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Month: November 2020

Correcting Misconceptions About Capital Gains Tax

“The elimination of sanctuary cities, payroll taxes and perhaps capital gains taxes, must be put on the table,” President Donald Trump tweeted on May. 6.

The Democrats, led by House Speaker Nancy Pelosi, did not welcome the idea.

It might seem like a political issue, just something that the Republicans and Democrats just cannot agree with. However, some pundits are saying that the president’s statement was a product of misconception about the capital gains tax.

What the law says

The law provides that when an investor buys at a low price but sells the same property at a high price after a year, the long-term capital gain will be taxed at a rate that has been greatly reduced.

To put it into perspective, the rate of the tax for a top-bracket salary is 37%. However, the long-term capital gain is only taxed 23.8%. That is basically a discount of around 35%.

What would be the implication if Trump has his way?

The implication is that the wealthier individuals are again getting the better of the deal with the government. This is because the people who will enjoy the discount on the capital gains are wealthy individuals who can afford to invest on properties. Now, the president wants to remove that discounted tax altogether.

Basically, when Republicans claim to be lowering taxes, they usually mean lowering taxes for the wealthy. However, they also believe that such move would benefit the economy.

Taxing investment will not turn off investors

The biggest misconception about investment income is that when capital gain is taxed, people wouldn’t want to invest anymore. This is not the case especially with something crucial in terms of income and other related investment matters.

For example, what if the price of water goes up? Does this mean that people will stop buying water? No, it doesn’t. It may mean that people will be more circumspect about their water-buying practices compared to before, but they will still buy.

It’s the same with investment tax. Whether the rate is zero percent or 20%, people who have the money will still buy and sell properties.

There have been various technical models studied related to capital gains tax. The Atkinson and Stiglitz model, for example, was established in 1970. The model implies that capital income should not be taxed. However, the study was based on the premise of how much a person owes through wage and salary. The issue here is that it did not take leisure into consideration.

Another model looked into was the Judd model, which was tackled in the 1980s. It basically means the same thing that in the long run, the tax rate for capital should be zero. The model looks at economic growth over a long period of time.

The Judd model was analyzed to be faulty because it relies on the tenet that taxing investments will lower investments.

What happens now?

The debate between Republicans and Democrats continue. The public should listen to the arguments on how they would benefit whatever happens. In the end, the decision will depend on whether a Republican or Democrat controls the United States Congress.

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