Today, Green Eagle is about to offer a solution to a supposed problem that has gripped tax policy for decades, and which, as usual, business interests in government (i.e. Republicans) and the press have succeeded as portraying as utterly intractable. That is the issue of the difference in taxation between ordinary income and capital gains.
It is forgotten that there was originally a relatively rational reason for treating capital gains income differently from regular income. That is because much capital gains income comes from investments made years in advance of the profit; investments which, because of inflation, were worth more than their dollar value at the time they are sold. To give a hypothetical example, let's say that a person makes a $10,000 investment in year one, and sells his investment in year six, for $20,000. Under normal standards, that would represent a profit of $10,000. However, let us suppose that, between year one and year six, there was, say, 20% inflation. That means that, in year six dollars, the investment was actually worth $12,000, making a profit of $8,000 in year six dollars, not $10,000. Taxing this as though the entire thing took place in year six dollars was, quite reasonably, thought to be both unfair and a disincentive to investment. So, the idea of taxing capital gains at a lower rate than ordinary income, was born.
Of course, as soon as there was a consensus for that idea, the origin of it was erased from memory, amid endless demands from the rich that less and less taxes be imposed on their income. This has culminated in the absurd demands of many Republicans that capital gains not be taxed at all, and in the very real unfair advantage that people who don't work for their money now enjoy.
Here is how easy it would be to treat capital gains fairly. First, a small table could be included in tax forms, updated every year, looking like this:
This shows how much inflation has decreased the value of every dollar invested at any point in the last ten years. When calculating taxable income, the taxpayer would use the "inflated value" section of the chart to determine the value of the effective investment in current dollars. For example, $10,000 invested in 2006, for this tax year would have a net present value of $11,750. This figure would be subtracted from the amount realized from the investment this year, giving the net taxable income. This ludicrously simple (by IRS standards) rule would instantly compensate investors for the effect of inflation (as I mentioned, the only real reason to treat capital gains differently from ordinary income) and remove the disadvantage that multiple-year investments have over other forms of compensation*. Incidentally, it took me about twenty minutes to find inflation figures for the last ten years and compile this chart.
Now, here is the point that I want to make with this whole discussion. I am not an economist nor an accountant. There is nothing in my proposal that is in any way profound, or beyond the reasoning capacity of many politicians and economists today. The reason that you do not hear any of them offering simple solutions like this for our economic problems is not because they are stupid, but because they don't want simple solutions, they want unfairly beneficial treatment for the rich who pay their salaries. Rather than dealing with a real, but simply solved, problem, they create a cloud of obfuscation, and in the darkness they manipulate into existence something created solely to benefit a small group. We see this over and over again- problems remain unsolved, not because politicians can't solve them, but because they won't.
*I want to add that, based on normal practice, I do not believe this chart need extend any more than ten years into the past. However, it could obviously extend for 12 years or 15 years, or any period thought fair.
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