If capital gains are taxed at 70%, there is an enormous incentive to hold onto assets; at 50%, less so; at 25% less so; at 15% much less so; and at 0%, money goes to the most productive assets.

At 0% money goes to the assets expected to be most lucrative, which is by no means the same as the assets that prove to be most lucrative, and given the varying shares of both public and private benefits and public and private costs, even investing and gaining the most lucrative investments is certain to be different than the most productive allocation.

And this is all in the part of the financial system that merely passes money around ... you are talking about pure financial intemediation. In a monetary production economy, depository institutions are able to generate new purchasing power, and so depository institutions (principally commercial banks) can provide finance directly if there are credit worthy borrowers and the central bank is not throwing monkey wrenches into the system in pursuit of an antiquated monetarist ideology.

In the end, new purchasing power must be created in order to finance the mobilization by commercial enterprise of new productive resources in order to expand productive activity, and new purchasing power is created either by government deficit spending to expand the supply of fiat currency or by increase leverage of credit-money created by banks on fiat-currency held as reserve assets, or a combination of both.

No amount of dollars chasing shares or dollars chasing corporate debentures in the US is going to make up for the massive current account deficit (past 5% of GDP in 2005 on a five year moving average and still plummeting down) which is destroying domestic purchasing power faster than breakneck on-book and off-book deficit spending can create it. And escalating indebtedness as a share of GDP is steadily undermining the overall quality of the aggregate commercial bank asset base.

A 70% capital gains tax is a red herring in discussions in the US, where capital gains taxes reached their peak at just under 50% in the late 70's and were all the way down to 28% by 1992, before the radical right wing attack on public non-military spending got underway in 1994. So take a level of 30%.

You have three pure coin toss, purely speculative investments, which therefore yield no income except through capital gain. One yields a gain of 9% on tails and 11% on heads. A second yields no gain on tails and and 20% on heads. The third loses 10% of its value on tails and gains 30% on heads. The expected return in all three cases is 10%.

Since these are purely speculative investments, if there is any risk aversion at all, these are not stable payoffs, and stock demand=supply adjustments result in a shift in those returns so that the higher the downside risk, the greater the average return.

Does this represent the most productive financial intermediation for the economy as a whole? Of course not. Those who are induced to hold the riskier positions not only accept the higher volatility of return, but they also impose greater risk of insolvancy on the system as a whole.

We therefore should lean against the wind in these markets. We should increase the inducement to hold the lower risk investment, and reduce the inducement to hold the higher risk investment, to reflect the systematic bias in social risk exposure.

And evidently, the more these assets are held by large  Ownership Unions with lives of indefinite extent, the more it is necessary to lean against the wind, since a large Ownership Union is able to diversify its financial holdings and reduce its exposure to stochistic risk, which permits it to adopt a profile that exposes the national economy to substantially higher levels of systematic risk.

Now leave the radical right wing wet dream of returning to the 1920's in blind faith that it does not entail returning to the early 1930's, and put capital gains taxation of 30% in place. The first two flips have equal value, a 7% gain, but the 1:2 10% risk of a loss is no longer compensated by a 1:2 opportunity of a 30% pre-tax gain, when that is a 10% loss against an aftertax 21% provides an average 5.5% return. The greater the risk the speculative invester exposes the economy to that he or she will lose his or her shirt, the greater the penalty imposed on that anticipated pattern of returns by the capital gains tax.

The flaw in the capital gains tax, of course, is that of taxing the capital base due to inflation. Given that the rapid turnover of assets imposes greater social costs than lower turnover of assets, and given that this is a penalty that compounds over time, I am strongly in favour of permitting indexation of capital assets for all assets held five years or more.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.