Back in 1997, recent college grads and newlyweds Jack and Diane had $2,000 in spare cash. Two options occurred to them.
The first: Upgrade their TV-stereo sound system. The upgrade would improve their viewing/listening quality for at least a decade.
The other option was to buy 100 shares of Apple stock. There were rumors Apple might go bankrupt, but both Jack and Diane suspected the company’s intellectual property might attract a buyer, bidding up Apple’s share price. On the other hand, maybe not.
From at least the mid-19th century, many, but not all, economists have argued that an income tax code that treats dividends, interest and realized (or unrealized) capital gains the same as labor income is a bad idea. That’s because it skews household spending and savings decisions in favor of spending. The benefit of the TV system—the additional viewing pleasure Jack and Diane obtain—is relatively certain and not subject to tax. The benefit of buying into a tottering company is the prospect of future dividends and capital gains, which are highly uncertain and subject to tax.
Taxing dividends and capital gains encourages too much consumption and too little savings, which is to the long-term detriment of households and the larger economy. The argument makes the case for taxing dividends and capital gains at a lower rate than ordinary income—or perhaps not at all.
This principle is embedded in current tax law, but President Biden proposes to end it for households earning more than $1 million a year. The Tax Foundation estimates the Biden plan will raise the top marginal capital gains tax rate from 29% to 48.4%. This is higher than any Western European nation, exceeding Denmark’s 42% rate and the unweighted 27-nation Euro average of 18.59%. Interestingly, seven of the 27 Euro nations, including Switzerland, have capital gains tax rates of zero.
Back to Jack and Diane. They did buy the Apple stock, and in 1998 daughter Phoebe came along. Alas, she spent her early years watching Barney on a second-rate TV system.
It wasn’t until 2012 that the Apple stock paid any dividends. However, the stock split several times and is now worth an incredible $1.4 million. Phoebe just graduated from college herself and has a well vetted startup idea that could use some venture capital. And of course, Jack and Diane would love to invest in Phoebe’s venture but for that darn capital-gains tax.•
Bohanon and Curott are professors of economics at Ball State University. Send comments to email@example.com.