[simplefish]

Just to spell it out - there are three (main) reasons why we would want capital gains taxed at a lower headline rate:

1) Capital gains are already taxed at the corporate level. People seem to intuitively understand how this works at the dividend level (dividends are paid with post tax dollars), but if you do the math, it works precisely the same with capital gains. (Please note: Tax incidence is complicated. Not all the corporate tax is borne by investors. Especially in small open economies like the UK, it's actually mostly paid by the workers via lower salaries.)

2) Speaking of which...capital gains are a tax on investment. Investment leads directly to increased labour productivity. Productivity leads directly to higher salaries. If we want employees to be paid a lot, we want, as a matter of public policy, to encourage investment. At this point the observant will pipe up "wait, are you saying it's good for the workers if we tax worker salaries more heavily than capital gains income?!" Yes, that's exactly what I'm saying, and it's supported by a rich body of empirical and theoretical backing. Heavy capital gains taxes are the precise policy you'd implement if you wanted to keep labour poor and unproductive. (If it helps, consider that investment is saving - it's an accounting identity - and the US has a big problem with low savings rates, which in turn means that they struggle to get enough investment without borrowing from overseas lenders. See the problem?)

3) Finally, investment income isn't just already taxed at the corporate level - it's also already taxed at the personal level too. Imagine two people, Spendthrift Sally and Frugal Frank. Both work at jobs making $200k/year, after tax. Sally spends all her income on consumption, and saves $0. Frank spends 75% of his income on consumption, and saves $50k/year by purchasing stocks which go up in value by 5% per year. After twenty years, Frank has spent $1m total on stocks now worth a cool $1.7m (clearly he follows the buy-and-hold school of investing). He is retiring, and wants to sell them all to re-invest in safer bonds. What tax rate do you think is fair? He made those investments with after-tax dollars. Do we now tax him again on the result of those investments? Don't we want people to behave like Frank, instead of Sally? And if we charge him 15% on his capital gains, he'd end up paying over $100k MORE total tax than Sally. Does Frank, who has scrimped and saved his whole life, really deserve to pay more taxes than Sally, who never saved a penny?

(The analysis becomes more complicated if Frank received the stock as compensation, instead of purchasing it with his salary. But keep in mind that he's still (1) taxed on that initial compensation and (2) is deferring consumption; a responsible choice which we as a society probably want to encourage.)

[akeefer]

To your points:

1) Sure, but effectively all income is multiple-taxed. Suppose I run my own business, and am paid by a consumer with their money that they earned as wages. If I turn a profit, I then pay taxes on that income. By this logic, I shouldn't have to pay taxes, because the consumer that paid me was using after-tax dollars, so taxing my income from them would be double-taxation, right? The double-taxation argument is simply not very-compelling because there's no one true wellspring of money; if there were, you'd just tax the source and call it good. But reality is way more complicated than that, and money is always taxed multiple times as it moves around the economy.

2) I don't think you're correct about there being empirical evidence of capital gains rates affecting those things. For example, see http://www.slate.com/blogs/moneybox/2012/01/19/capital_gains.... As far as I know, there's no credible empirical evidence that cutting capital gains rates deterministically helps investment or saving, or that raising them hurts those things. Sure, you can pick and choose examples with those outcomes, but you can also find plenty of empirical examples where those effects didn't happen. It's totally misleading to act like that's a settled question in economics.

3) He's paying more in taxes because he ended up earning more money. So yes, he deserves to pay more in taxes than Sally, because he earned more money. Otherwise, you could easily say "Sally decided to work part time and made less money than Fred. Does hard-working Fred really deserve to pay MORE in taxes than Sally?" Yes, yes he does; unless you really think that a poll tax is a good idea, even a flat-tax advocate would have to argue that someone who makes more money should pay more in taxes.

[simplefish]

1) Actually, no. We tax transactions. Your customer is buying a service from you, and we tax that. When you hire an employee, you are purchasing his labour, and we tax that.

But if you pay yourself a dividend, there is no transaction. If you own an asset, and it goes up in value, there is no transaction. (Capital gains tax is not on the transaction of selling your stock, but on the change in value of the stock; it's only realized at sale. Some countries do charge a transaction tax on stock sales, usually called a stamp duty, which is entirely different.)

More generally, we tax things when they change ownership. (We even tax things when you give them away!) In the case of a small business owner, everything in the business is owned by you. It's yours. You own the business, the business owns the couch, therefore, you own the couch. Ownership is inherently transitive. Even in a large business, everything is owned by the stockholders. Businesses are not people. (Note: At this point, people usually bring up Citizens United, despite the fact that the decision does not claim that businesses are people. Try reading it; it's actually pretty interesting.)

Thought experiment: Can we tax you on the rent you are implicitly paying yourself for living in your own house? Why or why not? And if we can't tax you on the value of the rent your house is providing you, why can we tax you on the value of the things your business is providing you? (Well, obviously, we can do it because the law says we can. But morally, the difference seems remarkably theoretical.)

Further thought experiment: Should you be taxed if you hire yourself as an employee? I'm actually torn on this one. Logically, the answer seems like it should be "no"; it doesn't matter if you hire yourself as an employee for a salary, or work for "free" in exchange for equity. Intuitively, it feels to me like it's okay to tax an owner on his salary but not his dividends. shrug Guess I'm not that logical. :)

2) Yglesias' post is suggestive, but doesn't really prove anything. As I said, there's a LOT of research on this point, and saying, as he does, "Germany added a capital gains tax, and their savings rate didn't immediatly change" does not really tell us as much as he thinks. Germany has also been noted for extremely low wage growth recently. Clearly the result of underinvestment caused by their pernicious capital gains tax, right? I doubt it, but it's no more implausible than Yglesias' argument.

[pfedor]

3) He has "more" money nominally but the majority of the difference is due to inflation. If Fred invests in TIPS with zero yield, he will have exactly the same amount of real money when they mature, but he will likely be faced with a big tax bill anyway.

[EricBerglund]

The issue I have with framing it as spending vs investing is that the main issue with capital gains revolves around the super rich, not people making $200k a year.

Sure, a tax rate difference might influence Sally or Frank to spend or save, but Warren Buffet is not going to go on a billion dollar spending spree rather than invest his money if the capital gains rate goes up 5%.

I guess my question is what would the super rich do with their money other than invest it?

[fleitz]

I think people are mostly concerned with the unfairness of the tax system.

If you put your time into something you're equally investing as if you put your capital into something, why if you put mere capital which is recoverable vs. time which is an unrecoverable good should you be taxed at a lower rate?

Employees invest their time into businesses and in return for their investment are paid a salary.

Every time money changes hands tax is paid. If I take my money and invest it into a latte then the coffee shop has to pay taxes on the money received from my investment. Worse yet, if I forget to drink my latte and it gets cold I can't deduct the depreciated value of the asset as a loss.

The only way in which the capital gains rate makes sense is if governments hold labour hostage (silly immigration policies) while capital is allowed to move freely.

I don't disagree with you that raising taxes is generally a bad idea, primarily because the government doesn't invest it wisely, but I do think that having differing rates for labour and capital is silly, especially when a person who invests time is guaranteed to lose their original investment, their time, whereas a capitalist merely has a chance of losing their investment.