Capital Gains Tax

25 04 2011

Capital gains tax is a tax on capital gains. Capital gains is the revenue made from selling capital assets, which are assets that are not easily sold to create cash and are kept for long periods of time. Examples of capital assets include investments, real estate, and in the case of businesses, machinery, land and buildings.

Why is this tax a good option?

1. Equity

Without the capital gains tax, people earning an income of $100 000 by working would be taxed, while wealthier people who can afford to invest in capital assets pay no tax from making a capital gain of $100 000. This puts the burden of tax on less wealthy individuals who have a harder time bearing the tax, rather than on those who have a higher amount of disposable income and can afford to pay more tax. Having a capital gains tax helps redistribute wealth in an economy and prevents the gap between the rich and poor from growing.

2. Stabilizes Amount of Taxable Income

The capital gains tax not only generates more revenue for the government, but also prevents people from putting all their money into capital assets as a way to escape taxation. This in turn prevents the depletion of the amount of taxable income available to the government. By maintaining a steady source of tax, the government will be less likely to experience a lack of financial resources to fund its activities and fall into debt.

3. Extraneous Costs

If there was no capital gains tax, taxpayers will attempt to find a way around paying tax by turning their income into capital gains. This would lead to higher costs for running the judicial system, because the court system must deal with cases of people illegally turning income into capital gains to escape tax, and the government will have to spend time and energy creating legislation preventing taxpayers from escaping tax illegitimately.

Why is this tax a bad option?

1. Discourages Investment

Investing in capital assets increases one’s income and spending power when one sells the asset to make capital gains. A capital gains tax decreases revenue made from capital gains and thus discourages people from investing and taking risks as a way to gain revenue. This slows economic growth as a result due to decreased consumption (due to lower incomes) and investment in innovation.

2. Money Lost

The growth in the monetary value of capital assets is often the result of inflation, so the capital gains tax would essentially be placed on inflation, not on an actual increase in the value of the capital asset. As a result, people could actually be losing money when they sell their capital assets. At this rate, individuals may be encouraged to spend their money rather than try to place it into capital assets for fear that they will actually lose money when they sell the asset. This can cause problems such as insufficient investment into retirement funds.

3. Decreases Flexibility in Choosing Investments

With a capital gains tax, investors may be discouraged from switching their capital assets to ones that offer a higher rate of return for fear of losing money when selling their old capital assets. This prevents the investors from increasing their income and spending power.

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