Academic

Nonsense and Taxes

By Calvin Massey

      Dorothy Brown, a tax professor at Emory, has an op-ed piece in today's New York Times, in which she argues that all income should be taxed at the same rate.  Well, not quite.  She wants capital gains and dividends to be taxed at the same rate as ordinary income, but I presume she is not advocating a flat rate applicable to all income, whatever its source or amount.  So, her argument is quite selective in the ringing contention that "it 's all income and it should all be taxed at the same rate."   Even granting her premise, her conclusions are wrong. 

      Dividends have already been taxed at the corporate tax rate, so their subjection to tax once again at the rate applicable to the recipient shareholder means that this income, unlike "ordinary" income, gets taxed twice.  Even with the present 15% rate applicable to dividends, dividend income is still taxed twice.  This is not the case with interest income, which Prof. Brown equates with dividend income.  Interest is a deductible expense to most payers of interest, so interest income is taxed once. 

     A reduced rate for capital gains is justified by several reasons.  First, high capital gains rates provide a substantial disincentive to realize those gains and reallocate capital to other, more dynamic and productive uses.  A healthy economy that provides economic opportunity for everybody is dependent upon easy transfer of capital from one industry or application to another.  Second, if capital gains rates equal oridinary income rates, closely held enterprises have an incentive to pay out the gains in the form of salaries, rather than reinvesting in the business.  There is, of course, a time value to money and if you will pay the same tax on receipt of money later as you will when you take it now, you are a fool to wait.  This means that emerging enterprises, which are usually closely-held, will grow more sluggishly and provide fewer employment opportunities for that secretary for whom Professor Brown is so concerned.  Third, the capital markets, funded by investors seeking a total return on their investments, will become less attractive.  Equity investments carry risk, as any sentient American can now attest.  If there is no compensation for the risk, in the form of lower capital gains rates, why take the risk?  Better to put the money into a debt instrument, and reap a higher interest return.  The problem with many large publicly held corporations today is, among other things, insufficient capital.  Professor Brown's proposal will starve them further, leading to the loss of more jobs.  Finally, consider all those American homeowners with unrealized gains on their principal capital asset, their home.  If the rate on those gains goes to ordinary rates, homeowners have yet another incentive to stay put, rather than suffer the tax consequences of sale.  Better to let the house go to the next generation, and be subject to estate taxation and a stepped-up basis, than to sell it now.  This is a specifiic version of argument number one.  

      In sum, Professor Brown's call for equality in tax rates is bad for the economy, bad for that secretary and her working siblings (soon to be formerly working siblings), and bad logic.  But "it's all income and it should all be taxed at the same rate."  How about a flat tax, Professor Brown?  

Full post as published by The Faculty Lounge on March 09, 2009 (boomark / email).