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Read this post if you like winning arguments with Republicans.
I keep hearing from Republicans that Obama's plan to roll back the Bush tax will result in an increase in the Capital Gains tax. They also say that the biggest increase in Cap Gains tax rate will be for lower income households. They also say that this is a broad increase because more than 50% of US households own stock, so it is not just about rich people. This is all true.
But, and this is a big but, this is all crap. Some Facts:
1. Under the Obama plan, the long term cap gains tax will go from 15 to 20% for most filers and from 0 to 10% for low income households.
2. #1 doesn't matter because the vast majority of middle income and low income households who own stock own it in a 401(k), 457(B), 403(B) or IRA and all of these accounts are exempt from these taxes anyway.
3. Obama's plan has lower income tax rates for lower income brackets. This is the only rate that matters in retirement savings, since when you withdraw money from a retirement account (over age 59.5) this is the rate you pay.
This is very simple, not too wonky, and yet I have never heard this question put to any politician anywhere, nor have I heard any Democrat make this point.
Maybe we need to turn it into a bumper sticker...any ideas?
Comments (27)
They'll get to it. They're all too busy at the moment trying to field oil price talking points.
June 19, 2008 9:41 PM | Reply | Permalink
Don't try to tell Charlie Gibson "#1 doesn't matter" about Capital Gains Tax Reductions, or he'll snap your head off. Charlie loves him some Capital Gains Tax Reductions. And he thinks that every average-joe making $100,000/year in New Hampshire should share in that good fortune. Why waste tax reductions on those lucky-duckies making under $50,000; after all, they don't have to pay ANY Capital Gains Taxes now do they? :)
June 20, 2008 3:10 AM | Reply | Permalink
Yay! You made the recommend list! Nice job, other Hobbes.
June 20, 2008 10:48 AM | Reply | Permalink
RE: Your point #2 above
I've been wondering for a while why the gains on the money I have growing in my 401(k) is going to be taxed at the future *income* tax rates, rather than at the (lower) capital gains rate.
As some say where I come from, "that don't seem right".
The theory behind the 401(k) and other tax-deferred savings programs is that when you withdraw the money -- ie. when you're retired -- your income will be lower, so you'll be taxed at a lower rate. But is that really true?
What if I'm actually successful as a saver and investor? I might be pretty well off when I retire. I mean, that is my goal, after all! So I'll be paying real income tax rates (like I am now), and those rates very well may need to be higher in 20 or 30 years.
So I'm actually thinking about reducing my 401(k) contributions, and just putting in the amount needed to get the company match. Then I'll invest the rest, after tax, in something that I can just pay capital gains tax rates on. You know, like the rich people do.
FWIW.
-- ARG
June 20, 2008 11:09 AM | Reply | Permalink
ARG,
Don't forget that you get a tax break now on your contributions to the 401k. So if you are in the 31% or 38% tax bracket now, and you cut x thousand dollars off the top of your income, that has value as well. Even in the future dollars going forward.
That said, I understand your point, but if your doing well enough that your future 401k withdrawals will be taxed at the highest levels, your taxes aren't going to be a real issue for you anyway :D.
--Uwaine
June 20, 2008 11:22 AM | Reply | Permalink
Good point. Even if you've got a million to retire on, that's not much money these days. You might live another 40 years, and you'll need at least $ 40,000 a year in income (all taxable). The other issue is you may need that money for long-term care and have to pay tax on every penny you pull out.
I'd also suggest a Roth for you, since it's all tax free, but I'm worried about tax policy changing so much that these breaks will go away.
I absolutely hate the complexity of a tax code it takes an attorney to understand. When Russia has a simpler tax system than we do -- something is very wrong in America.
June 20, 2008 11:54 AM | Reply | Permalink
One caveat on Roths...You don't have to pay taxes on it as we all know, but neither can you deduct losses. A few years ago I opened one with some bank stock on a broker's recommendation. So I'm stuck with a much deflated bank Roth IRA and will just have to wait until it recovers at some point in the future. Most likely my children or grand children will be the ones who see a gain on it.
June 20, 2008 4:55 PM | Reply | Permalink
True, income tax rates could be higher in 20 or 30 years, but... so could capital gains rates. I wouldn't advise making investment decisions based on some crystal ball about the state of tax rates in three decades.
Thing about 401(k)s and IRAs, etc. is that you get to decide how much to withdraw (subject to certain rules - there are minimum withdrawal requirements, but they're not too high). So, if you are very successful and wealthy, you'll be able to work with a financial planner to make withdrawals in a way that balances your taxes with your lifestyle needs. Depending on the nature of your investments, you might not have the same flexibility with capital gains decisions.
But, if you really want to invest in something else, work on paying off your mortgage. Gains on your house are essentially tax-free (assuming the housing market recovers and there are gains), and being mortgage-free is really helpful to that whole retirement lifestyle thing.
June 20, 2008 6:08 PM | Reply | Permalink
If "ARG" doesn't want to pay tax when he withdraws money from his IRA or 401(k), he could start putting his retirement savings into a Roth IRA, so that he doesn't have to pay cap gains tax when he sells appreciated assets, and doesn't have to pay taxes when he withdraws the money. But his contributions will be diminished by the amount of tax he pays prior to investing.
Evidently, "ARG" thinks that he shouldn't EVER be required to pay taxes on the money set aside for hius retirement. I can understand his sentiments, but that kind of a loophole would mean that everyone could avoid paying tax on all but the money they need to finance their present lifestyle. That's a much bigger loophole for the rich than for the poor.
He (or she) might be better advised to look at the deferred compensation packages which are popular with corporate CEO's, and like his 401(k), will permit them to shift income to a time in their lives when reduced wages will permit them to pay lower taxes on this income.
June 20, 2008 11:41 AM | Reply | Permalink
you're saying for anyone over 59 they will always pay at the lower tax rate, regardless of their annual withdrawl? I've never heard that before. Can you explain more?
June 20, 2008 11:48 AM | Reply | Permalink
My traditionally Democratic McCain-leaning friend (yes, such people exist) is concerned that increasing the capital gain tax would discourage investment and negatively impact a fragile economy. Anyone have insight into this?
June 20, 2008 11:58 AM | Reply | Permalink
In a vacuum, is it true to say that higher Cap Gains tax might depress some investment, but lets not forget, that the cap gains tax on "most filers" would go from 15-20%, this means that they would be able to keep 80% of their profits instead of 85% (state taxes notwithstanding). Are you going refuse to consider the chance to make $800 profit because you think you ought to make $850? It would be a great example of cutting off ones nose to spite one's face.
Also, the lower income tax rate that Obama offers, combined with new regulation already in place encouraging retirement investing by middle and lower income individuals should result in way more than enough money going into the market to offset any negative impact a higher cap gains tax might have. I think Obama's campaign has shown in their fundraising that a lot of little amounts of money can easily make up for a lack of a few big amounts.
June 20, 2008 12:26 PM | Reply | Permalink
I'm going to play devil's advocate here, though I'm not sure where I stand on capital gains.
MassDem, you're $850 example is specious. The issue with capital gains is whether to leave your money where it is or reinvest it. The higher the capital gains tax, the more likely you are to leave it where it is. Compounded over time, that 5% could be significant. Furthermore, if investors believe that the capital gains rate will fall in the future, they're even more like to wait to sell at a later point. Of course, investors will still buy and sell, but the higher the cost of selling, the less attractive that option will be, and those on the fence already will be less likely to sell.
Furthermore, it seems that 20% is the low end of what Obama is considering. He plans to raise capital gains taxes to somewhere between 20 and 28 percent:
http://money.cnn.com/2008/06/20/news/economy/obama_capgains/index.htm?section=money_latest
June 20, 2008 1:35 PM | Reply | Permalink
I love the Devil's Advocate...Pacino and Reeves...like mixing Johnny Walker Blue with Fresca.
My $850 Argument is certainly a simplification for the purposes of...well...simplification. The point is that the fact that you have to take a 5% haircut on your net profits isn't going to make you throw your hands up and say "nevermind, I'll pass on the profits altogether." The capital gains tax is only due when you sell an investment for a profit, so by definition there is no "compounding over time" since it is a tax that is only paid once during your ownership of a stock, whether you own it for one year or twenty.
I do not necessarily agree that a higher cap gains tax rate will make investors less likely to sell stocks (or funds for that matter) that they currently hold, but if it does, "buy and hold" is usually a much more sound strategy than constantly churning a portfolio - look at Warren Buffett. If a higher cap gains tax rate makes more investors look at the stocks they buy as longer term investments, then we all win because the stock market will be less volatile.
With regards to your last point, please explain to me why it is right that the rate on unearned income derived from investment gains has any business being lower than that on earned income derived from work.
Please also remember that, with the exception of the impact on overall market conditions, this is all moot for anyone who only owns stock (or mutual funds) in a retirement or education account since they are exempt from these taxes anyway.
June 20, 2008 2:52 PM | Reply | Permalink
Of course not. But you may well decide that you'll make more money by leaving your money where it is. Suppose that I had invested $1M and earned $200K. Reinvesting that $1.2M would cost me $30K at 15% and $40K at 20%, a difference of $10K. Suppose that I expect to make 5% this year if I keep my money where it is, earning $60K, or 6% if I move it, earning $69.6K. That $10K makes the difference, and I keep the money where it is.
That's with just a 20% profit. Suppose that I have doubled my $1M, so I have a $1M profit. The tax difference is then $50K. You could argue that the profit is going to be taxed eventually anyway. But it's much better to take the tax hit later after the profit has been compounded.
I'm simplifying here, and I'm not a professional investor, so I've probably mixed things up, but you get the idea. From what I've read, the experts seem to feel that a 20% capital gains tax is not a big a deal but that over 25% would have consequences, though the consensus is not solid by any means.
The concern is that with too high a tax, investors will make decisions based on the tax cost rather than on sound investments, leading to an inefficient market. Secondly, if investors hold on to investments, the government actually makes less money because it doesn't get to tax the profits that it would have had the investors sold.
I'm not arguing about what's "right." I have no problem with heavily taxing the rich in principle. But if the economy suffers, or if the government earns less money because higher taxes impact investor behavior, then everyone suffers.
Great analogy, but I hope that you weren't serious about the love part.
June 20, 2008 4:07 PM | Reply | Permalink
Ahh Genghis, your use of blockquotes puts my meager web skills to shame. I have no time to respond properly right now, but I'll get back to you a little later.
June 20, 2008 4:18 PM | Reply | Permalink
<blockquote>Put your block quote here</blockquote>
June 20, 2008 5:08 PM | Reply | Permalink
Simple and I'll submit a suggestion to Obama's campaign about it: give a tax break for investment in companies where the majority of employees live in the USA.
Likewise, a further tax break for investment angels who focus on startups where the majority of employees live in the US.
June 20, 2008 12:28 PM | Reply | Permalink
You're right -- "not too wonky" is key. Media talking heads love feeding us the easy stuff.
It's ridiculous that none of them challenge the Republican candidates on this. It would be such a swell "gotcha" for them--seems like they'd jump at it.
June 20, 2008 12:00 PM | Reply | Permalink
I don't like dealing with numbers. I find it confusing and the rationale makes no sense to me. people can tweak numbers to fit whatever arguement they want to make (look at Hillary). However, I do not trust the GOP. They have spent the last eight years using fear to get what they want. I do not think it will work this time.
June 20, 2008 12:18 PM | Reply | Permalink
ARG, you have a point. Also consider that your 401K and 403B contributions lower your Social Security Contibution and may lower your eventual benefits. If you are near retirement you should run the Socail Security calculator to see if it will reduce benefits more than it saves in taxes.
I have my lower income client contributing to max any company match and then contributing their max to a Ross IRA, after 5 yrs withdrawals are tax free.
What I tell people is that Obama's plan is likely to eliminate tax for those making 50K or less per year and bad for people making over 240K per year or who own oil companies, hedge funds and ship jobs overseas.
June 20, 2008 2:22 PM | Reply | Permalink
No. 401(k) deductions reduce your taxable income (Box 1 on your W-2), but they do not reduce Social Security and Medicare income (Boxes 3 and 5).
June 20, 2008 5:57 PM | Reply | Permalink
I love the Devil's Advocate...Pacino and Reeves...like mixing Johnny Walker Blue with Fresca.
My $850 Argument is certainly a simplification for the purposes of...well...simplification. The point is that the fact that you have to take a 5% haircut on your net profits isn't going to make you throw your hands up and say "nevermind, I'll pass on the profits altogether." The capital gains tax is only due when you sell an investment for a profit, so by definition there is no "compounding over time" since it is a tax that is only paid once during your ownership of a stock, whether you own it for one year or twenty.
I do not necessarily agree that a higher cap gains tax rate will make investors less likely to sell stocks (or funds for that matter) that they currently hold, but if it does, "buy and hold" is usually a much more sound strategy than constantly churning a portfolio - look at Warren Buffett. If a higher cap gains tax rate makes more investors look at the stocks they buy as longer term investments, then we all win because the stock market will be less volatile.
With regards to your last point, please explain to me why it is right that the rate on unearned income derived from investment gains has any business being lower than that on earned income derived from work.
Please also remember that, with the exception of the impact on overall market conditions, this is all moot for anyone who only owns stock (or mutual funds) in a retirement or education account since they are exempt from these taxes anyway.
June 20, 2008 2:53 PM | Reply | Permalink
Double comment - sorry
June 20, 2008 3:18 PM | Reply | Permalink
The capital gains discussion is interesting; I too am unconvinced on this, especially to the higher end of the spectrum (though I favor a more progressive system overall). But I am even more concerned about the idea of raising the corporate tax rate (and I'm always skeptical of anything called a "windfall profits" tax that doesn't concern actual gouging).
June 20, 2008 4:40 PM | Reply | Permalink
Darn, I read this because I want to know how we win the 'compromise' FISA Bill argument so that they take remove any immunity provisions. The 'compromise' is definitely compromising the american people.
June 20, 2008 6:09 PM | Reply | Permalink
Tough to win an argument when both sides are wrong...
June 20, 2008 6:23 PM | Reply | Permalink
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