The Breakdown

Explaining Southern California's economy

Easy choice: Money and no job, or a job and no money?

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47929 full

Felix Salmon has a great post today about, basically, why we need to tax capital gains at a higher rate. I made a rare Tuesday appearance on "America Now" — the radio program hosted by the always lively Andy Dean, with whom I usually discuss and debate economics and business on Fridays — and wound up talking about this very topic, as it relates to Mitt Romney's taxes. 

In a nutshell, capitals gains is income derived from investment returns — selling stocks and bonds, or collecting dividends, that type of thing. The argument in favor of keeping them lower than income tax is that people with money to invest, i.e. the affluent, need an incentive to keep investing. The idea is that a virtuous circle will be created, with investment creating jobs and jobs creating income and that income being invested, by people who wouldn't otherwise invest. Presto! Economic growth!

Some critics of raising cap gains — and cap gains, currently at 15 percent, are at rather low historic levels after being cut during the administration of George W. Bush — don't like that the tax represents a second bite at the apple for the IRS. Income is taxed first as income, then taxed again if it yields a return when invested.

Felix looks at this in the context of how much better people with money to invest are doing right now than people with mere jobs:

[I]t would stand to reason that the share of national income going to labor should be rising, not falling. Labor incomes are going up, the number of employed people is going up, and income from savings is going down. And yet! It turns out that people with capital are so rich, and getting so much richer, that it’s not even close. All that belly-aching about the plight of savers on fixed incomes in a zero interest-rate environment? Well, you don’t see it in these numbers. Looking at this chart, if you were given the choice between having money and no job, or having a job but no money, it’s not obvious which one to go for.

That's a drastic verdict. And it reminds me of my favorite chart of all time, above. 

It's the Dow Jones Industrial Average. And it's my favorite chart of all time because it shows the DJIA...for all time!

As you can see, up until the mid-1980s, the Dow went pretty much nowhere. Then it took off like a rocket, fueled by a massive debt expansion that began to turn into cataclysmic boom-and-bust cycles in late 1990s. 

Financial assets went from being something that no one really needed to invest in to something that could provide massive returns and that, with the decline of traditional pension and retirement plans, people had to invest in (although, on the flipside, you had to deal with massive losses).

Why didn't anyone need to invest in stocks? Because incomes and basic savings were enough. For almost the entire 20th century, the Dow stayed under 2,000. Then, in the past 30 years...Boom! Plus 11,000 points. 

The most recent recovery in the markets has also been spectacular. If you'd put money in back in 2009, you'd be sitting on a hefty return right now. This is why you want capital, rather than a job, in Felix's deft analysis. With capital, you buy assets and watch the returns roll in and that's all you have to do. If you have enough money, you can treat this as income and see it taxed at 15 percent (or less). 

If you have a job, you get to go to work every day and be taxed, in some cases, at a much higher rate.

This is obviously not a case against investing. In fact, it's pretty clear that you need to think about investing now more than ever.

The rich are getting richer. So much richer, in fact, that it doesn't entirely make financial sense to not be rich. So maybe critics of raising capital gains are worried about the wrong thing. They're afraid that investors won't invest. But they should be worried about workers not working.

Follow Matthew DeBord and the DeBord Report on Twitter. And ask Matt questions at Quora.

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