Bohanon & Curott: Taxing capital positive factors like labor income is a nasty thought

In 1997, the youngest college graduates and newlyweds Jack and Diane had $ 2,000 in cash left over. You could think of two options.

The first: update the TV stereo sound system. The upgrade would improve viewing / listening quality for at least a decade.

The other option was to buy 100 shares of Apple. There were rumors that Apple could go bankrupt, but both Jack and Diane suspected that the company’s intellectual property could attract a buyer and increase Apple’s stock price. On the other hand, maybe not.

From at least the mid-19th century, many, but not all, economists have argued that an income tax law that treats dividends, interest, and realized (or unrealized) capital gains the same as labor income is a bad idea. This is because household spending and saving decisions are skewed in favor of spending. The benefits of the TV system – the added viewing pleasure Jack and Diane get – are relatively safe and not taxable. The benefit of buying into a volatile business is the prospect of future dividends and capital gains that are highly uncertain and taxable.

Taxing dividends and capital gains encourages too much consumption and too little saving, which is detrimental to households and the larger economy in the long run. The argument is in favor of taxing dividends and capital gains at a lower tax rate than normal income – or maybe not at all.

This principle is embedded in current tax law, but President Biden is proposing to end it for households making more than $ 1 million a year. The Tax Foundation estimates that the Biden Plan will raise the highest marginal tax rate on capital gains from 29% to 48.4%. This is higher than any Western European nation and is above Denmark’s 42% rate and the 27-nation unweighted euro average of 18.59%. Interestingly, seven of the 27 euro countries, including Switzerland, have zero capital gains tax rates.

Back to Jack and Diane. They bought Apple stock and in 1998 daughter Phoebe joined them. Unfortunately, she spent her early years watching Barney on a second rate television system.

It wasn’t until 2012 that Apple shares paid dividends. The stock has split multiple times, however, and is now worth a whopping $ 1.4 million. Phoebe has just graduated from college herself and has a well-reviewed startup idea that could use up some venture capital. And of course Jack and Diane would love to invest in Phoebe’s business, but for that damn capital gains tax. •


Bohanon and Curott are business professors at Ball State University. Send comments to [email protected].