Stop Favoring Investors, Speculators over Middle Class


I, like most members of the middle class, particularly in California, just paid a tax bill that seemed less like my fair share than a shakedown by the Mafia. Increasingly, for people who run small businesses or earn a decent income, the tax bite is becoming ever more like in Europe, with total bills in high-tax states like ours reaching upward of 40 percent. It’s like paying the bill for a big dinner without eating the food – we get hammered like Swedes but without the free education, health care and other benefits of a more conventional welfare state.

Most galling is that, while the middle class has endured ever-higher taxes, those who have benefited most from the Bernanke-Obama “recovery” continue to get the biggest tax breaks. This is largely the investor class, who have been able to reap the benefits of the stock-market boom and, in some areas, including coastal California, the steep rise in real estate prices.

Of course, the rich and corporations have all sorts of ways to avoid taxation – like offshore accounts – but the real class divider is capital gains. Today, long-term capital gains are taxed at the federal level at a maximum 20 percent, while the small-business owner, writer, consultant or professional, if they do relatively well, are stuck with income tax rates up to 39.6 percent, approaching twice that level.

Generation gap

Overall, you don’t have to be super-rich to be hit. The portion of the tax burden absorbed by the top 20 percent of earners has grown – a California family with an income of $150,000 would qualify – from 65 percent to 90 percent. Even worse off are younger families, which generally have less to invest and have been stuck with a tepid job market; from 2007-10, households of people under age 40 have seen their net worth drop, while older Americans have now recovered most of their losses from the economic downturn.

In the past, this differential in tax rates often was furiously justified – usually by conservatives – as sparking investment and job creation that would benefit younger and poorer Americans. This argument is increasingly specious; the recent massive stock-market boom has been characterized by relatively low investment in plant and equipment, meager job growth and, by the way, ever-increasing inequality. In 2009, due largely to lower taxes on capital gains, the 400 highest-earners, with gross incomes above $200 million, paid an effective tax rate well below even those in the top 1 percent, which includes many small-business owners and professionals.

Defenders of the tax break will also cite “democratic capitalism” and point out the fact that so many people depend on the stock market. But, in reality, stock market capitalism is becoming less democratic: Stock ownership has become more concentrated, with the percentage of adults Americans owning stock the lowest since 1999 and a full 13 points lower than in 2007.

Depression-era inequality

As the hard-pressed middle class has withdrawn from the market, due to mistrust or lack of resources, the very rich have been having a veritable feast. To be sure, the top 10 percent gained half of all reported income, but the top 1 percent accounted alone for halfof that. This is one reason why inequality is now greater than at any time since the Great Depression.

Increasingly, then, the benefits of the plutocratic tax break are ever more thinly shared. I am sure we all are happy that when the 50 or so lucky insiders at WhatsApp collect their $19 billion from Facebook, they will pay taxes on that windfall at well below the rates paid by the salaried upper-middle class professional or small-business owner. Yet their product, although no doubt cool, is unlikely to produce many jobs, or even boost productivity.

The biggest beneficiaries, besides the insiders, will be sellers of luxury homes and vehicles, and the high-end restaurants and shops in the already saturated, overpriced Silicon Valley market.

Where’s the left?

Clearly, something needs to change, and, ironically, one wonders where the class warriors of the Left are on this. They have become increasingly bold (or honest) in stating that we should continue raising taxes on the middle and upper-middle classes, as a recent New Republic piece suggests, but seem less than vehement about equalizing taxes on capital gains and other income.

This may have something to do with the shift in backing for “progressive” causes coming from the very people – Wall Street traders, venture capitalists and tech executives – who benefit most from the capital gains scam. The confluence of big money and populist rhetoric is epitomized by New York’s powerful senior senator, Charles Schumer, who has made a career of both raising money from Wall Street financiers and defending preferential treatment for their outsized profits. Their growing power over the party of ever-expanding government leaves only one place to finance Democrats’ ambitious plans – the middle and upper-middle classes.

I don’t hold all that much hope that reform will be pushed by most Republicans either, since they for far longer have been the party of accumulated wealth. But, as far as I can see, it is mainly conservatives, such as retiring Congressman Dave Camp, who seem ready to embrace the notion that taxes should be equalized between income and investment within the context of a flatter revenue system.

SPotty support

But too many Republicans remain in love with lower taxes on investment, with some conservatives placing a similar faith in the positive effects of low capital gains as progressives do on the need don hair shirts to reverse global warming. Rand Paul’s proposal for a flat tax addresses some of these ideas, although Paul still seems to think capital gains should be taxed at a lower rate than normal income. This proposal may be better than the current system, but progressives rightly predict it would not address the fundamental inequality in the tax code.

All this is distressing, given that it is clearly time to reform the tax code to stop favoring investors and speculators over middle-income earners. This may prove the best way to slow the dangerous accumulation of financial assets by the few, notes author Charles Morris. He also adds that such reform could have many positive effects on the economy. Cutting the top 1 percent’s share of Americans’ total income to 14 percent or 15 percent, still higher than the pre-1980 norm, he calculates, could allow us to spend about $1 trillion for middle-class tax relief, relief for the poor, health care, education and infrastructure.

The need to jettison the capital-gains advantage has also been endorsed by Larry Summers, former Treasury Secretary under President Clinton and a former Obama adviser. Even Bill Gross, the head of Newport Beach-based bond giant Pimco, has suggested that, given the perverse effects of the tax system, that capital gains income should now be taxed at the same rate as regular income. Gross admits his investors did not like the idea since such changes are not in their immediate financial interest.

With some leading conservatives, business leaders and liberal economists on board, perhaps this is still an idea whose time has come. Clearly, the current tax regime is not working, having just created a shallow “recovery” largely enjoyed primarily by the very richest members of society. It is time for people on both right and left to admit that such a recovery is not socially sustainable or congruent with the fundamental notion of democracy. It is time to reform the tax code, so that it works not only for the rich and well-placed, but the rest of us, as well.

This article first appeared in the Orange County Register.

Joel Kotkin is executive editor of and Distinguished Presidential Fellow in Urban Futures at Chapman University, and a member of the editorial board of the Orange County Register. He is author of The City: A Global History and The Next Hundred Million: America in 2050. His most recent study, The Rise of Postfamilialism, has been widely discussed and distributed internationally. He lives in Los Angeles, CA.

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lower corporate taxes to 5

lower corporate taxes to 5 percent so business will invest here. raise inflation adjusted capital gains to income tax rate to make up the difference.for flat taxers the is a difference 50,000 500,000 5 million 5 billion. our top professionals making between 80000 and 350000 should not be the ones screwed.

Capital Gains are Subject to Risk

Mr Kotkin has forgotten that while wages are pretty much guaranteed unless you are working for a distressed company (and even then they are top priority in liquidation), whereas capital gains are not. So in addition to the inflation issue, there are no guarantees when making an investment that there will be a gain. Certainly the stock market boomed back after the crash, but I'm not at all inclined to think that was Obama's doing.

Also, most financial analysts will claim that the value of an asset ultimately represents the expected value of after tax future cash flows. That's sometimes a head scratcher when you consider how stocks bounce around day to day, but anyone who has ever been involved in buying or selling a business has probably been exposed to spreadsheets where cash flows are forecast in mind boggling detail. If taxes on capital gains are increased then by the theory asset values should decline so as to bring after tax returns back into line with where they were before the tax increase. If that happens, everyone's 401k plans take a hit. Is that something we really want to do?

And in what world is this really a priority? We seem to be able to get plenty of investment money for software startups, new hedge funds, movie productions, etc. that employ white collar workers or the gentry as Mr Kotkin sometimes calls them.

What we need is investment in industries that will hire the working class. Those often require significant investment in plant and equipment, not to mention taking on risk. Mr Kotkin often notes that such investment is being made in Texas, the south or in the plains states but often not in CA, NY or other northern states.

If we think that is something we want does anyone really believe we'll obtain such investment by telling the financial backers that "oh, by the way, while we want you to make these investments we really don't want them to become big financial successes and we'll tax the bejesus out of you if they are"?

I think you have this backwards.

So...why not lower the top income tax rate to the same as the capital gains rate? I fail to see why government needs another dime of my money.

I don't think the median taxpayer pays anywhere close to 20% in taxes. No big deal, though, an equal rate is pretty much fair. Lower the top income tax to 20%, remove the Federal Deduction for State Income and Real Estate Tax, and you get a relatively flat and fair system.

Tax Real Capital Gains

One issue with capital gains is that we wind up taxing inflation. Instead of the lower tax rate, we might have the taxable amount being
(Sale Price-Purchase Price *Current CPI Index/CPI Index when you bought it). That way, we tax just the real buying power increase. That treats things like the Facebook founders' windfall differently from the farmer who sold the land he's had for 30 years.

Given the play that Piketty's Capital in the 21st Century has been getting, I'm surprised he didn't get a cite here.