First, DR's question was not limited to interest, but also to CG and dividends, which your source does not discuss (that's fine).
Yes it does. The example is interest [
future compensation for deferring consumption today + future compensation for the loss of consumption (purchasing)
power today] but you can assume that the return includes an investment premium [
future compensation for the uncertainty of principal] as well and none of the logic changes at all.
Secondly, he only deals with simple interest and not compound interest. Compound interest would shake his hypothetical numbers up quite a bit.
They wouldn't. The comparison is still between
the effect of tax on consumption today versus the effect of tax on consumption in the future. The future can be [
ten years] and the return can be [
10% compounded annually] and the comparison between scenarios 1, 2 and 3 will still be the same one. (Try it)
Third, he assumes all investment income is/was originally derived from wages
Correct. More specifically, capital is always assumed to be
deferred (saved) income. This is the case for any capital that was derived from the input of labour. It is not the case for the "economic rent" type of excess cash flows gleaned from extracting resource endowments, which is not discussed. And I would agree with the argument (if you were to make it; I can just as easily make it anyway) that such economic rents should be taxed
without concern that they were already taxed before, which they were not. Australia is doing this with mining, ostensibly for environmental reasons. Most countries effectively do it with oil and other resources by maintaining state ownership of extracting firms or by licensing private firms exploration and extraction rights.
we know that, in the real world, this is false (and goes back to my previous point regarding compound interest).
As above, reinvesting capital income via multi-period compounding of returns does not change the comparative effects of scenarios 1, 2 and 3. Compounding investment/interest returns doesn't change the outcome that with positive capital income tax,
future consumption is taxed more highly than present consumption. And that is the only argument advanced.
Note, by the way, that Landburg's case is completely agnostic to income/wealth
inequality. Each scenario is the
same individual (a hypothetical "you"), with the
same starting capability, and is a comparison of what tax you pay for consuming today versus what you pay for consuming tomorrow. Taxation arguments founded on the reduction of inequality are completely separate from this.
Also, In the example given in scenario 3, it would still be a better investment to save all of your money and consume nothing (or as little as possible) because the rate of return is substantially higher than the rate of taxation (100% interest/50% tax).
It's not relevant whether it is a "better investment", which is not an objective claim anyway. What is relevant is the tax rate for spending versus the tax rate for investing and spending later.
In a no-tax hypothetical economy, the
net present value of investment (the expected gross return discounted back to today for the things I mention above--inflation, real risk-free rate, volatility of principal) will equal the value of consumption for the two to be in equilibrium. Now assume that the rate of return on investment that equilibrates this is 100% per day ["
not very realistic but of course the example works just as well with realistic numbers"]. If taxes are imposed on wages and investment income, then the equilibrating rate of investment in the economy will fall relative to the rate of consumption. In other words, people will invest less relative to what they consume. If tax design does not want to produce this effect, then
capital income should not be taxed.
Now it might sometimes be a policy
objective to reduce investment and stimulate consumption, but it is not a
default objective of tax policy. And that is the point--if you're going to tax capital income, you'd better be aware that it discourages investment relative to consumption.
Further, an individual's effective tax rate will decrease, not increase as claimed.
No, it increases, as shown. If you save all your money your consumption tomorrow is 1 scone with both taxes and one scone today with both taxes, but your pre-tax consuming power is two scones today and four tomorrow. Hence if you save it all, your future consumption is taxed at 75% whereas present consumption is taxed at 50%.
If I save my post-tax $1, and earn $1.50 after adding interest and subtracting tax, I go from netting $1 on day one to netting $1.50 by day two - lowering my tax burden from 50% to 25% - not increasing it from 50% to 62.5% as claimed. Which is to say that, even under the conditions of scenario 3, every dollar saved represents an additional $.50 per day increase.
You are basing your claim on an assumption that the investment return should count as reducing the effective tax rate, which is not legitimate unless the investment return came from the taxing authority, which it doesn't.
This is because the principle amount is not taxed (only the profits to date).
Taxing the principal would be a wealth tax, which some countries have but which is not part of the argument. The argument is against the taxation of the
income from capital (wealth). If the wealth is also taxed, then future consumption is taxed even more highly than present consumption; investment is stuill further disincentivised relative to spending.
I don't consider it to be an extreme position to treat income the same regardless of source - it should be the null position.
Well I suppose it is possible to tax capital income
more highly than labour income, which would move "equal tax" away from the corner. But what country does that? I am not aware of any that do and I suggest that the range of actual positions goes from zero capital tax to the same rate as income tax, those being the extremes.
And as I said--there are also other arguments in favour of taxing capital income. But someone said they are aware of no valid argument against taxing it, and this is that.
I don't see it as valid, in the slightest
I hope you change your mind. All your points have been addressed above
