Progress on the latest tax bill coming out of Congress is being reported. Senate Finance Committee Chairman Charles Grassley, R-Iowa, and House Ways and Means Committee Chairman Bill Thomas, R-California have been working to resolves issues between the bills coming out of the two chambers. Tops on the list is an extension of the 15% maximum tax on capital gains and dividends. Also included is relief from the Alternative Minimum Tax for some 15 million middle income taxpayers.
In order to pay for the extension of the preferential rate for capital gains and dividends, the House bill leaves out some pretty important items: the tuition deduction, the tax break for teachers who buy their own school supplies and a research and development tax credit for businesses.
I have never understood the preferential treatment of capital gains and dividends, especially dividends. Back when the top tax bracket was 70% (and, yes, I’m old enough to remember) the capital gains rate was 20%. The wealthy have gotten significant cuts in the tax brackets – the top bracket is now 35%. I see no reason for capital gains to be a maximum of 15%. And if dividends are taxed at 15%, why not interest as well? Both are investment income. Doesn’t it penalize conservative savers over risk-takers? Is that what we want to accomplish?
I’m fully in favor of indexing the Alternative Minimum Tax for inflation. This tax was designed to capture some tax on wealthy individuals who, due to other deductions, paid no regular tax. Because it has not been indexed, it is getting a lot of working people.
With the cost of college soaring, doing away with the tuition deduction is ridiculous. And that teacher supplies deduction is a big $250. Come on – the House would rather give fat cats a break over teachers?
Time to email my representatives.
VIVIAN J. PAIGE | All Politics is Local 
It’s fascinating to me to hear of another Democratic blogger who is also a tax professional (I’m a tax attorney). We simply must have lunch some time. I imagine that, if Webb wins the primary as I expect, then I’ll make it down your way at some point during the summer.
We should definitely have lunch.
Oh, and I totally agree with you about the teacher tax deduction. What do teachers make these days? If they are a single parent, after the deductions for the kids, what do you think their effective tax rate is? 10%? 15%? You and I know that the $250 deduction is really worth about $40 tops, probably more like $25.
Yes, we’ll have to get together. I’m coming to RIchmond in a couple of weeks.
Yes – that tax deduction isn’t worth much so why mess with it?
The purpose of lower (or zero) tax rates for capital gains is well-known — to encourage investment in businesses, who can use that investment to grow, improving the economy and employing more americans.
If you buy that, including dividends is a rational and actually necessary move. By taxing dividend higher than capital gains, the tax code artificially inflated the value of stock price inflation over return of income via dividends. So rather than pay dividends, business would buy back stock or build up cash, both in an effort to raise the value of their stock. Since paying dividends is a better indication of REAL income (it’s hard to fake income when you have to send real checks), we needed to change the tax code to eliminate this artificial bias toward stock price inflation.
If you wanted to push a lower tax rate on interest, I’d be with you. The argument isn’t as clean, but you could still say we want to encourage savings, and lower taxes on interest would do so. As it is, SOME interest gets special treatment, others don’t — that is why we won’t see this, because it subsidises state and county borrowing (because they are allowed to issue tax-exempt bonds at a lower interest rate).
The tax code as it is makes people to odd things. For example, if you have both normal investment, AND an IRA, you should put all of your INTEREST investments in the IRA, and use your normal investment for risky stock purchases. The reason? Capital gains are taxed at a much lower rate than interest — but ALL earnings in IRAs are taxed as normal income at retirement. So your IRA should have all the non-favored investments.
From a theoretical perspective, a fair tax code would tax investments only on the inflation-adjusted increase. If I buy a stock, and 5 years later it has only increased at the rate of inflation, I haven’t really made ANY money – the sale gives me money that buys the same items I could have bought 5 years earlier. But I can’t imagine how complicate THAT sort of calculation could be.
The lower tax rates for capital gains is a quick-and-dirty way of mimicking the theoretical desire for taxing only REAL gains, while encouraging people to invest for the long term.
What I don’t like is that while gains are fully taxed in the year they occur, losses can only be taken against gains, with only $3,000 loss allowed each year. People like myself, without a lot of money, and with large losses in the stock market, literally can take DECADES to write off all of our losses. If you earn $10,000 in one year, and lose 10,000 the next, it will be 4 years before you get your losses reflected in your taxes — but if you lose 10,000, and gain it the next year, all of the losses are taken care of in that year.
I like the teacher tax deduction — although it signals a problem with local schools providing the tools teachers need.
I’m glad that you agree that interest should be included. However, I disagree with the argument of taxing investments only on the inflation-adjusted increase. (We agree that it would be impossible to implement, so this is all theoretical.) The problem with that argument is that, while the tax brackets are adjusted for inflation, wages are not. And because of that, wage earners are making LESS money in real dollars but paying higher taxes. It is blatantly unfair to tax wage earners at a higher rate than investors.
I have a copy of the tax return form that was used for 1913, the first year of the permanent income tax. (We had some temporary income taxes before that.) I also have tax forms from the 1950s, when the top tax bracket was 90%. And I have all the forms from 1977 to present. What you see in reviewing all of this is that there are consistencies in certain items, such as mortgage interest and business expenses, which have always been deductible. But then you see the things that have crept in – and out – over the years as Congress set about trying its hand at social engineering and caving in to special interest groups. What is clear to me today is that the special interest group best served by our current code is the wealthy. The capital gains tax rate is a reflection of that. Same with the increase (and eventual elimination) in the estate tax.
The working person, though, has little. I remember when they phased out the deduction for personal interest (like credit cards and car loans). This was followed by an explosion in home equity loans, as those with equity shifted their personal debt over. This happened before the rapid increases in real estate that we have seen over the last 10 years, at a time when property values were basically stagnant and all the options for mortgages didn’t exist. So who benefitted from this? Certainly not your average Joe.
And before you ask – no, I am not in favor of a flat tax. It would cause most middle class folks to pay more in taxes that they do now. What I would like to see, however, is a simplified tax code. Take that 1913 return (which was 4 pages including instructions) and adjust it for inflation. The result would be a very large standard deduction and then a graduated tax on the amount over it.