A Better Capital Gains Tax

Taxes on long-term capital gains have fluctuated in recent years, with rates as low as 0% (for lower income groups) and as high as 28%. At the end of 2010 capital gains rates will likely revert to 20% after being at 15% for several years. While long-term term capital gains enjoy a tax break, short term capital gains (on positions held less than one year) have long been taxed at marginal income tax rates. While dividends have more recently been accorded the same tax breaks as capital gains, interest payments continue to be taxed as marginal income.

Capital gains tax breaks are designed to encourage investors to invest in the economy for the long term, thereby promoting economic growth. As currently structured, the capital gains tax break doesn’t really achieve this, as it simply rewards investors that hold a position for more than one year. The law does not distinguish between investments in startups or IPOs and in purchases of existing equity shares. With regard to real estate, the law encourages the tax-free flipping of properties via 1031 transactions, but does not reward investors who improve their properties.

Rather than subsidizing investments in existing shares and property, shouldn’t capital gains tax breaks attempt to promote new investments? This could be easily accomplished by lowering the capital gains tax rate to 0% for all new capital investments, irrespective of investment duration. A new capital investment could be defined as an investment in which the target company directly receives the proceeds of the investment. Investments in IPOs, secondary offerings, startup companies (including angels and VCs), and real property improvements would qualify, while purchasing of existing shares and real estate would not.

A 0% tax rate on new investments would incentivize real investment in the economy, rather than encouraging simple tax-related shuffling of existing investments. In order to offset deficit impacts, traditional capital gains tax breaks could be reduced or eliminated. Moving to a system in which new investment is incentivized would tip American finance away from the casino mentality of recent years, and back towards its original purpose: investing in promising companies for profit.

2 thoughts on “A Better Capital Gains Tax

  1. Trust cost, one thing congress and the democratic party forgets to realize as well as the american public, is that the capital gains tax is NOT indexed for inflation.

    If you buy a house in the 1980s for $2 million dollars, and its worth $3 million dollars today assuming an inflation of 50%, your house has the same value, but the IRS will tax you on $1 million dollars, hence you won’t be able to sell your home at a profit but rather at a loss.

    On the contrary, if in the recent years you bough a house you could profit on the housing boom by the $500,000 capital gains exclusion, and the $1.1 million dollar home interest deduction, this unfairly subsidizes real estate BUT only in the short term and that is not indexed for inflation.

    Comments welcome,

  2. Are profits from short sales taxed as capital gains, if so doesn’t that contradict the purposed of the tax?

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