My fantasy capital gains tax

My Proposed Capital Gains Tax Policy

In a discussion on my facebook, we're talking about what we'd like to see in a Democratic party platform.  As some of you know, I'm kind of a tax policy nerd, and I was asked for details about how I'd restructure the capital gains tax.  It got long, so I'm putting it here.  If you are not a wonky nerd, this post will have nothing of interest.  OTOH, I've tried to keep this readable with minimal background knowlege, so some bits are a little over simplified.  Feel free to ask questions, or for more details, in the comments!  If you're my friend, and want to join the discussion, you can do so here: https://www.facebook.com/sara.someone/posts/10106298492821833 . I've done my best to verify all the facts and figures in here, but if something is wrong, please let me know and I'll fix it.

What are capital gains, and why do we tax them differently from other income?

Skip this section if you can already formulate a coherent answer to that question.  "Capital gains", roughly, are profits made from the appreciation (increase in value) of an investment.  These gains are realized when you sell the asset.  The archetypal example is real estate.  If you buy a piece of real estate for $100,000 and then sell it 10 years later for $180,000 (which is about 6% appreciation per year; VERY reasonable for urban real estate), you have made a capital gain of $80,000.  (NOTE: As I will discuss below, there are special rules for primary residence homes).  It would be problematic to tax that at the same rate as income, among other reasons because the "gain" involved occured over 10 years, but the income all happened at once.  Also, because there wasn't significant labor involved in the profit.  To tax capital gains at the level of normal income would STRONGLY disincentivize long-term investment, which is a recipe for disaster that would rapidly concentrate wealth, property, and especially the means of production in very few hands, and encourage such ownership to be largely hereditary. (which is the direction the current policies push us toward, IMO)

When our capital gains policy was invented, almost all capital gains investments were infrastructure (the is "means of production") that the government had a clear interest in subsidizing, things like people buying homes and businesses buying new machines for their factories.  However, over the last century, it has become the case that most capital gains are on much more abstract things like stocks, mutual funds, and other securities.  To my mind, this clouds the waters as to whether or not we actually want to subsidize all capital investments at the same level.  (you'll see below some policies to address this)

To greatly over simplify, capital gains tax policy is about balancing two opposing forces:
High capital gains taxes slow growth.
Low capital gains taxes concentrate wealth.

How do we currently tax capital gains?

Again, if you already know, skip this section.  Right now, the US tax code splits capital gains into two categories: short term (investments held for one year or less) and long-term.  short term capital gains are currently taxed (more or less) as normal income.  Long term capital gains are (broadly) taxed as follows:  If, as a single person, you make less than about $38K in total income, they are not taxed at all.  Most taxpayers pay 15%.  Single people with an income over about $425K pay 20%.  These rates have dropped very significantly in the last 20 years.  In 1997, the top rate was 28%, and the lowest 15%.  Obamacare is largely financed by an additional tax on capital gains: People who make more than $200K per year pay an extra 3.8% on the lesser of (capital gains + dividends) or (earned income).

There are many weird details:  Under most circumstances, the first $250,000 per person profit from the sale of a primary residence are not taxed at all.  "Collectible" or "luxury" assets like coins, precious metals, art, and etc are taxed at a higher rate (around 28%).  There are lots of other details to this, particularly in how the brackets work for married couples. Google can provide WAY more details if you want.

What's the problem with our current system?

Many people, particularly republicans, like to argue that higher capital gains taxes slow economic growth.  The data does not support that claim.  About 70% of all capital gains are accrued by people in the top 1% of income.  this is largely because normal people build almost all of their long-term wealth in their primary residence and in retirement accounts, like 401Ks, that have their own tax rules.  People who live off of income (trust fund kids, hedge fund managers, etc) end up paying only 20% tax, which is disgracefully low.  For comparison, that is significantly lower than someone making $39K per year (national median income is about $55-60K).  Further, the non-graduated nature of the long-term vs short-term categories incentivizes flipping property on short scales; there is no benefit to incentivize long-term tending of property.  Finally, current policy does not distinguish between investments with relatively immediate public good (such as home ownership and factory expansion) and investments with very little direct benefit to the public (such as mutual funds).  

What do I propose?

For long-term gains accrued on investments held for at least 10 years

• No tax at all on the first $50,000 of capital gains for a single person or married persons filing separately, $150K for a couple filing jointly. (I think there is significant social benefit to incentivizing married couple to jointly own their primary residence)
• Thereafter, exclude an additional 5% per year.  That is to say, if you bought a house for $100,000 20 years ago, there would be no tax unless you sold it for more than $271K.  
• Exempt the first $50K of capital gains on business equipment and real estate held for more than 10 years.
• 0% for the lower half of all incomes (currently, that means less than about $55-60K)
• 12% for incomes up to $200K
• 18% for income $200-500K
• 25% for incomes $500-5 million
• 30% for annual incomes over 5 million

For gains accrued over more than 3 but less than 10 years

• 0% for the lower half of all incomes (currently, that means less than about $55-60K)
• 13% for incomes up to $200K
• 18% for income $200-500K
• 25% for incomes $500-5 million
• 33% for annual incomes over 5 million

For gains accrued over more than 1, but less than 3 years:

• 0% for the lower half of all incomes (currently, that means less than about $55-60K)
• 15% for incomes up to $200K
• 20% for income $200-500K
• 28% for incomes $500-5 million
• 35% for annual incomes over 5 million

At all levels, impose an additional 8% tax on capital gains from hoarding, ie "collectible" assets.