Comment on taxable income

I posted the following comment to "CommonWealth:Assets vs. Income" by Will Rice on the Facebook page of the Coffee Party. It and the comments are various positions about taxing interest and capital gains.

If John and Mary start a company and sell stock in it to you, you have made an investment. If later I buy that stock from you at more than you paid John and Mary, I'm not making an investment in John and Mary's company; I'm providing you with liquidity for your investment. John and Mary have gained nothing from my purchase of your stock. Well, not quite, the liquidity I have provided to you makes it easier for them to sell new stock if they need to expand.

If purchase of stock on the open market is truly an investment, then why are you taxed at the full rate on the whole amount that you withdraw from your IRA or 401k? You are not taxed on the sale price minus the cost basis as you would be if you had bought stock for a regular account.

In either case, we have not done much work for our gains, unless you count biting nails when the stock goes down as work. The people who have done the actual work are John, Mary, and their employees. They have sweated and worried as we watched on the sidelines. And for this, we tax them at a higher rate. That does not sound like an incentive to get people to work.

Worse, we expect them to pay for all the infra-structure that makes their company successful: education, streets and sewers, police and fire, courts, and many other public goods. Those who pay a smaller portion of their income for public goods are free riders; without public goods they would have much smaller incomes. If you don't think public goods matter, consider that more large corporations tend to have their headquarters in "high-tax" states than in "low-tax" states. The public goods in the "high-tax" states made the corporations possible and the CEOs like the quality of life in these states. See "The fallacy of ranking states by 'tax burden'".

We're sorry, Wall Street???

For a marvelous piece of sarcasm, read, "Dear Wall Street, We're sorry" by David Weidner, MarketWatch, 2010-01-26, subtitled "How the Little Guy Ruined Wall Street".

Let's do away with capital gains taxes, dividend taxes, and estate taxes by...

Replacing them with taxing withdrawals from savings. Not withdrawals from your passbook savings account or your money market fund. That could well be money that was already taxed, especially considering the low interest on these currently.

I think a better plan would be to create investment accounts similar to IRAs. If you put money into an IRA it is not taxed. When you withdraw money from an IRA you are taxed at the wages rate on the full amount of the withdrawal, regardless of the source of the money: original contribution, capital gains, dividends, or interest.

In one way, you can look at an IRA as a lousy investment tax-wise. You may have saved some taxes at time of deposit, but you may be paying for more taxes than if you had put the money in a traditional mutual fund, especially if you had large capital gains over the life of your account.

However, if we move all investments to IAs, we solve the problem of taxing capital gains, dividends, and interest at a lesser rate than taxing work at a desk or bench. We also eliminate many of the side effects of people changing investments to get some tax advantage. The markets may be less chaotic at year's end as people buy or sell stock for some advantage.

We also solve the problem of estate taxes. Those who bequeath or who are bequeathed often don't want a penny of taxes to come out of the estate. But what happened to all the capital gains taxes that might have been paid if the deceased had lived. If an Investment Account is bequeathed, the beneficiaries would only be taxed on the money they withdrew. They would be free to buy and sell investments in the Investment Account without being concerned about the tax consequences of the transactions.

Probably most opposition to this plan would come from those benefiting from the current tangle of tax laws - lawyers, estate planners, and so on.

I've been sitting on this idea for some time; I was prompted to write about it after reading "Savings Accounts for All: Simple, but Not Easy" by Ron Lieber for the New York Times and republished today on Yahoo! Finance.

I also posted the above to http://www.whitehouse.gov/contact/