A Common-Sense Approach to Capital Gains Taxes
Jim Blair

Some people claim that capital gains should be taxed exactly the same as other types of income. Sounds "fair"... so why treat it different?

Well, for one thing, is it really income at all? Most people who encounter the tax do so when they sell their house. Typical situation: a family bought a house in the 1950's or 60's. It was very expensive at $30,000, which was the most expensive thing they ever purchased: it was 4 times the annual family income. Now they want to sell to move to a small apartment since the kids have left home. Inflation has raised the price of housing (along with almost everything else), and they sell it for $200,000 (4 times their annual family income!). So they have a capital gain of $170,000 to pay taxes on, probably at the top rate since the year they sell they are those rich that everyone wants to "soak". They may need to live the rest of their live on this money (plus social security), but it wouldn't be "fair" to let them keep it.

The house situation is so obviously unfair that two special exemptions to the normal capital gain are made. But these create their own problems. There is a "one time only" deduction of $130,000 from the capital gain of a house IF the seller is over some arbitrary age (58, I think). If the amount of the deduction is not adjusted for inflation it soon becomes too little to matter much. A more serious problem stems from the other exemption: if the money from the sale is spent on another house, you don't have to pay the tax. This has the effect of driving UP the price of housing in the areas where people move. Sell a modest 2 bedroom house in California or Boston for $500,000, and move to the mid-west, there the same size house costs much less. But you must spent it or pay the tax. Does this make any sense?

Remember that the house, or any other form of investment, was bought with income that had already had taxes paid on it. In that sense, this is taxing it a second time. And much of the "gain" is just the loss of purchasing power due to inflation. If people just blow their money on consumption or at the Casino they won't have to pay this tax.

Maybe the government needs the money to function. But capital gains tax is strange that way. When the rate was lowered from 28% to 20% in the early 1980's the revenue collected rose dramatically. When the rate was raised back to 28% in 1987, revenue fell. Tony Snow had a column on this in USA TODAY, Nov 28, 1994. A letter criticizing the Snow column was printed a few days later. The critic pointed out that when the economy did well, the capital gains tax produced the high revenue and when the economy slowed down the revenue fell.

This tax is on investment, and lowering it makes investment more attractive. Investment is a big factor in why the economy does well. The critic reminds me of the "expert" who announces that they have discovered that, contrary to popular belief, the moon is more important than the sun. Why? Well the moon shines at night when we need the light. The sun just shines during the daytime, when we can see well enough.

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