TAMPA, December 1, 2012 ― President Obama and the Democrats were successful in 2012 largely on the strength of some rather outlandish demagoguery. “Billionaires pay fewer taxes than their secretaries” was one slogan that was particularly successful.
The Obama campaign successfully made an issue out of Mitt Romney’s taxes, finally getting Romney to admit that he paid around 13% of his earnings in taxes over the past several years. The “fair share” crowd contrasted this with the higher percentage that would have been paid by a secretary in the 28% bracket, for example, who would still pay more than 13% even after deductions.
That Americans bought this specious argument is more worrisome than that the Democrats made it.
Romney’s tax percentage was low because most of earnings came from capital gains, not income. Capital gains are just what they sound like. They are the appreciation in the value of one’s capital. If you buy a stock at $5 per share and its price goes up to $7 dollars per share, you have realized $2 in capital gains. If you sell that stock at a $2 dollar profit, the government wants a percentage.
Right now, Mitt Romney would pay 35% income tax and 15% on capital gains. The average secretary would pay 15% income tax and 15% on capital gains. So, Romney’s tax liability as a percentage of income is more than double the average secretary’s. His tax liability on capital gains is the same. Obviously, Romney’s nominal tax payments in both categories would exceed the secretary’s by orders of magnitude.
That’s how things actually are out here in the real world.
So why is the tax rate on capital gains lower than on income? Because “capital,” by definition, comes from previously taxed income.
When a person earns wages or a salary, or receives disbursements from a business he or she owns, it is income. Much of that income is going to be spent on living expenses or discretionary spending. The government is going to take its bite out of it, too. Whatever is left over after all of that is “savings.”
Savings is the difference between what one produces and what one consumes. It is the one and only source of capital (besides fiat money printing, but that’s not real capital). Its source is income, which is taxed in the United States.
How do savings become capital?
The answer has to do with what economists call “time preference.” A person with a high time preference prefers present satisfaction, while a person with low time preference prefers future satisfaction. In other words, some people will blow all of their money the moment they get it and some will forego material benefits in the present in order to realize greater benefits in the future.
Those in the latter group, whether they are billionaires or average income earners, are “capitalists.” They forego the benefits they could enjoy from their savings now and instead invest that money for the future.
This involves risk. While one is guaranteed the full value of one’s savings if it is spent now, one risks losing all of it by investing in the future.
Finally, we have the truth about the “greedy capitalist.” She is someone who acquires capital by consuming less than she produces. She then makes a decision not to live it up on those savings in the present, but to responsibly invest them in the future. She isn’t necessarily rich. She may earn $35,000 per year, but if she saves and invests what’s left over after expenses and the tax man, she is a capitalist.
It is that decision and that decision alone that can create new jobs in an economy. All new business ventures or expansion of existing businesses require capital. They require savers to exercise a low time preference and forego benefits in the present to realize greater benefits in the future. Those greater benefits are “capital gains.” Capital gains are the incentive for job creation.
Now, the government wants to tax them even more.
You don’t need a Ph.D. in economics to figure out what that will do to the economy. Right now, the secretary and the millionaire can keep 85% of any gains realized from investing their capital. That is their only incentive to risk losing their savings and make those job-creating investments, instead of just enjoying the benefits of their savings now.
If they could only keep 72% of capital gains, would there be more capital investment or less?
What if they could keep 100%?
Tom Mullen is the author of A Return to Common Sense: Reawakening Liberty in the Inhabitants of America.