The Wall Street Journal is reporting that the issue of capital gains taxes may come up in tonight’s debate, and the Obama campaign has attacked Mitt Romney for paying a 14.1% tax rate last year. But as my former Cato Institute colleague Chris Edwards tells the Journal, “[Romney] should be prepared not to act embarrassed about paying his 14% rate and proposing to keep low rates for high earners … there are a lot of good defenses” of paying a lower rate on investment income.
One of the better defenses I’ve read of this was a piece by left wing blogger/former Center for American Progress Action Fund fellow Matthew Yglesias. He writes:
You imagine two prosperous but not outrageously so working people living somewhere—two doctors, say, living in nearby small towns. They’re both pulling in incomes in the low six figures. One doctor chooses to spend basically 100 percent of his income on expensive non-durables. He goes on annual vacations to expensive cities and eats in a lot of fancy restaurants. The other doctor is much more frugal, not traveling much and eating modestly. Instead, he spends a lot of his money on hiring people to build buildings around town. Those buildings become houses, offices, retail stores, factories, etc. In other words, they’re capital. And capital earns a return, so over time the second doctor comes to have a much higher income than the first doctor…. [A world in which] people with valuable skills take a large share of their labor income and transform it into capital goods is ultimately a richer world than the world in which such people just go out to a lot of fancy dinners.
That’s the theory, at any rate. It’s a pretty solid theory, it’s in most of the textbooks I’ve seen, and it shapes public policy in basically every country I’m familiar with. Even researchers like Thomas Piketty and Emmanuel Saez (see “A Theory of Optimal Capital Taxation”) who dissent from the standard no taxation of investment income position think capital income should be taxed more lightly than labor income.
Low capital gains tax rates, then, incentivize investments that ultimately make the size of the economic pie larger for everyone. Obama’s preferences on tax policy, were he actually king of the world, would see those incentives stripped away. That would ultimately lead to more rich people hoarding their income, or going on trips to France, or what have you. Here’s Obama during the last presidential election cycle answering ABC’s Charlie Gibbs question about Obama’s plan to effectively double capital gains taxes: