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Capitol Games on Capital Gains

David Callahan

There are a great many ways in which the "Buffett rule" is a very clever proposal. It highlights an appalling loophole in the tax code, aligns Obama with America's most successful investor, and has focused attention on how Obama wants to raise taxes on the truly well off, as opposed to all those upper-middle class households making just over $250,000.

This last point is especially important, since politicians and the media love to tell sob stories about strapped affluent households who supposedly can barely make ends on low six figures -- when, in reality, the Obama tax hikes will mainly affect truly high earners.

But for all its brilliance, there are ways in which the Buffett rule is turning out to be a distraction. For one thing, commentators have had a field day pointing out that the number of rich people who live entirely off their capital gains is small, which is true, and also that most rich people, in fact, pay a higher tax rate than ordinary Americans, which is also true. Critics of tax equity have thus gotten an opening to charge Obama with demagoguery, which is nonsense. The Buffett rule is one small dimension of the plan, not the plan itself. And it does correct a very real problem even if that problem is not so large in the grand scheme of things.

But the bigger annoyance here is that the Buffett rule has not sparked the clear conversation we should be having about capital gains taxes. The problems with today's low capital gains rate go far beyond the ability of millionaires to duck proper taxation. Taxing wealth creation at a lower rate than work has other well-known problems, too.

The rationale for such lower taxes is that we want to incentivize people to take risks. But those incentives can have unintended consequences, as we saw during the real estate boom. One reason that so many Americans got into the game of flipping homes is that such speculation was -- and is -- a bargain under the tax code. Profits on real estate gains were -- and are -- taxed at 15 percent (or nothing if the home is your main residence for two years and you and your spouse make less than half a million dollars in gains), and that rate sure beats what you'd pay in combined federal, state, and payroll taxes for a normal day job, especially for more affluent professionals. Throw in the mortgage interest deduction and you can see even better why this form of speculation was so popular.

Another problem with taxing work more than wealth is that it advantages those who have wealth to begin with. It takes money to make money, as the old saying goes, but most Americans don't have money. We just have our labor. It's not fair that the tax code advantage the leveraging of an asset that so few people have, while disadvantaging an asset that we all have.

Of course, if you really pull the lens back, it is not ideal to tax either work or wealth creation, which are  both (generally) positive behaviors. It would be better to tax pollution, over-consumption, and other negative behaviors. But if we're not going to make that kind of radical shift, we should at least tax work and wealth equally.

These are just a few points that need to be part of a focused conversation on taxing capital gains that the United States should be having. Once all the hoopla dies down about the Buffett rule, maybe that debate will actually begin.