Labor and Capital, and How They’re Taxed

Wednesday, October 3, 2012 at 2pm
By John Friedman

The country, and even some of the globe, waits expectantly for the presidential debate tonight. Afterwards, heads will talk, pundits will opine, spinmeisters will spin, and watercoolers everywhere will be privy to more political comment than usual.

Can everything the presidential election is about be contained within 90 minutes followed by a couple of news cycles?

Clearly not.

But there is a concept that can illuminate much of the whole thing, having to do with the way economies are structured. The concept is that there are two types of economic actors out there, within the economic layer of our lives, each of which inherently embodies economic power; one is labor and the other is capital.

Stereotypically and simplistically, if you’re a working stiff, then your power comes from your ability to toil and endeavor and accomplish, which you can exchange with duh man, who has capital — that’s from whence duh man’s power comes — and who can pay you some capital in exchange for your ability to toil and endeavor and accomplish on duh man’s behalf.

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Now this is not the time or place to delve into economic philosophy (nor am I the one to do it!).

But this is the perfect place to talk about the financial health of all those reading this blog, and to, part and parcel of that conversation, also talk about how our tax code has changed over the last decade.

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Income taxes are all about taxing . . . income. Income, in turn, comes from one of two buckets: some of your income comes in to you as a result of your laboring, and some of your income comes in to you as a result of capital you might have previously acquired over the years (because money tends to beget other, new money).

Most readers are familiar with labor-generated income: for employees, it’s their paycheck, and for self-employeds, it’s the bottom line on their profit & loss statement (more or less . . . ).

From those incomes we all pay income taxes (except Snipes and others of his ilk). Most folks pay income taxes at marginal tax rates of 25 to 28 percent

Two asides: if you don’t know what a marginal tax rate is, why, then, you don’t know The First Thing about taxes. I’ll write that one up one of these days. Also, the all-time greatest source for historical income tax rate data is brought to you by the friendly folks at The Tax Foundation. Please do take a look in there; it is a truly eye-opening experience for a lot of people).

Back in the 90s, some people with high incomes paid income taxes at a marginal tax rate of 39.6%. George Bush’s tax code changes killed that bracket off, and all hell has been breaking out over the last several years about whether that bracket should come back at all and, if so, whether it should apply to lots of folks (those making over $250k per year) or not that many folks (those making over $1 million per year)

And get a load of this: when George Harrison wrote, lamentingly, in the first line of Taxman that he’d gone down to the crossroads to see his taxman, and that the taxman had simply said to George, Here’s one for you, nineteen for me, he was indeed complaining about a 95% marginal tax rate, which the UK did indeed have in the 60s, a time at which we here in the U.S. had already had, for a decade or so, marginal tax rates that topped out at only the paltry, Here’s one for you, ten and a ninth for me, i.e., a marginal income tax rate of 91%.

So that’s labor: on the margin, it’s taxed at 25% or 35% for most folks. Back when, it was taxed on the margin as high as 91%.

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Under our current tax code, capital does better.

Capital-generated income comes in several forms, primarily falling into three camps: there’s (a) dividends, which is the sort of capital-generated income that stocks beget, and then there’s (b) interest, which is the sort of capital-generated income that bonds and bank deposits beget, and then there’s (c) capital gains, which is the sort of capital-generated income that comes from selling an investment for more than you paid for it.

These days dividends and capital gains are, for the most part, taxed at a rate of 15% or less (for low income people, the rate is . . . 0%), while the interest each person receives is taxed at the same rate as the labor-generated income that person receives (that’s right: our current tax code is very churlish towards bond income).

Back in the day, dividends a person received were taxed at the same rate as that person’s labor-generated income was taxed at. And as for taxes on capital gains back then . . . well, that the Cap Gains Tax, as they call it, has been so much of a politcal football slash punching bag for so long that trying to sumamrize recent history of CG taxes would tax both my word limit and your reading limit. Suffice to say that, before 2001, tax rates on capital gains were, for the vast majority of people in the vast majority of circumstances, taxed vastly more than 15%.

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So today we have a system in which a lot of capital-generated income is taxed at 15%, while a lot of labor-generated income is taxed at 25% or more.

And that is how you can end up with really rich people paying far lower tax rates (and here I intentionally leave off the “income” modifier to refer to the overall tax burden a given person pays, including payroll taxes, income taxes, sales taxes, property taxes, fuel taxes, etc., etc., etc.) than just about every other normal person in the country.

These, I do sincerely believe, are facts, based in reality (though filtered, necessarily, through my perceptive apparatii).

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So what’d’ya think of that system?

Once again, gentle reader, I leave this to you as a Rorschach test.

Is this a good system? Does it make sense? Should working stiffs pay higher tax rates than people who are floating their boat off of the capital they’ve accumulated over the years?

And then this: as the debate unfolds tonight, what do you hear each person saying about labor and capital, and does any of it/part of it/all of it make sense?

 

904 words (less than a ten minute read, sans links)

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