Buffett Rule - Class Warfare

[GTsail]

Anyway, I can tell you how to fix this little problem of injustice right now. Stop classifying capital gains as income. It isn't income. Any middle class homeowner would agree that when his house goes up $10,000 in value he hasn't made $10,000 unless he sells. And even then it's an investment that paid off, not income. He took the risk, he gets the reward. If you want to tax capital gains at 30% you need to tax all home value increases at 30%, because they are fundamentally capital gains.... what's that? No?

Capital gains is not income. Stop classifying it as such and you'll see Mitt Romney's overal tax rate shoot through the roof - way higher than his secretary. That's what he already pays on his income now, you just can't tell because capital gains are getting confused with real income.....

Danoff's post got me thinking about the differences between Capital gains and other types of income, and whether Capital Gains should get taxed at different rates or not taxed at all.

My first thought was that I'm not sure that the income being received from capital gains is all that different than income being received from other activities.

Two scenarios: You have $10k to invest:

1) Lets say that you decide to open a lemonade stand near your house. You buy a bunch of supplies, lemonade ingredients, buy some advertising, pay a sales staff, and spend some money on a lemonade stand. All of this costs you the $10k. By the end of a year you sell $20k of lemonade, so your income is $10k. This $10k is fully taxed as schedule C income and you pay whatever the tax rate is depending upon your overall tax rate (lets say 25%).

2) Lets say you invest $10k in the stock of Starbucks. Starbucks takes this investment and opens up a juice bar within one of their stores and sells lots of juice over the next year. The value of Starbucks stock goes up $10k, so at the end of the year you sell your stock for $20k and have a capital gain of $10k (and pay tax at the 25% rate).

In both cases, you made $10k and in both cases you risked $10k, because it was possible that you might have lost money in either scenario if the juice sales did not materialize.

Why wouldn't the income/proceeds from either scenario be taxed at roughly the same rate? Aren't they both income?

Or should buying Starbucks stock get preferential tax treatment to encourage all coffee fanatics to invest in stock? Or maybe lemonade stands/schedule C earnings/small businesses shouldn't get taxed, and only wages should get taxed?

Respectfully,
GTsail

 

[Danoff]

Well, in scenario 1 you have a business - that $10k in profit doesn't actually get taxed as long as you re-invest it in the business. If you pay it to yourself as income, it becomes income.

In scenario 2 you buy part of a company that goes up in value. You sell that part of the company and no longer own it at the end of the year. In scenario 1 you're still in the lemonade business scratching yourself checks from the company holdings into your name for personal use. In scenario 2 you're OUT of the juice business having bought and sold a stake of something that increased in value.

Let me put it this way, we can consolidate these two scenarios into one scenario... scenario 1.

You decide to open a lemonade stand near your house. You buy a bunch of supplies, pay a staff, and spend $10k. At the end of the year you sell $20k of lemonade and scratch yourself a $10k check for the profits. You then sell the entire lemonade stand for $20k to someone else to run. Our government would tax your $10k in income as well as your $10k in capital gains.

The first part is fine with me. It's you taking a cut off of a trade transaction. There's no risk in it, the money is there, you just take some of it and pay a tax on commerce. The second part is you taking a risk by buying something with post tax dollars and hoping it becomes worth more in the end. The government coming in and saying you need to pay tax again seems wrong.

 

[Joey D]

I like the Buffet Rule for the reasons Dapper posted on the first page, it keeps Congress in checks and attempts to bring them down to reality.

However, the whole tax thing would be way easier to handle if they just threw a flat tax out there. You know everyone pays 30% of their income in taxes, that way it's fair for everyone. I'd be paying the same share of my income as the CEO making billions, he'd just write a bigger check than I would.

 

[GTsail]

Another Capital Gain situation:

1) Lets say that you go to work for an investment banking firm. The Firm allows you to use $1 million of their capital. During the year you buy and sell stock and make $100k for the Firm. The Firm pays you a salary of $95k for this effort. The Firm keeps $5k to cover the cost of capital.

2) Lets say that you decide to go into business by yourself from your home (you dislike traveling by train every day into Manhattan). You borrow $1 million from a bank. During the year you buy and sell stock and make $100k for yourself. At the end of the year you pay back the $1 million bank loan plus $5k for interest. Your schedule C/self-employed income is $95k.

In both situations, you earned $95k during the year for buying and selling stock.

Should the $95k be taxable in both situations? Or should only the wages earned in scenario # 1 be taxable?

Respectfully,
GTsail

 

[Danoff]

Another Capital Gain situation:

1) Lets say that you go to work for an investment banking firm. The Firm allows you to use $1 million of their capital. During the year you buy and sell stock and make $100k for the Firm. The Firm pays you a salary of $95k for this effort. The Firm keeps $5k to cover the cost of capital.

2) Lets say that you decide to go into business by yourself from your home (you dislike traveling by train every day into Manhattan). You borrow $1 million from a bank. During the year you buy and sell stock and make $100k for yourself. At the end of the year you pay back the $1 million bank loan plus $5k for interest. Your schedule C/self-employed income is $95k.

In both situations, you earned $95k during the year for buying and selling stock.

Should the $95k be taxable in both situations? Or should only the wages earned in scenario # 1 be taxable?

There's a major difference between the two scenarios (I know you're trying to make them as parallel as possible). In the first case, you take no risk. You perform a service which you're promised a commission from. In the first scenario, your wages are $95k and the company's capital gains are $5k.

In the second scenario you are the company. You take the risk (even though the bank is fronting the money, you owe the bank even if you lose money). Again, you're not paying yourself for a service, you're purchasing something that is changing in value (like everything you purchase). In this scenario your capital gains are $95k and the bank's wages are $5k.

Let me throw a counter-example at you.

Timmy buys a pack of baseball cards every weekend with money he earned for making his bed every morning. He keeps the baseball cards in mint condition, and trades them with his friends who are also into baseball card collection. Eventually he manages to trade for a very rare card that is worth a lot of money.

Timmy invested a grand total of $100 over a year to buy baseball cards. Through careful trading, networking, and holding the right cards, after 5 years he is able to turn a profit of $20,000.

Timmy owes the IRS capital gains on the profits from his baseball card trading. Make sense to you? This is not income. Timmy isn't getting a salary for a service. He's risking his own capital purchasing goods that are changing in value and try to do so intelligently.

 

[MatskiMonk]

Timmy's Mum and Dad should start charging him rent.

 

[GTsail]

Well, in scenario 1 you have a business - that $10k in profit doesn't actually get taxed as long as you re-invest it in the business. If you pay it to yourself as income, it becomes income.

In scenario 2 you buy part of a company that goes up in value. You sell that part of the company and no longer own it at the end of the year. In scenario 1 you're still in the lemonade business scratching yourself checks from the company holdings into your name for personal use. In scenario 2 you're OUT of the juice business having bought and sold a stake of something that increased in value.

Let me put it this way, we can consolidate these two scenarios into one scenario... scenario 1.

You decide to open a lemonade stand near your house. You buy a bunch of supplies, pay a staff, and spend $10k. At the end of the year you sell $20k of lemonade and scratch yourself a $10k check for the profits. You then sell the entire lemonade stand for $20k to someone else to run. Our government would tax your $10k in income as well as your $10k in capital gains.

The first part is fine with me. It's you taking a cut off of a trade transaction. There's no risk in it, the money is there, you just take some of it and pay a tax on commerce. The second part is you taking a risk by buying something with post tax dollars and hoping it becomes worth more in the end. The government coming in and saying you need to pay tax again seems wrong.

In your new scenario above, you are no longer comparing wage income to Capital gain income, but are just considering the tax treatment of the Capital gains earned from selling a lemonade stand.

So how about this situation:

1) Same scenario as proposed above: you start a lemonade stand, sell some lemonade, and then sell the lemonade stand for $15k (so you have a $10k capital gain)(I am assuming a tax basis of $5k in the stand).

2) Your partnership (called Lemons 'R Us) is in the business of buying and selling Fruit Juice stands. You happen to see a nice lemonade stand, so you buy it for $5k. At the end of the year you sell the stand for $15k (so you have a $10k capital gain).

In both situations, you received a $10k capital gain.

Should the capital gains be considered income?

Are the two capital gains different in some material way that would require differential tax treatment?

Respectfully,
GTsail

 

[Danoff]

I see no fundamental difference between those two.

 

[GTsail]

.....Timmy buys a pack of baseball cards every weekend with money he earned for making his bed every morning. He keeps the baseball cards in mint condition, and trades them with his friends who are also into baseball card collection. Eventually he manages to trade for a very rare card that is worth a lot of money.

Timmy invested a grand total of $100 over a year to buy baseball cards. Through careful trading, networking, and holding the right cards, after 5 years he is able to turn a profit of $20,000.

Timmy owes the IRS capital gains on the profits from his baseball card trading. Make sense to you? This is not income. Timmy isn't getting a salary for a service. He's risking his own capital purchasing goods that are changing in value and try to do so intelligently.

This is exactly the point that I'm trying to make. What is the difference between selling "capital" assets vrs selling "non-capital" assets? You are still "selling" an asset, and earning some income.

If yesterday, you purchased the above baseball card for $100, and sold it tomorrow for $20,000, would you consider the $19,900 earned as income?

Why would holding the baseball card for 5 years, and then selling it, eliminate the income that you earned from selling the card?

Respectfully,
GTsail

 

[Danoff]

If yesterday, you purchased the above baseball card for $100, and sold it tomorrow for $20,000, would you consider the $19,900 earned as income?

Nope, that's speculation with post-tax dollars. It's really the difference between taxing trade and taxing investment.

A baseball card appreciating is an investment (though selling it is trade).
Buying a portion (or all of) a company is an investment.
Selling your labor is trade.
Selling goods you produce is trade.

 

[GTsail]

Nope, that's speculation with post-tax dollars. It's really the difference between taxing trade and taxing investment.

A baseball card appreciating is an investment (though selling it is trade).
Buying a portion (or all of) a company is an investment.
Selling your labor is trade.
Selling goods you produce is trade.

When did you pay any tax on the $19,900? It was only earned over the last two days.

How is buying a baseball card yesterday for $100 and selling it tomorrow for $200 (or $20k) any different than a store buying a TV yesterday for $100 and selling it tomorrow for $200?

Aren't they both "selling" an asset? Haven't you received some sort of monetary renumeration for your efforts in both cases?

Respectfully,
GTsail