There's a pretty simple solution: Abolish the capital gains tax, and tax all capital gains at the income tax rate. There is no more "capital gain". Only income. Whether your income was earned through labor or rents on capital that you own seems rather irrelevant to me.
Suppose I had invested $1 million in a private company 10 years ago. It is now worth much, much more, how much no one really knows. I go to a bank and mention I own 100,000 shares of XYZ corp. Could I have a loan please, collateralized with some of my shares? The bank says sure, how about $2 million at prime +0.3%. I say that's just fine.
Under current tax law there is no capital gain recognized, and it's hard to imagine how there could be, I don't even know how much my income is at this point, only that some bank is pretty sure it's bigger than $1 million. It's not that this was some complicated tax avoidance strategy through the Isle of Mann either, it's just a loan. Taxing non-cash income as cash income causes many difficult problems. Ask folks who exercised options on shares whose value evaporated during the lockup period how they felt about their tax bill?
This is an arms race we can't win, I'm pretty sure there's always going to be assets with values to murky to tax, but not too murky to borrow against no matter how generous we are with defining income. The top 0.1% are going to be a moving target, there's too much money at stake for them not to be.
This issue is generally described under the heading "effective capital gains tax rate" in the literature, which back when the rate was higher was between 3.4% and 6.6% (1960 to 1978).
What percent of very wealthy Americans do you think would renounce their citizenship based on this? How much less investment capital would there be in the USA based on that?
Note: Not asking for a value judgment ("good riddance if they do!" - not productive). Just your estimate as to what percent of wealthy Americans would give up their citizenship and how much less investment capital would result. It's an important detail to consider.
Echoing what rayiner said - where are the rich going to go?
Europe is less friendly to the rich - extremely so in the most pleasant of places. China? India? Neither are very pleasant places, and even with truckloads of cash has a hard time competing with the quality of life enjoyed in the US even under onerous taxation.
I think you're not giving enough credit to the American quality of life - it's why my family immigrated here from Asia. While developing Asian countries have seem dramatic improvements in the last two decades, the QOL in most of these countries still pales in comparison.
Just about anywhere someone used to the Western quality of life would want to go would have higher taxes.
That's not true. How about Hong Kong or Singapore where you certainly get a western style life with extra benefits: safer, cleaner, live-in maid service, better access to healthcare and a 15-20% all in tax rate. Have you been to Thailand or Indonesia? Sounds ridiculous but this is happening right now. I'm in banking and I hear my clients talk about it all the time. They're doing it as we speak (slowly migrating their business operations and key personell)
The thing about entrepreneurs is that they are an irrational bunch. I could introduce you to a couple of people who would rather put all their money into a boat and sink it than pay it as additional tax. Sounds crazy but from a growing number of people's perspectives, the problem isnt excess taxation, its excess taxation coupled with gross mismanagement. Nobody likes seeing their money go to waste, especially to causes they dont agree with (ie union pensions for government employees that retire after 20 years of service).
For instance, New Zealand. Nice place. Great People. First class quality of life-- better than the USA. Higher taxes than the USA in many ways, but the government is so much less corrupt that the taxes are much less of a burden. You don't mind paying when you see you're getting value for the money.
I was born in Thailand and go back to Bangkok regularly. Unless you want to live in isolation (maybe with your banker buddies), there is no comparison between living in the US and living in Thailand.
"Nobody likes seeing their money go to waste, especially to causes they dont agree with (ie union pensions for government employees that retire after 20 years of service)."
So the ultra rich obstruct attempts at making the system more efficient (i.e. getting rid of the for-profit healthcare industry in America which costs the average American more and delivers worse outcomes than other industrialized countries) and then use that as an excuse to not pay more taxes? That's a pretty good racket they got going there. The world's smallest violin must be playing for all those poor downtrodden multi-millionaire bankers...
There are many places an american can go. Unlike the USA, most countries don't tax your worldwide income. So, for instance, you could become a citizen of any of the EU countries that don't tax worldwide income, and earn your income outside that country tax free (and live outside it as well.)
I know of several countries within the EU where you can be a citizen and pay essentially no taxes, or extremely low taxes. These are very pleasant places as well. For instance, one location is the side of a very nice lake in switzerland (Campoin d' Italia) and Andorra has some nice tax advantages, and one of the best climates in Europe. Monaco is not bad, though expensive for my tastes, while Licthenstein, Austria, Switzerland, and all this british islands whose existence is for purposes of avoiding taxes aren't too bad either.
The idea that you can't have a high quality of life in China or India compared to the USA seems silly to me, but I haven't lived in either of those countries. There are many countries in Latin, South America, Asia and Europe where you can have as high a quality of life as the USA, or higher, and at much less cost than the USA.
I think the idea that anywhere desirable is worse than the USA is a kind of parochial perception. Of course ones preferences can vary, but, for instance, in many ways much of eastern europe is nicer than the USA, even though they are "poorer". There are many countries that are in many ways richer, or where you can have a better quality of life at the same or less cost.
I just think that people in every country believe that their country s superior to others, and can't imagine how anyone would want to live in another country... but they also haven't experienced those other countries.
I've visited a lot of countries, and have yet to visit one that was terrible, and about %50 of them are better than the USA in noticeable ways, and the ones that aren't as good, aren't as good in ways that aren't really all that bad.
"I know of several countries within the EU where you can be a citizen and pay essentially no taxes, or extremely low taxes."
If so, then why have the rich not moved already? Indeed, why have you not gone to these places? I mean, no tax, whether on capital gain or income, is better than any tax is it not?
I dont think your right. I've been in Bangalore for 2 months and its hard to decide where I have a better quality of life. Here I can rent a brand new 3 bedroom with gym and swimming pool for $400. Driver for $200 a month. Hospitals are cheaper and about as well equipped. You get all channels including HBO for $5 a month. Savings rate in a CD is 10%.
With the rampant unemployment in the US - I cant see why you would consider the US to be the higher quality of life right now.
Remember we're talking about the top 1% or 0.1% of the population here. The unemployment rate simply doesn't enter their quality of life equation. But quality of life is a big deal for rich people.
There are a number of surveys (Mercer, Economist, International Living etc) that rank countries according to quality of life factors and it's always the same places at the top of the list: Western Europe, Australia and New Zealand, North America, maybe Singapore and Japan. These are all, unsuprisingly, expensive places to live.
Wealthy people immigrating is a global phenomenon too; a few months ago there was a spate of news articles regarding rich Chinese looking to get out of China due to the low quality of life (eg http://www.time.com/time/world/article/0,8599,2077139,00.htm...).
If we are talking the top 1% then they can buy a building in Bangalore and put a helipad on it to fly them to the airport where they can travel wherever they want.
Ambani bought himself a building and a helipad to commute to his office. That way you've fixed the commute problem too.
Bangalore weather is also pretty awesome. I wish I had my kite and board ... its been windy the whole past month ...
I'm not sure a significant portion of people will renounce their citizenship over the capital gains tax rate. We didn't have a brain drain or mass emigration when the top income tax rate was 91% either.
To make tax policy based on a fear of wealthy Americans deciding to stop being American seems ludicrous.
Similarly, I think investment capital will remain in the US because of the opportunities this country provides for investment and enterprise. You have many countries which have much lower, or even zero capital gains taxes and only the ones with talent and the ability to produce return attract and maintain significant amounts of investment capital.
The Isle of Man, Jamaica, and Mexico don't have any capital gains taxes, but are obviously not attracting the kind of capital that the US does- and for good reasons.
When the top income tax was 91% (from 1951-1964), the capital gain tax was 25%. So while doctors and small businessmen pay >50% tax on earned income the uber rich paid 25%
Renounce their citizenship to go where? Europe (which is far less friendly to the rich)? Asia (what's the point of being rich if you have to live in the developing world?) Fears of wealthy people leaving are a red-herring.
Plus, who says we have a shortage of investment capital in the US? There is a ton of money floating around from pension funds and 401k accounts, even leaving out the money held by the very wealthy. If you look at the economy today, it's absurd to say that lack of capital is the reason for the lack of top-line growth.
For those of you responding skeptically to Lionhearted's question, I'm in the business of helping these people exit the United States. At any given point I have four or five of these cases going.
The total number for 2009 was 743, though, which is pretty small peanuts by the scale of the U.S. economy. It's not even large as a proportion of very-rich people.
That's the number of people who renounced. And that number is going up dramatically, and I've heard that the published figures for renouncement are way under-reported. (as in here are lawyers who have more clients who have renounced than the government claims renounced in total.) But on both sides these are just claims.
The number of people who simply moved their butts and their assets overseas is much higher. You can tell this is the case because the administration has been saber rattling for the last four years, and starting to work their way into currency controls.
Did you know, in order to renounce, you have to get the permission of the government? They charge an exit tax too for your funds. This is a currency control and it is one of the things that marked the soviet union as a bad regime. If you can't move your money in and out of a country, then you're not likely to invest in that country.
I'm not very rich, and I will renounce as soon as my second citizenship gets in. It will be easier for me because, not being very rich yet, I will be more likely to get permission of the government to give up my citizenship.
Yeah, I'd support making it both easier to leave the U.S. as well as to enter it--- make both renunciation and green-card procurement easier. I think the U.S. would come out pretty well on overall balance there, because it's a fairly popular place to live, and is artificially keeping out many people who would like to live there.
The evidence I can find is that the outward flow is a trickle rather than a flood (or even a modest current), though. Even if the 743 number is a 5x underestimate, that's still not much. I'm not sure it even balances the rich people flowing the other direction, e.g. the businessmen getting green cards under the ">$1m to invest" criterion (and no doubt there would be more of them if the green-card process were streamlined).
I don't think the U.S. is particularly unique in making it hard to renounce citizenship, though perhaps it's for different reasons. Many countries make it very hard to renounce citizenship if they think you're doing it to get out of mandatory military service, for example. For economic reasons, many require that there no longer be any links with the country, e.g. you can't renounce German citizenship if you still own businesses or property in Germany. France seems to have an additional timing requirement, where you can only renounce French citizenship within the first year after acquiring a second citizenship, so dual nationals can't decide 10 years later to leave the country and renounce the French citizenship.
But for every one of those wealthy Americans who is looking for a way out there is at least one wealthy person, if not ten, from China, Malaysia, South Africa, well, as you say, everywhere - looking for a way in to the US.
Their money comes with them.
We live in a global economy, however the number of doors or opportunities that are opened to you is related to how wealthy and/or educated you are.
The wealthy can renounce U.S. citizenship and lose the protection of U.S. system on their properties. Just don't cry when some thugs in their new home island state rob them of their wealth.
The U.S. system provides the scalability for these people to make vast wealth. Shouldn't they pay it back to keep it up? The system is expensive to upkeep. There ain't no free lunch.
Renouncing your citizenship for tax reasons triggers secondary tax laws that offset any benefits. (It's been a few years since I reviewed any tax law, but I've not heard of any changes in this area.)
Good point, but could you argue that those Americans that would renounce their citizen ship are already hiding that income in untaxable locations already?
I wonder if it would be a wash, you suddenly up the tax, and everyone that was ducking anyway leaves and the rest get taxed and fill the void.
All speculation of course, none of us would have numbers to know.
My thoughts exactly - the problem the author is alleging isn't that these things exist, it's summarized in his last paragraph:
A highly complex and largely discrete set of laws and exemptions from laws has been put in place by those in the uppermost reaches of the U.S. financial system. It allows them to protect and increase their wealth and significantly affect the U.S. political and legislative processes. They have real power and real wealth. Ordinary citizens in the bottom 99.9% are largely not aware of these systems, do not understand how they work, are unlikely to participate in them, and have little likelihood of entering the top 0.5%, much less the top 0.1%. Moreover, those at the very top have no incentive whatsoever for revealing or changing the rules.
In other words - the alleged problem is that you can't fix this tax stuff even if you wanted to because the people in control are the ones benefiting (and most other people aren't aware / don't care enough).
I'm not taking a position either way, just clarifying what the author is saying.
(The marginal rate of tax on capital gains is generally much lower than the marginal rate of tax on an equivalent earned income. The investment professionals who strike it big do so by engineering their income to arrive in the shape of capital. Tax it as income and suddenly a whole lot more tax revenue shows up ... and the Gini coefficient in the society in question drops a little bit.)
Taking advantage of capital gains might be tax avoidance from a certain point of view, but it's also a useful for helping grow wealth and the economy in general.
Having large sums of private capital helps the economy-- how does it help it? By making it easy to borrow money, like the VC that so many HNers are seeking.
So the argument for differential taxation of income versus capital gains is to incentive investment. However, I'm not sure investment needs to be incentivized right now. There is a ton of private capital floating around right now looking for productive investments in the US, and they just don't exist. So the money goes overseas, or into elaborate, questionable financial instruments.
It is not even clear that it is tax avoidance. In most situations the capital gains preference is meant to mitigate, and in fact only partially mitigates, income taxation at the corporate level.
Preferences for real estate and investment managers in the form of carried interest...well, that's another story.
If capital gains were taxed as regular income, that would mean a whole lot more money would be flowing into the governments coffers, and as such the income tax rate could be lowered as a result for all parties. You'd have to run the numbers to see but it seems reasonable.
Another problem with taxing capital gains heavily is that it distorts investment by discouraging dividends and buybacks in favor of risky attempts at growth. Companies irrationally choose to grow and make high risk acquisitions rather than simply pay out big dividends. This contributes to business cycle instability, as well as inefficient allocation of capital; the incentive is to keep capital locked up in a conglomerate.
The idea that it is possible for those that earn vast quantities of money more than your "standard joe" to pay _less_ tax on that considerably larger cash pile.
The line about lobbying for a new corporate exemption on "repatriating" cash from either tax havens or anywhere else abroad at the pitiful tax rate of 5.75% compared to the base 10% that someone that works at a diner has to pay illustrates the issue rather well.
This is cash that was taxed once in the foreign jurisdiction at whatever prevailing rate was in effect there. With the exception of the US, nearly all developed countries have territorial tax systems at which the rate on those foreign profits would be 0%.
A repatriation holiday would be a huge (and poorly targeted, considering nearly the entire benefit inures to about 10-20 firms) giveaway, but it's only discussed in the first place because of our strange worldwide corporate tax system.
If a non-US citizen works at a diner in a tax haven or anywhere else abroad, and brings money into the US, they typically pay 0% tax (to the US) on that money.
This is the analogous situation to non-US corporations (possibly owned by US corps) leaving profits overseas.
But typically, they are working there, not setting up a virtual office. If these super rich are working in the US, they should pay tax. If they are not working, why don't they deserve to be taxed?
The super rich working in the US do pay tax on their income. You seem to be conflating many separate issues, so let me explain in detail how it works.
Sergei Brin pays taxes on his income to the US.
Google Ireland doesn't pay taxes to the US on income earned in Ireland until they transfer the money to the US. (They do, however, pay taxes to Ireland.)
A guy working at a diner in Ireland will, as far as I know, never pay taxes even if he does transfer money to the US.
Google UK also pays most of it taxes to Ireland, despite the revenue being from the UK. Wonder if that has anything to do with Ireland having lower taxes?
I'm assuming it's increasing the long term capital gains tax rate. According to http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United..., the short term rate is as arjunnarayan suggested, barring any differences in exemptions between capital gains and income tax rates.
It's also an issue of timing and deferral. Because one can offset short-term capital gains with capital losses, and individuals generally have absolute control over realization of capital gains, the effective rate on capital gains can effectively be zero or near-zero given sufficient liquidity, despite a statutory rate equal to the ordinary income rate.
You also need to end the Federal Reserve and make fractional reserve banking illegal so no one can create new money and give it to themselves. Allow the market to handle the distribution of purchasing power. Not the government banking cartel.
