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Author Topic: Corporate Taxes?
KenBean
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Hi guys
$ .02

Corporations presently pay no federal Income taxes. In a true sense they pay no taxes of any kind.

Here is why: Corporations adjust their costs and pricing structures to ignore whatever tax burden is placed upon them...they simply raise their prices enough to make the taxes a "pass through" to the people who buy their products and services.

This idea of taxing "companies" is one of those myths socialists in sheep clothing love to run out to muddy the issue, by throwing mud at "profit making entities".

Some major costs of doing business that show up on every "Income statement" in every company:

Revenue.....

Cost of Sales (COS)..........

Cost of Services............

Cost of Materials...........

Interest costs...........

Overhead (which includes salaries and FICA)

Tax burden...........

Add X % for return to risk-capital investors

equals sales price per unit times the number of units sold.

What I am saying, is that taxes on "companies" are nothing more than masked taxes paid by the end user-consumer.

Most of the younger folks here do not remember why Reagan got elected in the first place. He was elected by two primary groups of people. One group simply lost faith in Carter's ability to "bully pulpit" us out of a near catastrophic inflation spiral.
The other group was even more concerned with our losing streak in the cold war/international respect war. Carter was trying to give EVERYBODY A PONY.

The very rich can only wear one pair of shoes at a time, or live in one house at a time. So why don't they just close their company doors at a given point of wealth accumulation, take their money, and move to a tax haven?

Answer 1: self interest. In many cases, "enlightened self interest".

Answer 2: ego. They like to feel that they are doing something constructive, making payroll for their employees, and making profits for the people who risked capital on their ideas and business acumen.

Thank goodness a certain percentage of our population is gifted, and interested in...making money. Our system encourages them to keep on doing so, enriching us all.

They make the pie bigger.

The cool thing about our system is that any one of us (Americans) can still amass a lot of wealth in a million ways that have nothing to do with a degree from a University....and they all have to do with working harder and smarter...and starting our own "company" and paying the price in blood and fear making it successful.

A good friend of mine calls himself a "paper boy". He gets up (at 3 AM) every morning and delivers papers. But unlike other paper boys, he has asked the people he runs into on his paper route if since he is there every morning anyway, is there anything else they would like him to deliver.
(entrepreneurs among you note.)

He is fifty plus now and worth several million dollars. He started with nothing but a paper route. He now has over twenty five excellent, highly motivated employees, making high 5 figure incomes helping him deliver papers ...and stuff.

Quite candidly, they are all as dumb as dirt, but they are dependable, and cheerful, and they make more money than most mid managers, (and professors),in the country with a degree.

One of those guys told me once "Mr. Bean the coolest part is that I'm off work by noon, and I don't even have to think about work till tomorrow morning. The rest of the time is mine with no worries."

I think that is something to cheer about on this, the fiftieth aniversary of Mad Magazine and Alfred E Neuman's motto.

Best regards all
KenBean



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TomDavidson
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"He gets up (at 3 AM) every morning and delivers papers. But unlike other paper boys, he has asked the people he runs into on his paper route if since he is there every morning anyway, is there anything else they would like him to deliver."

I'd just want to point out, for any paperboys who might be reading this, that this is an EXCELLENT way to be fired from any newspaper delivery job you have.


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KenBean
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Hi Tom

CURSES UPON YOU!

(The Houston Paper knows precisely what he is doing. They also know that he is "legit"
and that our other paper would give their left one to have him deliver THEIR papers.)

Kidding aside, Tom, there are a GAZILLION EXCUSES to fail, or not to even try to push the envelope. To be a VICTIM. (and there are too darned many people masturbating young people into being victims. Crude but true...you consarned communist, law abiding east coast liberal mf.

This fellow figured out a way to dodge the stupid, and so can anyone else. Anyone on this forum may write me any time, no charge, to talk about how to do'dat.

Entrepreneur's motto: "It is always easier to seek forgiveness than to expect "oh yeah, go get rich"".

"Barstool lawyers" ALWAYS TELL YOU THAT 'IT' CAN'T BE DONE...PROBABLY ILLEGAL!!!

Please allow them to have quiet illegal fornication with themselves.............AND WRITE ME!

The lawyers I retain know very well not to waste my "meter" telling me what CANNOT be done. They understand that it is what they can figure out HOW to do it that get's them paid by me.

See, Tom, If a paperboy is reading this...bless his li'l heart...QUIT GIVING HIM AN EXCUSE TO BE A LOSER AND A WHINER AND A FAILURE...........AND A VICTIM.

Hell, I could make a million dollars over the next three years...............COLLECTING ALUMINUM CANS!

lAW AGAINST THAT?

Of course not, but barstool lawyers could convince a lot of our less experienced, (younger ) readers that it is true.

Whose side are you on?

(I have a money machine in mind for NOT rich liberals too. Write me and let's discuss it, privately, you have my word.)

Tee Hee
KenBean


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TomDavidson
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In all seriousness, every paper for which I've ever worked has a standing policy that calls for the immediate termination of any paperboy who solicits for any other purpose. But if somebody can get away with it, more power to 'em; I know a guy who paid for his college education by delivering food to college dorms, only to eventually have the bottom fall out of the business when the college forbid that kind of solicitation.

Go ahead and E-mail me your idea, by the way; I've been officially unemployed since March, and while the occasional freelance job is keeping food on the table, I'm getting a little desperate for good ideas. I'd appreciate any you have, especially if they apply to hardworking guys who don't have bachelor's degrees.


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LetterRip
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quote:
Corporations presently pay no federal Income taxes. In a true sense they pay no taxes of any kind.

Here is why: Corporations adjust their costs and pricing structures to ignore whatever tax burden is placed upon them...they simply raise their prices enough to make the taxes a "pass through" to the people who buy their products and services.


Ken,

Do you believe that Pepsi, Coke, Nike, etc. would reduce the prices on their goods if they paid nothing in taxes? Are you aware that companies often sell the same product for different prices in different markets, even though the costs incured in both markets are often very similar (if not the same)?

Goods and services are generally priced at their profit maximizing level. What this level is varies substantially by geographic region, economic prosperity of the region, etc. (When I say profit maximizing there are a number of considerations encompassed, such as consumer expectations, competitor barriers to entry, competitive pricing, potential for obsolescence, and many others.)

Retailers, wholesellers, etc. do sometimes use formulaic 'cost + profit margin (or cost * profit margin)'; extremely comoditized items, also occassionaly use that approach; and some services, such as insurace, are required by law to justify the pricing of their services (of which tax burden might be a legitimate consideration), However, those are the exceptions, not the norm.

If corporations had no taxes they would still charge roughly the same for goods and services. Taxes determine how profitable those goods and services are to provide, but have little impact on what price the good or service will be (there is some impact, but not really in the way you suggest).

The factors you mention above do determine whether or not a particular product or service will be profitable enough that the business is willing to provide it (as opposed to other profitable goods or services). Thus taxes do have an impact in that fewer services and goods that are marginally profitable will be provided (which in a no tax situation would have a higher profit margin), but that really is a different consideration all together.

LetterRip

[This message has been edited by LetterRip (edited October 27, 2002).]


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KenBean
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Hi Letterip

Your points are well taken. Pretty accurate too.

I was trying to get across a very theoretical model pointing out that our entire system taxes individual people.

What is sad to me is that the secretaries and working stiffs of our country pay the tab for most of the government sponsored entitlement programs. They have little maneuver room, and little voice, and their frustration is, I believe, misplaced toward "corporations" rather than where it belongs.

Over simplisticly for sure, but I was trying to point out that taxes are simply another cost to do business, to any "profit vehicle".

I do have strong feelings on behalf of the poor, and the disabled, or partially disabled.

Someone noted in Maniacles's post that they would like to see some choice on taxpayers' part as to where they would donate toward those folks' needs. I like that.

For instance, many people I know have opted out of the "United Way" as it became apparent how little of the donated money actually reaches the end-needer.

I'm sure you are familiar with the concept of "people painting their own cell bars around themselves". I see that so often and also know organizations who addres that problem pretty well. I would love for X % of my taxes ear-marked for those organizations.

"corporate tax burdening" is not the answer, I think, but rather "tax application".

Best regards
KenBean


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LetterRip
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Ken,

I agree that gratuitous increases in the corporate tax burden is not really a good idea.

My opinion on taxes, in general, are that they should only be for those items which the tax payer derives benefit from, or to compensate for an externality that the tax payer is causing, but is unlikely to pay for.

However, I am for estate taxes, because the majority of estates taxed have seriously underpaid the tax burden of the individual. Not neccessarily by evasion (though there is certainly plenty), but through advantage of the numerous tax loop holes that congress is happy to provide. Also, the wealthy historically paid lower capital gains taxes than the middle class, etc., so estate taxes seem the only way to rectify this injustice. (Unless we are willing to retroactively apply taxes to the wealthy to correct these distortions...).

I would like a 'lockbox' on taxes, so that taxes from a specific source can only be used to pay for what the tax is related to/intended for. Thus taxes on cigarretes could only be used for health care, medical research, and anti-smoking campaigns. Corporate taxes would only be used for those things which benefit corporations such as infrastructure, defense, education, and research. Things such as parks, national monuments, etc. shouldn't be paid for by corporate taxes since they derive little or no benefit (actually corporations that derive revenue from tourism do, thus some of their tax dollars might be justifiably used for such.)

I'm curious how difficult it would be to accurately assess the degree to which different corporations derive benefit from different infrastructure, regulatory bodies, etc. (Seems like there should be some decent economics literature on this...).

Anyway, enough rambling...

LetterRip


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Baldar
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quote:
However, I am for estate taxes, because the majority of estates taxed have seriously underpaid the tax burden of the individual.

Now where do you get that from? Doesn't income tax (income to the family included. Provide a tax burden?

What about the family farm? It appreciates in value to an incredible level as urban sprawl approached. The farm might be in the family for generations, but when the father dies and the inheritance is left to a son, the appreciation is such that the son cannot affort to pay the 70% death tax and the 32% income tax on the earnings of the left after 70% has been taken.

quote:
Also, the wealthy historically paid lower capital gains taxes than the middle class, etc., so estate taxes seem the only way to rectify this injustice. (Unless we are willing to retroactively apply taxes to the wealthy to correct these distortions...).

Now that is ridiculous. Until Carter was president the capital gains tax was 50% and then it was reduced to 28% during the Carter years. Of course this lead to an "increase" in revenue by 20% that year. Generally Capital gains taxes have been equal to or higher than other income taxes. Especially in the last 30+ years. Check your facts out. Would raising the capital gains increase revenue, it has been found to increase when the capital gains tax is "reduced" not increased. Also more people of the "middle class" now look at capital gains taxes as an additional burden because it is not based on income level or deductiblity the way other taxes are based. It is the following:

A tax assessed on profits realized from the sale of a capital asset, such as stock. It usually runs about 20%. That is only if you hold the capital asset for a year or more, if it is less than a year (and technically not an investment) then you pay the going tax rate as an individual (30 - 40%). So in essence what a capital gains tax rate is supposed to do is encourage you to not sell your capital assets but hold them as an investment for more than a year. Your view Letterip is a bit inaccurate where the capital gains tax is concerned.

Look here to calculate them.

Capital Gains tax calculator


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LetterRip
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Baldur,

quote:
Now where do you get that from? Doesn't income tax (income to the family included. Provide a tax burden?

What about the family farm? It appreciates in value to an incredible level as urban sprawl approached. The farm might be in the family for generations, but when the father dies and the inheritance is left to a son, the appreciation is such that the son cannot affort to pay the 70% death tax and the 32% income tax on the earnings of the left after 70% has been taken.


There are a few cases, such as moderate sized farms, where I fell that the estate tax is unfair to (I don't recall what the cutoff value is offhand but the current cutoff seems 'fair' in the majority of instances...), but as will be shown below, the extremely wealthy both currently, and historically, tend to avoid substantial amounts of taxes. That was what I was refering to, should have been a bit more explicit.

I didn't say that capital gains was historically lower than income tax, I stated that the wealthy paid a lower capital gains tax than the middle class. Although I couldn't find the specific item I was trying to recall (I believe it was a specific loop hole prior to 1986 that was being abused pretty much exclusively by the wealthy, however the research I did on the topic was over five years ago, so it is a tad fuzzy..) the below is probably adequate to make the point.

Read these links from the book
The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed (1999)
Leonard E. Burman
http://brookings.nap.edu/books/0815712707/html/19.html#page_middle
http://brookings.nap.edu/books/0815712707/html/20.html#pagetop

etc.

That was what I meant by the wealthy not paying their fair share of the tax burden.

LetterRip


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Baldar
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Actually the capital gains tax is a tax on investments that are sold. Investments provide a key portion of the impetus for this economy. You tax capital gains too much, you reduce investment (no incentive to invest just consume which is different). Also much of the investment now comes from the middle class. So your point of capital sales tax impacting only the rich (who you seem to think don't pay their taxes when in fact they pay most of them) is really moot. The highest tax bracket hits at around 75,000. Many of these families do invest in stocks or other vehicles do increase their monetary income (1 - 2% at the bank does not work).

Death or estate taxes kick in at about 750,000 or perhaps a million (too bored to look it up), however that is not very much when you consider the way land prices have risen, especially here in California. When they do kick in 75% of the asset must be paid, which means you must liquidate the land if you do not have the money. The remaining 25% faces a 36% tax base. You have a million dollars left to you in assets (not money) you pay the following . 750,000 in taxes and an additional 90,000 on income from the inheritance. I find that grossly unfair, regardless of your income. If its not fair if you receive less than a million dollars why is it suddenly fair when you receive more than a million dollars?


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KenBean
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Hi Back Letterip

Again, excellent points. I think we might be going somewhere here.

On the one hand, I know that "capital formation" is one of the key ingredients of our success as an economic engine.

Estate/death taxes are a large percentage of "capital formated )

HMMMMMMM. Now maybe there is an area to explore for "lock-boxes", "or directed donation" or something...

With some serious head scratching how and where, I think most wealthy people would not mind being taxed heavily on estates so vehemently, if THEY had some choices of where to direct the money...and maybe even have their name on it. Pretty neat legacy.

Best regards
KenBean


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msquared
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Ken and LR,

That is why the very wealthy should have a will and leave most of their estate to the charity of their choice. The Gov. does not get any, many other people are helped and they can still leave their heirs a nice sum.

msquared


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KenBean
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Hey MSquared

Whaddya mean they can donate it to help people instead of giving it to the gubmint?

Why I swan. I thought that was what the gubmint does with it.

Axe any politician on the left.

Best regards
KenBean


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Jon Camp
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I read a book by a financial advisor 4 or 5 years ago that basically said the inheritance tax has so many loopholes in it that the only people who pay it are those that didn't realize they were eligible to pay it, and thus didn't plan for it, and couldn't avoid it. He explicitly called it a "voluntary tax." He then went on to highlight 2 or 3 different methods of getting around it, although he did say he expected Congress to close those loopholes -- eventually. Whether they have or not, though, I don't know.
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msquared
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Jon,

You are basically correct. The really wealthy can set up trust funds and limited family partnerships and other ways of avoiding much of the tax. It is worth it to the to do so.

The guy who gets nailed is the family farmer, the small business man and even the middle manager who bought some land or a nice house, and throught appriciation, is now worth $1 million. I personally think that all tax amounts need to be indexed for inflation. You are going to see thousands of people get nailed with the AMT in the next 5-10 years, since it is not indexed.

msquared


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LetterRip
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quote:
Actually the capital gains tax is a tax on investments that are sold. Investments provide a key portion of the impetus for this economy. You tax capital gains too much, you reduce investment (no incentive to invest just consume which is different).

I never stated otherwise.

However, I should note that the wealthy often can restructure things so that the income can be recieved however is most beneficial for tax purposes. Ie when australia had 0% capital gains taxes (prior to 1986 I think), things such as interest were merely restructered on paper as a capital gain so that the wealthy weren't paying much in taxes.


quote:
Also much of the investment now comes from the middle class.

http://www.cesj.org/homestead/caseforcapitalhomestead.htm
quote:
[T]he top 10% own 90% of all directly-held corporate stock.

Of course the middle class has pensions as well, so you might be considering that to be part of 'much'. Not sure what the ownership would be then.

Of all corporate stock ownership (ie including pensions, etc.)

quote:
The top 1% of America's wealthy own nearly 50% of all U.S. corporate stock.

http://cog.kent.edu/lib/teodosio/SusEconGrowth.htm

Of course, both sources are using only US held stock, if we include non US corporate stock, the percentage is much more concentrated with the wealthy. If we include other investment vehicles then the concentration is even higher.

Of course, you may have different definitions of 'much' and 'middle class', ie much might mean 10% or less, or middle class might include part of the 10% most wealthy.

quote:
So your point of capital sales tax impacting only the rich (who you seem to think don't pay their taxes when in fact they pay most of them) is really moot.

I was talking about legal tax evasion. The wealthy are using tax loopholes to, according to the book on capital gains tax I noted above, will avoid paying half of the capital gains that would normally be paid without such loopholes.

Also, since your facts don't appear to square with the reality, the point is far from moot.

quote:
The highest tax bracket hits at around 75,000.

?? Where is that number from?
The highest rate (39.6% for short term gains) is at a vastly higher income (300,000$ give or take a bit, as I recall...).

quote:
Many of these families do invest in stocks or other vehicles do increase their monetary income (1 - 2% at the bank does not work).

Could you clarify? It isn't clear who you are refering to as 'these families'. (I think 75,000$ income rate, but not sure...).

quote:
I find that grossly unfair, regardless of your income. If its not fair if you receive less than a million dollars why is it suddenly fair when you receive more than a million dollars?

It is not particularly 'unfair' since the individual did not earn the inheritance in the first place. I'll have to check your numbers on this later, since they seem a bit high. (I personally believe that assets totalling less than a million should be exempt...)

However, as to why it should be less unfair for numbers above a million...

Wealth is on a continuum, a million and one dollars is not much different from a million dollars. It is mostly the orders of magnitude that are important.

The greater the order of magnitude of wealth,
1) the larger the percentage of income is due to luck and windfall profits.

2) the more value has been derived from the government both directly and indirectly. (Ie farm, tobacco, oil industry, and numerous other industry subsidies supplement the income of the wealthy far more than that of any other social class, targeted tax breaks to individuals, perferential zoning and condemnation of land, etc.)

3) The higher the likilihood that the income was derived from unethical (though not neccessariliy illegal) means. Ie the unlawful monoply behavior of Microsoft.

4) The higher the likilihood that the profit was derived from preferential positional and social effects.

So, in short, because the degree that the wealth is based upon the merit, skills, and hard work is much less significant determinant for large orders of magnitude wealth, than it is for small orders of magnitude wealth.

LetterRip


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Baldar
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Letterrip you will need to back up what you say and you are missing a number of key factors.

quote:
------------------------------------------------------------------------
Actually the capital gains tax is a tax on investments that are sold. Investments provide a key portion of the impetus for this economy. You tax capital gains too much, you reduce investment (no incentive to invest just consume which is different).
------------------------------------------------------------------------

I never stated otherwise.


So by reducing the benefits of a capital gain you what???? Reduce investment. Whether you say it or not the effect is the same.

[quote[However, I should note that the wealthy often can restructure things so that the income can be recieved however is most beneficial for tax purposes. Ie when australia had 0% capital gains taxes (prior to 1986 I think), things such as interest were merely restructered on paper as a capital gain so that the wealthy weren't paying much in taxes.[/quote]

My question would be how its done in America, I certainly can't do it. I find your example (australia) to be less than realistic because you are confusing a loop hole provided by the government with a program that increases investment. Can you give a US example of US citizens not paying taxes based loopholes since the wealthy pay the vast majority of taxes in the US today? Such tax evasion would be illegal in the US.

quote:

quote:
------------------------------------------------------------------------
Also much of the investment now comes from the middle class.
------------------------------------------------------------------------ http://www.cesj.org/homestead/caseforcapitalhomestead.htm

It does not speak to the subject at hand. And most of the stock market is now in the hands of small investors. No more Rockefellers, 401K's are what drive the market today. Your realize of course that the top 10% is anyone that makes over 175,000 dollars a year (including dual income families). Top 20% come closer to 120,000 a year. It makes sense that they invest more in the stock market than the lower 50%, I suggest you have bought into an article that uses half truthes to prove a point rather than thoughtful data. You will not that they qualify the stock as directly held when in fact "indirectly held stock" is the vast majority of stock (ie held in 401K's). You are assuming directly held stock is all stock. This is wrong.

More factual numbers can be found here:

Analysis of CBO numbers.

Most corporate stock is not publicly traded, I might suggest that those who incorporate do so as venture capitalists and usually have their own money involved. Generally it is those with money (the wealthy) that take such risks.

quote:
I was talking about legal tax evasion. The wealthy are using tax loopholes to, according to the book on capital gains tax I noted above, will avoid paying half of the capital gains that would normally be paid without such loopholes.

Legal tax evasion is a laughable point to be honest since everyone wants to evade taxes legally (or do you pay extra without being asked?). I suppose you want to include chartiable donations, investments into research and development, help for the needy and all those other "leagal tax dodges" that our democracy has chosen to put in place? Your point seems to be more of a anguish at the success of others a type of "class warfare" that is used by most liberals to equate success with evil somehow. Your points are moot.

Raise the capital gains tax and investment will fall, less investment means less money to create new jobs. The fact that someone gets rich taking those chances has nothing to do with it. I might suggest that you look at who pays the majority of taxes. Its certainly not the poor.


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Baldar
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Only lotto winners get lucky, everyone else I have known has been wealthy based on hard work (and yes a little luck). Can you name some people that were lucky without having to work for it or is that another reflection of your personal bias?

Value derived from the government? I doubt it,


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Baldar
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quote:
The higher the likilihood that the income was derived from unethical (though not neccessariliy illegal) means. Ie the unlawful monoply behavior of Microsoft.

If the actions were not illegal then there would have been no court case Letterip, so I am not exactly sure what you are saying. Also I would like you to explain to me what Microsoft did that was unethical since the court was ruling on the bundling of software. I assume that you feel that if you receive more product for your price by bundling many seperate components of software that it is unethical to do so, especially at the expense of the competition?

quote:
The higher the likilihood that the profit was derived from preferential positional and social effects.

Are you suggesting that a govenment that controls profit will in all likelihood encourage the movement of people from one class to the next? That somehow a government that oversees our income will encourage people to strive for higher income levels and hence produce a more efficient greater outcome? I don't think you can support such a theory. The Soviet Union certianly could not.

It sounds like income jealousy or envy to me, why should the rich make more? Personally I never cared how rich the rich became, I cared more about how well off I could become. I never resented another man having more than I did (which is what you seem to be indicating). I want the government to interfere as little as possible in the choices I make. In my opinion it has done so, so far.

Do you really think the govenment is concerned with a level playing field? Then tell me why congress opted out of Social Security and has a different "privatized" system?



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Jon Camp
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Here are the amounts of taxes paid by the top income earners, going back to 1986. One thing you'll note is that the share of taxes paid by each. Note that the share paid by the "Top 1%" fluctuated a bit from '86-'94, but has only increased since then, and the top 1% pays 37.42% of the taxes. The top 50% pays 96.09& of all taxes. You'll also note that the top 50% starts at $27,682 of adjusted (ie "taxable") gross income.

Granted, that means that's the figure after all deductions, but that means the actual gross to be in the "Top 50%" is only around $40K a year.

The floor to be in the top 25% is $55K "adjusted" which is still only about $70K or so actual gross. I don't consider that "rich," by any means.

And the source is the IRS, so I'm not using a "questionable one."


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TomDavidson
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"Also much of the investment now comes from the middle class."

In all fairness, Baldar, the capital gains tax generally does NOT affect the middle class. While the middle class DOES make up the biggest chunk of investors nowadays, it's largely through tax-deferred or employer funds -- which don't generally concern themselves with capital gains taxes, anyway.

Capital gains taxes ARE a rich man's issue.


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Baldar
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In all fairness the middle class seems to be in the top 20%.

I know a number of middle class people who buy stocks and sell them, who invest in venture capital and must decide. Capital gains is not a rich mans game, it may not be yours, but then I don't think you are typically of the middle class (otherwise you would be republican or libertarian )

quote:
CAPITAL GAINS: A Tax on the Middle Class

Those who oppose reducing the capital gains tax argue that it would be a “tax cut for the rich.” But in truth, the capital gains tax falls most heavily on middle-class business people and investors. The wealthier an investor, the easier it is to structure investments so as to avoid capital gains taxes. The techniques that investors employ to avoid the tax are so common that the National Association of Securities Dealers includes them on its exam for trainee brokers. Some of the largest institutional money managers catering to wealthy investors advertise investment strategies that use computer models to avoid capital gains taxes. Indeed, wealthy rentiers living on income from traded securities can effectively avoid capital gains taxes altogether.

Taxing the Middle Class

An investor pays the capital gains tax only when he liquidates his investment. In practice, investors liquidate taxable securities and incur the capital gains tax only if they must do so in order to meet large, non-recurring expenses. Wealthy investors often hold onto assets that have appreciated in value until they die, passing them to their heirs and avoiding the capital gains tax (though not the estate tax) altogether.

In contrast, middle-class families who have either invested in securities or built small businesses typically must sell a large portion of their investment at the peak of their savings, in order to pay for a large expense like retirement, a child’s education, or the purchase of a home. At that time, these investors have no choice but to pay tax on their capital gains.

Consider the case of a Pakistani immigrant who saved for years to buy a New York City taxi medallion for $75,000 in 1984. The value of the medallion doubled to $150,000 by 1994, at which point the immigrant sold it, showing a capital gain of $75,000, on which he pays 28 percent in capital gains taxes.

Another hypothetical example: A married couple, a policeman and a nurse, have seen their combined annual income go up from $40,000 at age 21 to $90,000 at age 46. During the past 14 years, during which their income averaged $72,425, they have invested 8 percent of their savings, or $6,000 per year, in an investment fund indexed to the Standard & Poor’s 500; the value of their portfolio now stands at $96,600. This year their oldest child enters a university, so they liquidate 15 percent of their portfolio, giving them a taxable capital gain of $13,455. Again, they must pay the full 28 percent tax rate on this gain.

These cases illustrate two important points about the capital gains tax. First, studies that purport to show that most capital gains taxes are paid by wealthy individuals reflect a fundamental error: They treat individuals as “high-income” because of a one-time increase in earnings the year they realize capital gains. In both our hypothetical cases, the individuals probably earn over $100,000 in the year in question, but their normal incomes put them well within the middle class.

Second, the capital gains tax is a tax on nominal earnings—it is not adjusted for inflation. Much of the increase in the value of a taxi medallion, for example, reflects a decade’s inflation, not an increase in the real value of the medallion. To take a more extreme example, consider an investor who bought a small business for $100,000 in 1962 and sold it for $300,000 in 1995. In real terms, the value of his business is unchanged: $300,000 in 1995 dollars is worth about the same as $100,000 in 1962 dollars. Yet the businessman would pay $56,000 in capital gains taxes, leaving him with a negative real after-tax return on his investment.

Avoiding the Tax

The capital gains tax is applied to the net profit on investments sold in a given year. Therefore, an investor who sells profitable securities may offset his gains by also selling securities that have lost money. The owner of a small business or the small investor in a conservative mutual fund will not have such offsetting losses. But a wealthy investor is more likely to have access to sophisticated advice on how to manage his portfolio to avoid taxes.

Moreover, the wealthy investor has natural advantages in avoiding taxes. Because he has a larger portfolio, he will have to liquidate a much smaller percentage of it in a typical year than a middle-class investor would. Further, because he has more capital to begin with, he will have more flexibility to buy high-risk securities. That means more of the individual securities he buys will lose money—even though the overall return on his portfolio will be just as high as, or higher than, that of a middle-class investor.

When the wealthy investor liquidates a portion of his portfolio, he will be able to sell securities that have declined in value along with some that have been profitable, using the losses from the former to offset the gains from the latter and thereby reducing his tax liability. Yet even though he avoids paying capital gains taxes, the overall return on his portfolio will still be quite high, because his profitable investments have a high rate of return.

Testing the Model

We developed a computer model to simulate how much capital gains taxes three investors would pay if they employed optimal trading strategies designed to avoid capital gains taxes:

1) A small business owner who must sell his firm, which represents his entire net worth;

2) A middle-class investor who must liquidate 40 percent of his portfolio each year; and

3) A wealthy investor who must liquidate 20 percent of his portfolio each year.

The first investor’s case is simple: as in the example above, he pays 28 percent of his nominal gain.

The second investor diversifies his portfolio, buying 20 stocks, which, over 20 years, have the characteristics of the Standard & Poor’s index: average annual “volatility” (a measure of the fluctuation in the price of stocks) of 16 percent and average annual price appreciation of 15 percent.

Pursuing this optimal tax-driven investment strategy, the second investor seeks to offset the tax liability of his gains by selling stocks that have lost money. Our computer simulation shows that this investor is likely to pay an effective capital gains tax of 20 percent on the nominal gains from the profitable stocks he sells. His total after-tax profit is 12 percent. (An actual middle-class investor is unlikely to pursue an optimal tax-driven investment strategy. More likely, he would purchase shares of a mutual fund and pay the full tax on his profit.)

The wealthy investor also pursues an optimal tax-driven investment strategy, but he is at an advantage. Because his wealth is greater and his cash needs smaller relative to his total investments, he can invest in high-risk securities—those with high volatility. Because his portfolio is larger, the wealthy investor is likely to have the motivation and the professional support to adopt an optimal tax-driven strategy. In our simulation, he purchases 20 stocks with average volatility of 25 percent (as opposed to 16 percent for the S&P 500) and average annual price appreciation of 15 percent (identical to the S&P 500).

In this scenario, we found, the investor is likely to have sufficient tax losses every year to offset all the capital gains he needs to realize—with exactly the same pre-tax return on the investment in his portfolio. After taxes, he earns a total annual profit of 15 percent.

To sum up, in our simulation, the small businessman pays the full 28 percent tax on his profits; the middle-class investor pays 20 percent; and the wealthy investor pays zero.

In practical terms, it is likely that a wealthy investor would buy high-volatility stocks that also have a higher rate of return than the S&P 500. In this case, he would have a relatively higher proportion of gainers to losers, and may not have enough capital losses to offset all his gains. To test what would happen under such circumstances, we ran the model again, this time assuming the wealthy investor bought stocks with an average volatility of 25 percent and an average return of 20 percent. In this case, the effective tax rate is about 17 percent—still lower than that of the middle-class investor. His after-tax profit is 17 percent—higher than the S&P average.

The conclusion is startling: To the extent that wealthy investors must pay capital gains taxes at all, it is because they have earned pre-tax returns superior to those generated by the broad stock indices such as the S&P 500.

Abolish the Capital Gains Tax

The capital gains tax falls overwhelmingly on the middle class—specifically, on savers and entrepreneurs, the most thrifty and industrious members of the middle class. It is not a means of redistributing wealth from the rich to the poor: the wealthy may for the most part avoid the tax through well-known and commonly used techniques. Because the upward-striving middle class is the key to economic growth, the capital gains tax harms the economy by creating a disincentive to thrift and investment. The capital gains tax should be cut substantially—or, better, abolished altogether.

—David Goldman and Evan Kalimtgis

About the Authors

David Goldman is a Managing Director of Bear Stearns and Co. Inc. in the Financial Analytics Structured Transactions Group and is responsible for Fixed Income Strategy. He writes a monthly column for Forbes magazine, and has contributed to The Wall Street Journal, The Journal of Applied Corporate Finance, The Public Interest, The Washington Times and other publications.

Evan Kalimtgis is a Vice President in the Financial Analytics Structured Transactions Group at Bear Stearns and Co. Inc. He is completing a Ph.D. in Finance at Columbia University.




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TomDavidson
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"The capital gains tax falls overwhelmingly on the middle class—specifically, on savers and entrepreneurs, the most thrifty and industrious members of the middle class."

You know what just occurred to me? We've been bouncing around theories here, but no actual numbers. Does anyone have any hard numbers on the amount of capital gains tax paid on capital returns by income bracket?


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Baldar
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Look here

and here

If you or your family makes more than 200K a year you are part of the 77% that pays capital gains taxes.


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TomDavidson
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Yeah, I think it's safe to say that no family making $200K is impovershed.

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Jon Camp
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Here is a column (by a conservative) arguing for keeping the Corporate Income Tax, at least as long as a VAT is the proposed replacement.

Interesting that his primary reason for opposing a VAT is that it would unfairly burden the poor. . . .


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Baldar
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Tom, two teachers I know who are married make almost that much. It really is a stupid idea to increase capital gains. Try and think economically for a moment. How much have you invested to start up factories? To increase labor, let me answer that for you. Next to nothing.

Now allow me to ask you another question. How much do you think these "unimpovershed" people invest? Do you think they do it for charitable purposes? Would you deny the chance for Americans in general to make investments rather than be consumers? Do you understand economics?

What would you use to create a investment friendly atmosphere rather than a consumer based one? Rather that "carping diem", why not look at it logically once in awhile. Save the class warfare for the idiots who win elections of that stuff and vote accordingly.


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TomDavidson
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Hey, I'm an investor, myself -- and not JUST in tax-deferred funds, mind you. Admittedly, capital gains haven't been a problem over the last few years. *grumble*

That said, I have no problem with the existing capital gains taxes, because they CLEARLY don't discourage investment; given that so many of the wealthy own so much of the stock, it's pretty apparent that they're already willing to pay the costs. *shrug* And since it's a cost they can easily shoulder, I don't think it's too much to ask. In general, people who have to worry about capital gains taxes are NOT people who can't feed and clothe their children.


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Baldar
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I believe the best level of capital tax gains is not the present 20% but 15% because it is more balanced in creating investment. The more you take off the capital gains tax, the higher your investments will be, however, there is a point of diminishing returns in relation to investment and tax income. I believe one of the articles gave a compelling reason for the 15% number.
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LetterRip
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Baldur,

There is a lot to respond to, so I'll have to break it into multiple posts.

I think it might be useful to define 'middle class', the only US government definition I found was from the Beureau of Labor Statistics
http://www.bls.gov/opub/mlr/1988/05/art1full.pdf

Their paper also provides an overview of the literature on the 'middle class' definition. The BLS defines it as 60%-140% of median income adjusted for family size. The majority of research uses slightly smaller intervals.

The median income for a 4 person family http://www.census.gov/hhes/income/4person.html

was 62,228$ for the year 2000. (The median household income for 1999 was 40,816$, compared to the 4 person family income of 59,981$).

So we then have a range of 37,337$ - 87,119$.

So those with incomes of 200,000$ are more than double the 'upper middle class' income.

I'd be interested in seeing seperate median income definitions for urban and rural, or perhaps regional aggregation, so that cost of living is more inherent in the definition.

One quick and easy way to approximate this might be to take the states with the highest and lowest median incomes and use them as proxys...

So 82,702$ for connnecticut
gives 49,621$-115,783$

and 44,537$ for Arkansas
gives 26,722$-62,352$

So we have three ranges, with a maximum range of 26,722$-115,783$.

Now the 200,000$ is less than double our upper middle class.

From your writings, it seems that you are using a much larger range of annual income to mean 'middle class', what range do you think would be a better definition?

Interestingly a family Physician makes about 141,000$ (salary only, haven't see figures for total income). http://www.managedcaremag.com/archives/0103/0103.compmon.html

Are your acquintances making additional income through primarily investing that you are aware of? Incidentally, how do you know what they are making in annual income?

Anyway, I thought that it might be useful to get a better idea of what we mean when we use fairly common terms before we move on with the discussion.

LetterRip


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Locus
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*grin* ..in most cases buying stock isn't "investing" ..it's gambling.

If you want to invest find someone you believe in ..who wants to start a small business near where you live..and loan them money. If you'd like to spread the risk out then do it through a bank.

Any way you do it ..you may lose your shirt but hey ..at least you stand a chance of improving some regular ordinary lives in the process.


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Baldar
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So your saying that the majority of the top ten percent income earners in the US are middle class? Does that make sense to you?
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Baldar
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And Letterips alternative? He has none. Increase investment tax? Reduced investments? That will accomplish nothing except put more people out of work. Lesson growth. I have already shown how unfair the death tax is, I expect income jealousy will again raise its banner.

[This message has been edited by Baldar (edited October 29, 2002).]


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Grant Morgan
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"That said, I have no problem with the existing capital gains taxes, because they CLEARLY don't discourage investment; given that so many of the wealthy own so much of the stock, it's pretty apparent that they're already willing to pay the costs. *shrug* And since it's a cost they can easily shoulder, I don't think it's too much to ask. In general, people who have to worry about capital gains taxes are NOT people who can't feed and clothe their children."

I think that capital gains taxes effect investment differently depending upon income level.

For the most wealthy, I don't believe that capital gains taxes effect investment much at all. Someone who has $100,000,000 in the stock market isn't going to cash out and start a mad spending spree just because the tax rate on investments is raised from 20% to 25%. (Then again, I don't know that I want to see these people taxed at a higher rate. Their capital gains tend to be re-invested. One could look at tax money spent by the government as a different kind of investment. So the question becomes, who will choose investments that will better serve the good of the country? In general, I'd choose the successful multi-millionaire over the panel of senators, each with an eye toward re-election).

For middle income earners, however, investment is often painful. Putting a few percent of your income into some short-term or medium-term investment means that there is that much less money you have to spend today. The wealthy have enough to buy pretty much anything they want, and still have lots left to invest. Investment for the middle class is always a sacrifice (albeit, a sacrifice with a likely eventual payoff). The more capital gains are taxed, the less motivation there is to make that sacrifice. Given that one of our nation's biggest problems right now is consumerism, I would think that the government ought to encourage these middle income investors in any way possible.

So how about this: should capital gains taxes be progressive?


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LetterRip
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Baldar,

you stated

quote:
And Letterips alternative? He has none. Increase investment tax? Reduced investments? That will accomplish nothing except put more people out of work. Lesson growth. I have already shown how unfair the death tax is, I expect income jealousy will again raise its banner.

Since I'm not sure what you are referencing I'm not sure whether I have an 'alternative' or not, nor whether I've made any attempt to present one.

Could you please clarify what you are refering to?

Also, from the general tone with which you've posted in this thread, it seems you might have some erroneous assumptions about my opinion regarding taxes. Might you consider not passing judgement on my views until they've been presented?

Thanks,

LetterRip


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Baldar
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Perhaps I do, what is your stance on taxes, specifically the capital gains tax and the inheritance or death taxes?
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