Quote:
Originally Posted by whell
What are you talking about?
Example: let's say I live on a piece of property that has lots of trees. I cut down a tree and make 10 baseball bats out of it. In this example, the tree is capital - specifically the wood from the tree.
If I invest in someone else's business - via direct investment or stock purchase - I am adding capital to that business.
A capital gains tax is the increase in value of the capital that may be realized when capital is sold. If my investment in the business increases in value when I sell my stock - or when my direct investment is paid back - I am subject to tax on that gain.
Capital is not sourced from a tax break. However, if the tax rate on gains are too high, there is a risk that the tax becomes a disincentive to invest. Money - capital - is then more likely to sit on the sidelines in low risk, low return instruments. Lots of cash on a corporate balance sheet can make a company appear healthy. But it's also can be a sign of a company not making R&D investments or capital improvements. On a macro scale, it can negatively impact economic growth.
Sound familiar?
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The tree isn't capital. The tree is a resource. It's 'land' in the classical economics set of inputs: 'land, labor, capital.'
The capital in your example would be the equipment to cut down the tree and make it into baseball bats and transport them to market, among other things.
Capital may be created from existing inputs. For example, if you already have a blacksmith forge, you could use it to make an axe to cut down the tree. Or, capital may be the invested surplus of previous activity. For example, you might sell the blacksmith shop to get money to build the baseball bat shop, with the necessary saws and lathes and finishing equipment and so on.
Here's where the capital gains tax might bite, of course: it takes from the proceeds of the blacksmith shop sale, if there are gains. You might not have enough for the baseball bat project. Or, looking forward, you might want to sell the baseball bat shop as a stepping stone to build a plywood mill in a few years, but if the capital gains tax were too high, the numbers might not work, and you might say the heck with the whole thing and stick to blacksmithing. Lots of growth doesn't ever happen.
All this was your point, and you're probably feeling great now that I reinforced it for you so nicely. But hold on.
I've just made an argument for trouble if the capital gains tax is too high. There is also trouble if it is too low, or abolished altogether. Too low a capital gains tax incentivizes capital owners to liquidate, since the gain is untaxed, while income from operations or dividends is. This can be a drag on the economy, if the new uses of capital turn out to be less efficient that the ones that were liquidated.
In terms of our example, we're selling a known good business, the baseball bat shop, to get cash to build a plywood mill. There are risks here--the plywood business might present unforeseen difficulties. Loss to the owner, and to the economy. There's even more risk of negative growth because the new owners might not be so good at the baseball bat business.
So, the successful owner should stay with the productive baseball bat business unless there's a real quality opportunity for growth. The incentives are probably balanced best if there is the right amount of capital gains tax, to keep the analysis tax neutral between sticking with an existing income source, or liquidating it to invest in a new one.