Here's why the latter makes more sense to me. It's only at the risk-free rate of return that the two products you describe are of equal value. In order to realize returns higher than the risk-free rate, investors must do work. I think that the extra gain beyond the risk-free rate should be taxed as ordinary income, because that's really what it is: income produced by work.
Of course, actually implementing this policy isn't quite trivial: it requires a running estimate of the risk-free rate of return that can be agreed on politically, and it requires knowing exactly when assets changed hands (down to the nanosecond, for HFT). But it's well within our computational capabilities at this point.
So, should people who just stick their money in the bank at 0% for some period of time be able to claim a small loss on it? I would be fine with that, actually.
1. Are you claiming that taking risk is a form of work? Because the correlation between risk and expected return holds up very well empirically, and it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on. Even if risk and expected return had no correlation, it'd still only require luck, not necessarily skill, to often realize returns higher than the risk-free rate--just purchase one share of each of 100 risky stocks, and I guarantee that you'll have a significant return on at least one of them.
2. There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck, not work. Mutual fund managers, for example--whose literal job it is to earn excess returns--perform in aggregate roughly as well as the market, and the very best performers, at the extreme tail of the distribution, in one year are barely more likely than chance to do better than average the following year, and people in the bulk of the distribution are essentially flipping coins.[0] Again, these are people whose job it is to beat the market, and they're failing miserably.
3. In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value.
[0] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021
Yes, because you have to decide what risk to take.
> it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on
It would take a lot to convince me that you should pay a lower tax rate than I do on the money you make, just because the work you do is trading the stock market. (Essentially all my income is ordinary income.)
You may have a theory that says that your expected return from buying ETFs right now is higher than your expected return from buying T-bills. But if so, you had to do some work to develop that theory. In the absence of that work, the best predictor you have of the future value of the ETF is its present value.
> There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck
Fine. I have even less problem with taxing luck than I do with taxing work.
> In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value.
Making money consistently in the market takes work. If you don't believe me, ask a trader.
But again, I don't care about the distinction between luck and work. I don't care what your effective hourly rate is. Taxation is based on the amount of income, not on the amount of work it took to obtain it.
Let me make that concrete. I have a side business, with a partner, that brings in a mid-five-figure annual amount that we split roughly equally. (It's a support contract for a product we used to work on, sold to one of the last people in the world using that product; the company we worked for that produced the product is defunct.) In recent years I have needed to spend about 10 hours a year on this business.
I wouldn't call it life-changing, but it's a nice little piece of change and I feel very lucky to have it. But the IRS doesn't tax me at a lower rate just because luck was involved or because my effective hourly rate is so astronomical.
There is a big difference, of course, between this business and trading: I have no money invested in it that I could lose. But this points up what the real question here is: how much do we want to subsidize risk-taking as opposed to other kinds of productive activity? And I don't see why, at the moment, we would want to subsidize it at all. Our economy is already over-financialized, and this shows no sign of changing soon. I'm sure there are some macroeconomic circumstances in which incentivizing risk-taking would make sense, but the present day is not one of them.
You began this sub-thread by making the following claim:
> It's only at the risk-free rate of return that the two products you describe are of equal value. In order to realize returns higher than the risk-free rate, investors must do work. I think that the extra gain beyond the risk-free rate should be taxed as ordinary income, because that's really what it is: income produced by work.
With this in mind, look at the following table, based on historical returns since 1928:[0]
Stocks TBills TBonds
Arith avg. 11.50% 3.57% 5.21%
Geo avg. 9.55% 3.53% 4.93%
Std Dev 20.02% 3.06% 7.85%
1. Buy $1000 worth of equity ETFs. Sell them in 10 years. Expected value: $2,489.57. Expected tax paid: $223.44 (22%).
2. Buy $1000 worth of T bill ETFs. Sell them in 10 years. Expected value: $1,414.69. Expected tax paid: $62.20 (6.2%).
3. Buy $1000 worth of T bond ETFs. Sell them in 10 years. Expected value: $1,618.07. Expected tax paid: $92.71 (9.2%).
4. Hold $1000 worth of cash. Expected value: $1,000. Expected tax paid: $0 (0%).
Do these four products have unequal present values? No, they are equally valued at $1000, despite the fact that stocks have a higher expected return, because people are risk averse.
Are some of these products likely to realize returns higher than the risk-free rate? Yes--riskier assets typically pay a risk premium.[1]
Does investing in stocks require more work than investing in T bills or bonds? No.
Does investing in stocks require more work than investing in bonds, where "work" is defined as "possessing knowledge of, and acting on, the fact that higher risk assets typically have higher returns"? No, such knowledge is neither necessary nor sufficient. Unnecessary because plenty of people invest in stocks without any underlying research because they've been told to do so, or pay someone else to manage their money for them. Insufficient because plenty of people prefer the stability of lower-risk assets to stocks' higher expected return.
Look, I don't work in finance either. I'm a software developer. I try to save money, and when I do, I throw it into an ETF that tracks the market as a whole. I don't try to time the market. I don't try to identify growth markets or over- or under-performance of asset classes. If I wanted risk-free returns, I could use the time I spend logging into my brokerage account and buying equity ETFs to instead... log into my brokerage account and buy bond ETFs. Or I could use that time to log into a savings account and transfer money over from a checking account. I completely reject the idea that my personal decision to purchase stocks instead of bonds is work.
If you want to change your position to claim that taxation should discourage risk-taking, I strongly disagree, but that's a different argument entirely.
[0] http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/...
> I completely reject the idea that my personal decision to purchase stocks instead of bonds is work.
But you can see, can't you, that what active traders and investors do is work? I'm talking about the people who do select individual stocks and do attempt to time the market. To do that with any degree of success takes both skill and work.
And is what you're doing really different in kind from that activity? I understand that it's different in quantity; you're now just following a plan that you decided on previously, so the amount of work you're doing is very small by comparison. But is it really zero? You did a certain amount of reading and study before coming to the conclusion that your preferred strategy is to buy equity ETFs. Wasn't that work?
They only have that power because the rest of the country is disorganized/divided and un-unionized. There's more than us than there is of them. Ultimately they will cede this power at some point - the question is simply when.
Shinkei already put scare quotes around the word "punished" so any reasonable person should interpret that he does not mean "punish" in a formalized legal sense. His usage was a figure-of-speech and not citing any legal doctrine.
People can use <scarequotes>punish</scarequotes> the same way people can use <scarequotes>reward</scarequotes> when then say they felt "rewarded" with a tax credit for buying a hybrid electric car or installing solar panels. This is possible even though the word "reward" is nowhere stated in official USA tax code regarding those credits.
I'm not saying he attacked Shinkei. couchand criticized the message and not the messenger which is certainly acceptable. I'm pointing out that he's criticizing a figure-of-speech by stating to us the legal literal definition of "punish". Because couchand didn't parse Shinkei's "punish-as-in-sentiment", he made the mistake of equivocation[1] and talks about punishement-as-in-prison-sentence-from-illegal-tax-evasion.
It's as if someone says "butterflies in my stomach" and a nitpicker adds a ST-MrSpock/ST:TNG-Data type of literal reply. Mr Spock asks, "Why do people use the term 'butterflies'? Caterpillars cannot incubate in the human stomach and metamorphose into a butterflies." Most observers would find that response annoying instead of being relevant to the conversation about nervousness.
Sure, there can be other motives such as helping someone conquer stage fright but hopefully you agree that correcting someone with formal biology definitions of "butterflies" does not achieve that objective at all.
You usually purchase an admission ticket without being coerced to do so. Tax forms are filled with threats about what will happen if you do not comply. So while "punish" may not be the right term, it isn't anything like an admission ticket.
Your sentences are textbook examples of equivocating.
>People use the term punish when they feel like they've been punished.
Yes, they often do! Notice the word you just used to describe Shinkei's post? You wrote "feel" to describe "punish-as-in-sentiment-figure-of-speech". It's feelings/sentiments/perceptions etc.
Your attempted explanation after that was this:
>you're only punished if you fail to pay.
This is "you're only punished-as-in-assets-seized-or-go-to-jail if you evade taxes". It's a switch in semantics.
Because punish-as-in-sentiment is not equal in meaning to punish-as-in-jail, your proposed clarification is a non sequitur.
Since you're not aware of why one type of meaning (feelings) is not relevant to the other (jail), you are equivocating.
>I'm trying to figure out why people immediately think they are being punished by taxation somehow completely forgetting the [government services]
I know and it's understandable that you want to satisfy a curiosity. However, you'll just annoy people if you're equivocating 2 different meanings to justify your perspective while asking your question.
If someone says they feel "raped" by high taxes, you don't ape MrSpock and say "I see no genitals forcefully entering any orifice so I don't understand why people call it rape."
>they are an admission ticket to society.
They are not an "admission ticket". Admission tickets are pieces of paper that you submit to an usher or gate agent to be admitted to an event or airplane. (If you find that dissecting-figures-of-speech with literal definitions to be annoying, you've experienced firsthand why equivocation derails the discussion and is not helpful.)
Lastly, it seems like your answer to Shinkei was based on thinking he was against all taxes. If you read his post again, he was playing devil's-advocate for paying "punishment" taxes on a yacht. It's entirely reasonable for that type of person to raise taxes on himself for more police officers but feel punished for extra consumption taxes on luxury items since he's already paying sales tax on it.
By and large, the more you tax something, the more you discourage it.
In particular, in a discussion of wealth tax vs. consumption tax, you can't rely on the naive assumption that elasticity of consumption has a significant bearing on the net effect of a consumption tax.
See, e.g. http://ntj.tax.org/wwtax/ntjrec.nsf/4E562450B2F268D985256AFC...
Anyway, taxing in this way imposes a moral judgement on the use of a person's wealth... I consider myself a pretty liberal person, but even I see a problem with 'punishing' a person for spending a million on a yacht rather than starving children. We can incentivize that by making it tax-deductible, but that does nothing to solve the problem of the income tax disparity. I work a lot of hours and my payroll taxes are much higher than capital gains taxes--as Buffett and others have pointed out, that's what's unfair but it won't change as long as the people who get their income from capital gains have the most power to influence politics.