter-argument that people will work more if the after-tax percentage of their gross income is reduced, to make up the difference. I’m assuming the opposite effect prevails on balance.

  11. comment number 11 by: SteveinCH

    Brooks,

    I’m saying the following:

    1. Buffett’s proposal is hopelessly vague so any analysis is virtually meaningless.

    2. If, as would be rational, his proposal relates to adjusting capital gains taxes, the direction is as you describe but the magnitude is small.

    3. If his proposal relates to capital gains, the counterproposal that was in Diane’s OP is not comparable so the general principle doesn’t apply as we are comparing reductions in deductions in one tax code (ordinary income) with rate changes in another (capital gains). As such, the assessment is more complex than you describe.

    Now if you find that confused, not my issue.

  12. comment number 12 by: Brooks

    Steve,

    You said:
    the notion that increasing effective tax rates without increasing marginal tax rates is somehow better and that making a complex tax code more complex is a good thing seems really quite odd to me

    I read the “better” as “better than raising the same revenue by increasing marginal tax rates”.

    Did I misinterpret? If so, what did you mean by “better” — better than what?

  13. comment number 13 by: Vivian Darkbloom

    SteveinCH, thanks for clarifying that.

    As smart an investor as Buffett is, I’m surprised that he insists in lumping payroll levies into the “tax” basket. In fact, I’m fairly sure that, aside perhaps from BH stock, the best investment his secretary will ever make are those payroll deductions for social security and medicare.

    I’ve got a great investment scheme that should make everyone paying those onerous payroll “taxes” happy and that should rival Warren Buffett’s investment returns. It’s sort of like a viatical fund. Starting with the bottom 10 percent quintile of taxpayers and, preferably those over 50, I’ll refund those oppressed payroll taxpayers all the payroll taxes they have ever paid, plus interest based on the historical 10-year Treasury rate. I’ll also reimburse, on an on-going basis, each dollar of such payroll taxes these folks pay until they retire. In return, they will assign to me any and all future benefits and/or direct or indirect reimbursements from those programs.

    Too bad it’s not legal under Section 207 of the Social Security Act (42 USC 407) which was enacted August 10, 1939.

    So, the next best solution would be for the government to institute the same type of program and going forward eliminate these “taxes” altogether. It would put our fiscal house in order in one go: Although the government would need to initially borrow to fund the program, it should give a huge sitmulative burst to the economy. Aggregate demand would soar and more people would be put to work increasing income tax receipts. The stock market would soar. Our unfunded federal liabilities would disappear and future deficits would be eliminated. And, Warren Buffett and his secretary could stop complaining about the exhorbitant rates of “tax” she pays.

  14. comment number 14 by: SteveinCH

    Brooks,

    My point is your comparing reducing tax expenditures in the income code with increasing rates on capital gains (at least that’s my interpretation of Buffett’s somewhat fuzzy argument). It’s not obvious what the better solution is and I’m a proponent of simplicity so, since I think the economic effect will be small, I favor simplicity.

    You are free of course to disagree.

  15. comment number 15 by: SteveinCH

    Vivian,

    Buffett has to lump payroll into it. If he doesn’t, his point is hopelessly incorrect. He argues he pays 17.5% or so in Federal taxes.

    If you just look at income taxes according to the CBO, you would have to be in the 99 to 99.5th percentile for your average Federal income tax rate to be higher than 17.5%. That group has an average income of $550,000 give or take.

    Now, if Warren is paying his secretary $550,000; I think his point loses some of its punch.

    Interesting, according to the same CBO analysis, you’d need to be in the 80th to 99th percentile of wage earners for your average tax to be higher than Warren’s claimed tax with an average income of $120,000. His secretary probably does make that much but it’s funny he doesn’t mention it, leaving us to think she’s far closer to the median income than she probably is.

  16. comment number 16 by: ST Dog

    Brooks, what is the “free rider problem” you mention in comment 5?

    The simple fact is, anyone can send a check to the treasury either for the general fund, or specificlly to reduce the public debt. All those complaing that they should be taxed more can simply send the rest that they think they should pay to either fund.

    But they won’t, because they don’t really think they should pay more (they think others should pay more), or they are just dishonest in their claims.

  17. comment number 17 by: Brooks

    ST Dog,

    See http://en.wikipedia.org/wiki/Free_rider_problem

    The point is that one can favor policy compelling every member of some segment to make some particular sacrifice (in this case, higher taxes on the wealthy or at least on some sub-segment of the wealthy) without being willing to make that sacrifice alone of with only some small portion of that segment, and that is a perfectly rational and reasonable position in many cases.

    In the former case, one is willing to make the sacrifice in exchange for a much larger benefit — the benefit that would come if everyone in that segment made the same sacrifice — but not willing to make that sacrifice for the much smaller benefit that would come if he alone (or only some portion) of that segment make that sacrifice. The level of value of the transaction is very different, and (as a separate point) there also can be a matter of principle that one is willing to make the sacrifice only if others who “should”, in that person’s view, also make the sacrifice for the same collective benefit, do so.

    See also a related concept, http://en.wikipedia.org/wiki/Tragedy_of_the_commons In that case, to use the original example, a herder may realize that if everyone lets his herd graze to an optimal degree on the public grazing land, it will be over-grazed and everyone will end up worse off, so he’d be willing to limit his herd’s grazing to something sub-optimal IF the other herders did the same sufficiently to keep the land sustainable for grazing, but if others won’t also limit their respective herds’ grazing, he won’t be willing to limit his herd’s grazing, because the land will still end up overgrazed and his individual sacrifice will be for negligible gain.

  18. comment number 18 by: Brooks

    Steve,

    I see. So your earlier statement was simply way too broadly stated.

    As for reducing subsidies via the tax code vs. increasing capital gains tax rates, the former will reduce incentives to buy and/or produce those subsidized products (and reduce the related influence on prices, allocation of resources, etc., as well), and the latter will reduce the incentive to invest. Are you saying you find it “odd” that one would consider the former preferable?

  19. comment number 19 by: Jim Glass

    Buffett expanded on this for an hour on Charlie Rose yesterday and said that he’d like to see taxes stabilize at 19% of GDP and spending at 21% of GDP.

    That’s a whole lot more spending cut than tax increase going forward.

    He also said “his tax the rich more” idea was only about people making over $1 million a year, he doesn’t consider $250k “rich” these days, especially in places like NYC. And it would raise only about $50 billion annually compared to our over-$1 trillion deficits — so it is not a real budget gap closer, just a matter of principle.

  20. comment number 20 by: Jim Glass

    Buffett’s primary tax shelter is non-taxation of unrealized capital gains. This is a mismeasurement of true economic income (Haig-Simons income).

    Capital gain is not economic income. Look in the national income accounts at BEA.gov — you won’t find “capital gains” included in national income even when they *are* realized.

    The capital value of an asset is the future income it is expected to generate, discounted to present value. If the value of the asset goes up (capital gain) it merely means there’s a change in the result of the computation.

    If you *tax* an increase in the current expected value of future income, and *also tax* the income itself as it arrives, then you *double tax* that income.

    In the early days of the income tax the US Supreme Court repeatedly held (four times, IIRC) that capital gain is not income. E.g.: “Increase in value of capital investment is not income in any proper meaning of the term.” – Eisner v Macomber (1920). Then Congress changed the law to make sure it was taxed as such — Congress has the power to apply a “pig tax” to fish if it wants.

    Capital gain can be considered “income for political purposes”, we surely all know how that works.

    (Haig-Simons income is an artificial construct attempting to lever economic principles, such as the merits of a consumption tax, into the income tax that politics always generates. The US income tax system has never honored it except massively in the breach, the way it honors pretty much all economic principles.)

    … comparing reducing tax expenditures in the income code with increasing rates on capital gains …

    The favorable tax rate for capital gain is *not* a tax expenditure.

    A tax expenditure is the equivalent of conventional “expenditure” expenditure. If Congress wants to give a cash expenditure subsisdy to say the home building industry of $X, but then decides it would be politically smarter to do so by giving the home building industry tax breaks worth the same $X (as “cutting taxes by $X” plays a lot better than “handing out corporate welfare of $X that taxpayers have to pay for”) then *that’s* a tax expenditure.

    But taxing different kinds of income in different ways on the economic merits does not involve tax expenditure.

  21. comment number 21 by: AMTbuff

    >But taxing different kinds of income in different ways on the economic merits does not involve tax expenditure.

    Unless you really, really want the extra revenue. Then the elasticity of “tax expenditure” increases without limit!

  22. comment number 22 by: Jim Glass

    Buffett also tells Charlie: “I get $32,600 of Social Security benefits, partially tax free. This is absurd. (Laughs.) I shouldn’t be getting any of this. The rich should be means-tested out of entitlements they don’t need, totally”.

    So Buffett’s bottom line is: cap taxes at 19% of GDP … increase taxes only on “the rich” having income over $1 million (not $250k) … cap spending at 21% of GDP … start on that by means-testing the rich 100% out of entitlement benefits!

    I could negotiate using that framework!

    Yet the story line everywhere is: “Buffett says tax the rich to close the deficit!”

    Go figure.

  23. comment number 23 by: SteveinCH

    Good point Jim although if Buffett wants to cap taxes at 19% of GDP, he just needs to wait a decade. Taxes as a percent of GDP go up over time unless government acts to push them lower.

  24. comment number 24 by: Patrick R. Sullivan

    That’s not the way I read the evidence, SteveinCH. For a half century prior to this recession revenue pretty much bounced between 17-19%.

  25. comment number 25 by: SteveinCH

    That’s because Patrick Congress has been systematically lowering tax rates, particularly corporate tax rates for a very long time.

    Pretty much every major post war tax reform was to lower rates. It makes sense if you think about it.

    Rates are progressive…corporate income and personal income grow faster than inflation. Therefore the numerator grows faster than the denominator and, absent a rate reduction, revenue as a percent of GDP increases

  26. comment number 26 by: SteveinCH

    Add the words “and GDP” after “inflation” in the first sentence of the last paragraph.

  27. comment number 27 by: Vivian Darkbloom

    “If you *tax* an increase in the current expected value of future income, and *also tax* the income itself as it arrives, then you *double tax* that income.

    In the early days of the income tax the US Supreme Court repeatedly held (four times, IIRC) that capital gain is not income. E.g.: “Increase in value of capital investment is not income in any proper meaning of the term.” – Eisner v Macomber (1920). Then Congress changed the law to make sure it was taxed as such — Congress has the power to apply a “pig tax” to fish if it wants.”

    “If” that were the case, I would agree, but I don’t think it is the case. Eisner v. McComber did not involve the issue of whether capital gains, as we commonly understand them, should be taxed—the case involved the issue of whether a pro-rata stock dividend should be taxed. The answer was “no”, not so much because this would result in double tax, but because there was no realization event–the property held before and after the stock dividend was ruled to be economically the same. The selected quote is pretty much dictum.

    I don’t think the same is true with respect to cash received upon sale of a “capital asset”. Here, there is a realization event, BEA national income accounts notwithstanding. In essence, seller and buyer are sharing in that future expected income stream and seller’s price should reflect his anticipated tax burden. And, “double taxation” would only occur if the system does not allow capital losses. If the system allows capital losses, which the US system generally does (with some primarily timing limitations), there should be no overall “double taxation” , that is, if “capital gains” are taxed when realized and capital losses are deductible when realized.

  28. comment number 28 by: Jim Glass

    “If” that were the case, I would agree, but I don’t think it is the case. Eisner v. McComber did not involve the issue of whether capital gains, as we commonly understand them, should be taxed—the case involved the issue of whether a pro-rata stock dividend should be taxed. The answer was “no”, not so much because this would result in double tax, but because there was no realization event–the property held before and after the stock dividend was ruled to be economically the same. The selected quote is pretty much dictum.

    The fact that pro rata stock dividends weren’t income had already been decided before Eisner v Macomber. Then Congress changed the law to declare them so. But to support that change in the face of the prior Court ruling, the government still had to show that they were in fact income for them to be taxable as income. Even under the 16th Amendment only income is taxable as income.

    Thus the govt argued that the corporation’s prior accumulated earnings — income — were being distributed through the stock dividend, with the dividend recognizing past appreciation of the value of the corp’s stock (if the stock’s price hadn’t gone up there wouldn’t be any stock dividend), making that distributed capital appreciation income.

    While as a professional I loathe to quote Wikipedia, it sums Court’s holding nicely:

    “Although the ‘Eisner v. Macomber’ Court acknowledged the power of the Federal Government to tax income under the Sixteenth Amendment, the Court essentially said this did not give Congress the power to tax — as income — anything other than income”.

    Thus the Court’s statement: “Enrichment through increase in value of capital investment is not income in any proper meaning of the term”, which reiterated its earlier holdings on the point, all following the advice of the economists of the day. Of course all this law changed later not much later, but that’s another story.

    I don’t think the same is true with respect to cash received upon sale of a “capital asset”. Here, there is a realization event, BEA national income accounts notwithstanding. In essence, seller and buyer are sharing in that future expected income stream and seller’s price should reflect his anticipated tax burden.

    You’ve lost me. Simple case: take a bond giving a right to a perpetual fixed stream of income, like a consol. If the govt wants to tax the income from it, it taxes the income from it. Period. If it taxes the income from it *and also* taxes any change in the present value of the future income stream at the time the bond changes hands, then that is a *second* tax on something else.

    Call that a tax on “change of wealth during the holding period” or something like that, that’s OK. But if one insists on calling it a tax on income, then one must admit it is a double tax on the same income, because the income already is being fully taxed as it is received and the *second* tax is being applied to it too.

    Let’s not dismiss BEA national income accounting too quickly. It omits capital gains from national income for a reason.

  29. comment number 29 by: Vivian Darkbloom

    Jim,

    Yes, pro rata stock dividends were ruled non-taxable before Eisner v. McComber; however, that latter case *did* involve a pro-rata stock dividend. And, as a professional non-puppy lawyer (albeit a retired one who has perhaps lost some of her bark), who refers to the case itself rather than Wikipedia, the Supreme Court indicated its result was compelled by the earlier cases of Towne v. Eisner and Doyle v. Mitchell Bros Co. McComber did *not* base its holding on any concept of “double taxation”; it held that capital could be taxed but only when income from that capital is realized:

    “The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word “gain,” which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. “Derived from capital;” “the gain derived from capital,” etc. Here, we have the essential matter: not a gain accruing to capital; not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being “derived” — that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal — that is income derived from property. Nothing else answers the description.”

    This, and various other different ways of expressing the same thing, is merely to state that one must realize an accretion to net worth in order for income to arise. In fact, I’ve got no problem with the way you (and/or Wikipedia) have summed up the case in your latest post, because you and Wikipedia simply confirm what I wrote in the first place.

    The fact is, however, that in your initial post you wrote, in response to a comment that we perhaps should tax “*unrealized* capital gains” a la Haig Simons, that “capital gain is not income” and that “In the early days of the income tax the US Supreme Court repeatedly held (four times, IIRC) that capital gain is not income.” The courts certainly did not hold that. In fact, they held the opposite that capital gain (with the emphasis on gain as defined above) is income, provided the gain is realized. The United States has, to my knowledge, continuously taxed capital gains since 1913. I have considered the possibility that you meant to say that the courts have held that “unrealized” capital gains may not be taxed, but that is not what you wrote and your emphasis on “double taxation” in that first post strongly suggests that was not your intent (even though you’ve dropped that idea in the second post). And, of course, you wrote this:

    “Capital gain is not economic income. Look in the national income accounts at BEA.gov — you won’t find “capital gains” included in national income even when they *are* realized.”

    So, your initial objection to this appeared not so much the fact that the gains are not yet “realized”, but that to tax capital gains (even if realized) would result in “double tax”. In fact, even a mark-to-market regime need not entail any double tax and, while McComber has not expressly been overturned, most scholars (including Stanley Surrey as early as 1941) conclude that the realization requirement as expressed in McComber is no longer a constitutional impediment to a mark-to-market regime or an “accretions” type tax, but that the realization requirement is now merely one of administrative convenience. If it were otherwise, we likely would not have (Foreign) Personal Holding Company, PFIC, Subpart F, or Section 1256 rules, etc. (given these subsequent developments it is not entirely clear that a Haig-Simons or Haig Simons-Schantz tax would be unconstitutional) And, even these accretion rules do not ensure double tax and contain specific provisions to avoid double taxing.

    McComber, its predecessors and its progeny really have nothing to do with whether it is appropriate to tax income *twice* and has everything to do with whether income, as properly defined, can even be taxed once.

    Perhaps I should first read Scott Sumner before responding to your posts, because it seems to me that what you might really be driving at is that we should have a consumption tax (exclusively) and not an income tax, or a combination such as Haig-Simons, but you are forcing me to guess.

    As to the bonds, let’s take an example that is admittedly not “real world” but perhaps this stylized version helps you understand where I’m coming from. Let’s assume that we’ve got a 10-year Treasury that is issued with a coupon of 10% and Person A buys it on issuance. The anticipated future stream of income is $100 (without discount to present value). Let’s further assume that on the very next day, the prevailing rates of interest fall to 5% and A sells that bond to B. The market value of the bond therefore increases. When A sells to B, he realizes a “capital gain” on the sale and the tax code recognizes that gain. Let’s assume that’s $30. In essence, A is getting a part of the expected return on that bond that represents that delta between the 5% and 10 percent rate. Within the context of our income tax system, and in a real economic sense, has not A realized an accretion of wealth of $30? Are you saying he should not be taxed on that? B is a buy and hold sort of guy so he holds his bill and collects $100 of interest, which apparently in your vision, is and should be taxed. When the bill matures, B gets $100 back, even though he paid A $130 for it. If B is allowed to deduct that $30 of capital loss, the net “income” reported in these transactions is $100. A is taxed on $30 (his real economic gain) and B is taxed on $70 which represents his real economic income (albeit with some timing differences). If it were not for this system, it is true a net $100 of (interest) “income” would be taxed, but some of it to the wrong person. But, how does this situation constitute a “double tax”? I can see how a system that taxes wealth of an individual and also taxes “income” that same person derives from that same wealth could result in double tax, but that is not what we are talking about here. Your comment only makes sense to me if one assumes that the same asset is held by the same person and never changes hands and we tax accretions of wealth before they are “realized” and then the realized “income”, too, but that’s not what the current system does. Or, are you thinking that there is a “double” tax due to the fact that our individual and corporate tax systems are not completely integrated? (to this, I would have sympathy for that specific case, but you’ve painted with a very broad brush). Or, are you again following Sumner (and others long before him) with the idea that the only event on which income from capital should be taxed is upon consumption because it is only when consumption occurs that we have “income” at all?

    Here, you indeed have lost me (smiley face).

  30. comment number 30 by: Vivian Darkbloom

    Another point, quickly this time.

    Comparing the BEA concept of national income with the concept of income accruing to individuals under the income tax code is not appropriate or particularly useful. The BEA might logically conclude that when A sells a bond to B for $130 (at a $30 gain) and B is out of pocket $30 to pay A for that instrument, nothing should be booked. A’s gain is B’s eventual “loss”. What you fail to state is that the BEA also does not book capital losses in its national income accounts. But, the measurement of income for purposes of the income tax code is quite a different matter because it is concerned with what happens at the individual level: A *does* have a gain of $30 and, if everything else remains constant, B will eventually have a loss of $30. But, to net these two transactions for income tax purposes makes no sense, because A is not B. It would be like saying Microsoft and Intel should consolodate their income tax returns.