Capital investments aren't all the same

It's ironic that the bitter contest for the Republican nomination for president forced Gov. Mitt Romney to release his 2010 tax returns, setting him up as a prime example of the tax inequity issues on which President Obama is relying to argue for a tax rate increase on high-income Americans.

Opposition to any income tax rate increase remains a foundational principle for Republicans in Congress, the basis on which they risk voter discontent. Romney's tax returns undermine the principle in demonstrating that the very wealthy may be paying a lower tax rate than the average wage earner.

Typically, the individual receiving more than $1 million a year in income is not receiving most of it as earned income – what the average American worker receives in a paycheck. Those capable enough to have million-dollar incomes will, like Romney, receive much of it in stock options or other equities that aren't treated as income until they are converted to cash and considered capital gains. Under current tax law, capital gains income is taxed at a flat 15 percent, on a theory that capital formation is essential to American business and should be treated as a social and economic good to be encouraged.

But not all capital is the same. Romney's equity holdings are retained value in the company he had headed, as opposed to long-term investments in companies producing goods and services.

There are investments aimed at long-term equity value that support business growth. They fund infrastructure, materials and labor costs that promote development, and sometimes redevelopment, of a business. Shares in a successful business can have significant gain in net value over decades, despite periodic lapses, which is the experience with major corporate stocks such as General Electric and IBM.

But financial markets focus on short-term gains over business support, trading on volatility in values. It's an investment philosophy that parallels the expectations of a Ponzi scheme, accumulating wealth by risking that there will be a buyer willing to pay a higher price for a holding. Short-term trading can succeed, but it does not support national business growth. A focus on short-term gains tends to promote short-term revenue-enhancing or cost-cutting decisions – such as shifting production to low-wage/weak-regulation countries -- rather than long-term planning for plant, equipment and labor force.

Tax policy won't change investment philosophies. Neither will higher taxes on those earning substantial income from short-term capital growth pay off the federal debt. At best, additional revenues from a higher rate on millionaires will provide a Band-Aid for the national debt. Congress still needs to cut spending to avoid having to increase the tax load on all taxpayers.

Still, a higher rate on the very wealthy can offset some of the inequity in tax load on the majority of median-income taxpayers most affected by the regressive 15.3 percent payroll tax that supports Social Security and Medicare.

According to the Congressional Budget Office, low- and middle-income workers saw an 18 percent increase in income after taxes from 1979 through 2007, while after-tax income for the top 1 percent increased 275 percent. At the same time, federal government revenues from income taxes are lower while revenue from payroll taxes increased. (Trends in the distribution of household income between 1979 and 2007, CBO, October 2011)

Whether higher taxes on the wealthy who provide capital will affect job creation remains arguable. Physicist turned futurist Michio Kaku suggests job creation is more a factor of technology than capital accumulation, while technological innovations “create vast amounts of wealth.”

“But under capitalism, wealth is never stagnant,” he adds. “Wealth has to go somewhere. Capitalists are ceaselessly hunting for the next break and will shift this wealth to invest in even more speculative schemes, sometimes with catastrophic results.”(Physics of the Future: How sciernce will shape our human destinty and our daily lives by Year 2100, Doubleday/Random House, 2011)

* This blog includes additional material not in the original column, intended to clarify a point. The addition is underlined. Ed Tanji