I've been doing some reading on implications of reverting back to Clinton-era tax rates and was reminded of the "super long term" capital gains rate that we used to have. It was 18% for capital gains for securities held for five years or longer.

To the extent that we have a capital gains tax at all, it has always struck me as obvious that the rate of tax should decline as the length of the holding period increases, for no other reason than to address the phantom gains created by inflation. Of course, the other good reason for lower rates on very long term gains is to encourage investors to think like owners of businesses rather than poker players.

Short-term capital gains are already taxed as ordinary income based on the argument that those who engage in short term trading are benefiting more from their active "labor" in managing their investments on a short term basis rather than as "owners" of the businesses in which they invest. This makes sense to me. I wonder if a bipartisan compromise could look something like this (at the top bracket):

* Short term gains taxed at 43.4%
* Long term gains between 1-2 years taxed at 30%
* Long term gains between 2-3 years taxed at 20%
* Long term gains between 3-5 years taxed at 15%
* Long term gains over 5 years taxed at 10%

Given the average holding period of stocks, my guess is that this would be a net revenue raiser and could possibly encourage a more healthy outlook on investing.

None of my beeswax, but wouldn't it be much simpler to just do an
inflation adjustment on the [adjusted] cost basis and tax the gain as ordinary income?
(or at some constant percentage of the applicable ordinary income rate)

Five tiers of rates isn't exactly simple, and every cutoff you pick will
cause another bunch of loophole-driven strategies and time wasting.

Jim

None of my beeswax, but wouldn't it be much simpler to just do an
inflation adjustment on the [adjusted] cost basis and tax the gain as ordinary income?

That could be done but part of the idea is to provide an additional incentive for longer term gains.

I picked the proposed cutoffs mainly based on what I think might be palatable to the politicians in both parties. The Democrats would get a capital gains tax rate much higher than even Clinton-era levels for what is likely to be most capital gains while the GOP wold get lower capital gains rates than are even available today for very long term gains.

Anyway, this will never happen in today's political climate because it would be perceived as a "huge tax hike" by the Grover Norquist due to the higher shorter term rates and as a "huge giveaway to the rich" by the Democrats due to the outrage felt over anyone "getting away" with paying only 10% for the 5+ year rates.

I would agree in general IF each percentage rate included "or your marginal tax rate, whichever is less." I definitely believe that patient owners/investors should be rewarded.

Bob

Five tiers of rates isn't exactly simple, and every cutoff you pick will
cause another bunch of loophole-driven strategies and time wasting.

And since the time that is wasted is my tax lawyers' where does that leave me?....(I think I know)

jz

If the Senate bill passes the House, it appears that the capital gains and dividend rates will remain unchanged for individuals with income under $400K and married couples under $450K. Rates will rise to 20% for capital gains that result in taxable income in excess of those amounts.

It appears that the dividend/cap gains zero percent rate remains in effect for gains up to the 15% bracket (useful even for those with taxable income in excess of the 15% bracket if all/most of their income is in the form of dividend and long term capital gains). The 3.8% ObamaCare tax, however, is still going to hit individuals with income over $200K and married couples over $250K.

I would be willing to wager significant money on the claim that NONE of our esteemed Senators read this monstrosity before voting on it:

http://www.scribd.com/doc/118551686/Mat-12564

I will say that I'm pleased that dividends and capital gains continue to be treated the same.

But the big question remains whether this can pass the House.

You are preaching to the choir. I was disappointed when I heard that the fiscal cliff deal didn't include any provisions to increase the capital gains rates but only increases taxes on wages and business income. Tax the rich my left pinky! They are only taxing the upper middle class.

I was disappointed when I heard that the fiscal cliff deal didn't include any provisions to increase the capital gains rates but only increases taxes on wages and business income.

Actually the capital gains and dividend tax rates are going up to 23.8% for taxpayers with taxable income over $400K/$450K. Going from 15% to 23.8% is a substantial increase although the more I think about a structure incorporating a super long term rate, the more I like the concept.

My main concern with the capital gains tax involves limitations to capital mobility. If the rate declines for very long term gains, that concern is alleviated substantially. Few business ventures have an expected timeframe of just a single year. If we had a gradually declining capital gains tax rate, capital mobility would be improved for those who truly seek business investments as opposed to trading gains. The super long term rate could easily be far lower than 15% provided that shorter term gains are taxed at higher rates. Since the average holding period for marketable securities is so short, tax revenues would likely increase.

Such a system would require conservatives to be OK with higher than status quo rates for gains of a "short term" nature and liberals to be OK with lower than status quo rates for super-long term gains. I think the liberals could be brought on board with likely higher revenue. But I'm not sure conservatives could stomach the idea of higher rates of any kind even if the overall system is better from a capital mobility standpoint.

To the extent that we have a capital gains tax at all, it has always struck me as obvious that the rate of tax should decline as the length of the holding period increases, for no other reason than to address the phantom gains created by inflation.

And then you propose a list of declining tax rates as holding period increases.

I would rather see tax-deferred investment accounts, essentially IRA's but with no penalty or early withdrawl. Then trading goes on and as long as money not taken from account, gains are not taxed. But money taken from accounts is taxed as income when taken.

This moves us away from income taxes and towards consumption taxes. It is hard to find an economist who doesn't think we'd be better off taxing consumption than income. And the beauty part is no inflation worries: you are taxed on the dollar amount when you take it out to spend.