Capital and Taxes

At 10:18 PM 8/13/96, Brad Dolan wrote:

>... and while I'm ranting...
>
>Can somebody explain why:
>
>1. Good jobs of the future are knowledge jobs which require little
>capital investment.
>
>and
>
>2. We need a capital gains tax cut to encourage capital investment to
>stimulate the growth of good jobs of the future.
>
>?

Sure, as an investor in some small companies and a high-risk startup, I'll
give some thoughts on what motivates _me_, and why a capital gains tax cut
would help the economy.

First of all, let's dispense with any confusion between "capital
investment" and anything related to "capital goods" or "capital equipment."
The two things are not at all the same.

Consider a business that needs (or claims/hopes/plans) $1M in initial seed
money to get rolling. Sure, some businesses get started with less, or with
nothing, and finance growth out of sales. But a million bucks is not at all
uncommon for a startup company that needs some work to be done before sales
get started.

Note that this million dollars has nothing to do with buying "capital
investment," in the sense I think you mean (and in the sense I think Bart
Croughs meant). It may all go to salaries for, say, 5 people for a year or
two, plus office expenses, some other expenses, etc. Maybe even $50K worth
of computers. This a "knowledge-intensive" company with very little needed
in capital equipment.

How is this money raised, and what calculations does a potential investor
make about the risks, rewards, returns on investment, etc.?

For one thing, the gains on such an investment over some time period
(typically 3-6 years) are _capital gains_. These are now taxed at a
marginal rate of 28% Federal plus whatever state and local taxes may apply,
Here in California, the effective total marginal tax rate is 38-40%,
depending on some factors. (In several industrialized countries the capital
gains tax rate is zero, or nearly zero.)

But this 38% rate doesn't even tell the whole story. Suppose that I want to
make a $100K investment in this company my friends are trying to start.
Money has a cost, both in the "rent" that is charged on it, or the "rent"
that _could have_ been charged to another for an alternate use, and on
something else that's terribly important: taxes must be paid on other
assets sold to raise the $100K. For example, if I own shares in Intel,
bought many years ago, I have to sell $160,000 worth of Intel stock, send a
$60,000 check to Uncle Sam and Uncle Pete, and then send the remaining
$100,000 to my friends. If the new investment *doubles*, my $100,000 gain
is taxed at 38% and I'm left with a gain of about $62,000.

It doesn't take a number theorist to see that I may as well have not even
bothered. So long as I just sit on the Intel stock, no taxes are owed.
Sounds like a no brainer to me.

Yes, taxes will _someday_ have to be paid...but many of us are hoping,
praying, and pleading for a cut in the capital gains tax rate...at least a
rollback to the 22% rate of yesteryear (and 4% or less in states). This
huge "backlog" of unrealized capital gains (aka gains on paper, but not yet
taxable) is what is being spoken of when people like Jack Kemp and Steve
Forbes speak of "unleashing" the capital gains now tied up due to the high
tax rates.

(Letting capital flow more easily will also make for a more efficient
market. It may be that I would've liquidated much of my Intel holdings had
the tax penalty not been so high.)

There are many more things I could say, but this is already too long. Just
don't think in terms of "capital" as just being "capital equipment." It is
really "investment" in all its many forms.

"Free the capital--and I don't mean D.C."

--Tim May, author of "DOS Capital"

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>>>>> Brad Dolan writes:

BD> Now imagine that I want to make that $100K investment or, more
BD> realistically, that I want to invest $100K in my kid's college
BD> education.  I'm going to have to earn wages of $160K and pay $60K
BD> in tax.  It would make me cranky if the guy next door could just
BD> clip $100K of coupons, tax free, to pay for his kid's education.

BD> While I'm sure Steve Forbes could, I can't think of a moral
BD> argument why income from selling stock should be taxed at a rate
BD> lower (or higher) than than income from wages.

	Because, when you work harder (or more), you are (presumably)
producing more and adding to the economy.  When you leave money in an
inefficient investment, you aren't.  Of course, this is all based on
the premise that income taxes are moral in the first place. (;

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On Tue, 13 Aug 1996, Timothy C. May wrote:
> 
> But this 38% rate doesn't even tell the whole story. Suppose that I want to
> make a $100K investment in this company my friends are trying to start.
> Money has a cost, both in the "rent" that is charged on it, or the "rent"
> that _could have_ been charged to another for an alternate use, and on
> something else that's terribly important: taxes must be paid on other
> assets sold to raise the $100K. For example, if I own shares in Intel,
> bought many years ago, I have to sell $160,000 worth of Intel stock, send a
> $60,000 check to Uncle Sam and Uncle Pete, and then send the remaining
> $100,000 to my friends. If the new investment *doubles*, my $100,000 gain
> is taxed at 38% and I'm left with a gain of about $62,000.
> 
> It doesn't take a number theorist to see that I may as well have not even
> bothered. So long as I just sit on the Intel stock, no taxes are owed.
> Sounds like a no brainer to me.
> 
> Yes, taxes will _someday_ have to be paid...but many of us are hoping,
> praying, and pleading for a cut in the capital gains tax rate...at least a
> rollback to the 22% rate of yesteryear (and 4% or less in states). This
> huge "backlog" of unrealized capital gains (aka gains on paper, but not yet
> taxable) is what is being spoken of when people like Jack Kemp and Steve
> Forbes speak of "unleashing" the capital gains now tied up due to the high
> tax rates.


Now imagine that I want to make that $100K investment or, more 
realistically, that I want to invest $100K in my kid's college education.
I'm going to have to earn wages of $160K and pay $60K in tax.  It would 
make me cranky if the guy next door could just clip $100K of coupons, tax 
free, to pay for his kid's education.

While I'm sure Steve Forbes could, I can't think of a moral argument why 
income from selling stock should be taxed at a rate lower (or higher) than 
than income from wages.

Jamie Whitten, late chairman of the House Appropriations Committee once 
said, "All anyone wants is a special advantage over the next fellow.  
Understand that, and you've understood the intent of every law ever passed."

I think that applies to tax law.

bd