WASHINGTON, September 6, 2014 — Vice President Joe Biden has called for reforming the U.S. tax code in such a way that it values a paycheck as much as unearned income. That means America needs to have a serious discussion on the capital gains tax.
For most Americans, the lower rate for capital gains tax serves as a long-term incentive to invest their money in order to ensure their financial future. It builds wealth for retirement and fuels the continued economic growth of the country. For wealthier Americans, however, the lower rate is not an incentive to invest; instead, it affords them a windfall for money they would have invested anyway, though altering the tax benefit may change how they invest.
Because stock markets afford individuals a convenient vehicle for investment, versus directly risking their savings in a local business venture, most people invest in the national and global economies through a 401K retirement plan, an IRA, mutual funds, bonds, CDs, and other financial instruments. This means that money is funneled into investments that have more stringent reporting requirements, with the greatest benefits and risks going to those who invest in segments expected to grow the fastest.
The benefit to the economy is a readily available, broad base source of capital that can be used to expand economic activities on Wall Street and on Main Street. This has helped make America’s financial sector one of the world’s strongest, and one of the most vibrant sectors of the U.S. economy. Unfortunately, the financial sector does not employ a great deal of labor compared to the greatly diminished manufacturing sector; a vibrant financial sector does not directly create many jobs.
Consequently, steering too much money into the financial sector may hurt the economy as a whole; it diverts money away from the economic activities that directly benefit most Americans. Growing economic disparity, stagnating and shrinking wages, and lackluster job creation as the capital gains tax has been cut hints at the validity of this argument.
People need well-paying jobs to sustain strong consumer spending — the lifeblood of the economy — and build their investment portfolios — get access the benefits of economic growth and supply the economy with capital — while enjoying a comfortable lifestyle. When people lose their ability to both afford a comfortable lifestyle and invest for their futures, the economy is in trouble.
From the 1970′s until about 2008, average income Americans were able to compensate for diminishing wages and lost financial opportunities by working longer hours, living on multiple incomes, decreasing family size, forgoing certain luxuries, relying on state support, and, in the case of the growing poor classes, forgoing necessities, thus ultimately hurting themselves in the future.
Today’s economy is built on increasing returns to those who can afford to be investors. This translates into a situation where an excess of capital is driven toward investments with the highest payouts, thus creating economic bubbles. In turn, Wall Street firms and affluent individuals have been increasingly able to use extremes in the markets to siphon capital out of the economy, especially with their use of exotic financial instruments. Because emerging economies often see periods of faster growth than developed economies, capital is being increasingly routed to emerging economies to create over reliance on imports, outsourcing, and crescendoing commodity prices.
In tandem, production is cheaper in underdeveloped countries due to abundant, underdeveloped natural resources, cheaper human resources, and a lack of important regulations. Yet only a relatively few in these underdeveloped countries significantly benefit from the exploitation of their national resources.
Capital flows out of developed countries and into developing countries, fueling their growth while undercutting labor-intensive industries in the developed countries. Although the U.S., Japan, and Europe are stalwart economic safe havens, growing uncertainty in these economies and growing, yet fluctuating, confidence in emerging markets means capital is more often going to be diverted to developing nations. Manufacturing may be returning to the U.S., but price instability for commodities like oil is helping to drive this resurgence. Should costs stabilize and foreign imports continue to become more reliable, the manufacturing industry will once again see decline.
Consequently, the capital gains tax needs to be recalibrated to better reflect the interests of national economies. Beyond an immediate, honest effort to better understand and discuss the effects of tax policy, Americans need to hold a constructive public forum on the issue that can actually translate into action. This starts with economists developing economic models that do not overvalue financial capital by undercutting the value of intellectual and labor capital.
In other words, economic models need to focus on serving the interests of the average citizen.
U.S. policy may eventually cap the benefits of the lower capital gains tax rate, so it can act primarily as an incentive for middle-income households. Paying down the national debt is one option for spending the increased revenue resulting from limiting capital gains, while shifting the tax savings associated with reducing the capital gains tax discount is another.
Cutting overall tax rates would be nice, but governments might consider subsidizing another type of capital that would drive growth where it is most needed. With free trade, policymakers and economists assumed America would develop an economy fueled by the service sector and intellectual property. Clearly, this model does not provide for the interests of most Americans as most do not own significantly valuable intellectual property and service industry jobs are often low paying, but policy shifts can help better spur the good paying jobs people need.
Improved business models, technological advances, economic uncertainty, and a lack of demand have created an economy that does not need the skills and labor of millions of workers. Innovations and the spread of new technology can, however, create good paying jobs by sparking novel industries. Coupled with improved patent laws, offering a tax discount on par with current capital gains tax deductions for royalty payments on novel technologies and other innovations would make them far more valuable. By making patents and other intellectual property more valuable, financial capital would be steered toward innovation, thus ultimately creating new industries and jobs.