The rich and their stonks

April 25, 2021

Dear Readers,

What we do in life echoes in eternity, and what we write on the internet can echo for, like, a couple days.

One tweet from the news organization Axios has caught a lot of attention for seemingly editorializing about Biden’s tax plans.

As many people observed, the change to the top marginal income tax rate is neither new nor eye-popping. The same rate, 39.6%, applied in 13 of the last 30 years.

Moreover, U.S. history has witnessed much higher top marginal rates. In the 1950s and early 60s—a period often portrayed as the heyday of the American middle class—the top marginal rate was greater than 90%. In the late 60s and the 70s, when American companies like Apple, Microsoft, and Oracle were founded, it was 70%.

What is new and important, however, is the treatment of capital gains. As Bloomberg News puts it, “the proposal could reverse a long-standing provision of the tax code that taxes returns on investment lower than on labor. Biden campaigned on equalizing the capital gains and income tax rates for wealthy individuals, saying it’s unfair that many of them pay lower rates than middle-class workers.”

This is where Axios’s framing arguably obscures what’s going on. Biden’s proposal is actually to generally restore the tax rates for high earners from the Obama and Clinton years and make the capital gains rate the same as the rate they pay on ordinary income.1

Talking about Biden’s proposal this way, one hopes, could generate a more wholesome, conceptual debate about whether the income a very rich taxpayer gets from gains on invested capital ought to be taxed at the same rate as income derived from a similar taxpayer’s labor.

So, let’s talk about it that way. The beginning of that debate is to observe that the capital gains rate for the highest earners is currently 20%,2 far less than the top marginal tax rate for ordinary income is 37%.3

Why has the tax code historically had more favorable rates for capital gains than for ordinary income?

The standard explanation—the one I was taught over and over again in law school—is double taxation. There are, fittingly, two different ways to make the argument.

  • The first way is to contend that any money a person invests has already been taxed as part of individual earnings before they saved and invested it, and therefore taxing the proceeds of after-tax dollars amounts to a penalty for saving rather than spending that money.4

  • The second way is to assert that whatever entity a person invests in, and by extension its ownership, has already paid its own corporate or similar taxes and therefore capital gains taxes constitute “a second layer of taxation at the individual shareholder level.”

Both arguments are superficially appealing, but they’re both logically shaky and, perhaps more importantly, rest on assumptions that just aren’t borne out in reality. I’ll offer just a few quick points:

  • As the term “capital gains” implies, amounts saved and invested are generally speaking not taxed again; the investor’s gains are taxed.

  • A lot of income that’s taxed at the capital gains rate isn’t the proceeds of any savings or investment made by the taxpayer. The wildly lavish, perennially undertaxed compensation of private equity and hedge fund managers largely falls into this category via the carried interest loophole.5

  • An investor’s gains on an investment are, in an ideal world, somehow linked to the corporate income of the subject entity, which is subject to taxes, but that’s truly only theoretical. In reality, the value of an investment and the income of the entity can be wholly disconnected. Hope, buzz, and salesmanship, for example, can generate investment gains just as well as real corporate income, but they can’t be taxed.

  • Corporations are increasingly efficient at avoiding—and also deferring for a really long time—paying corporate taxes. An investor might purchase Apple stock, hold it for years, and sell it for a premium before any of its iPhone sales income from that time comes back to the United States from Ireland.

Beyond these specific points, I’d argue, it is intuitively unfair tax policy. Without even using any tax avoidance strategies, a billionaire like Robert Mercer can keep more of every dollar of his proceeds on sales of appreciated stock than, say, a crew member on the Mercer yacht who makes $89k per year would keep of her last dollars of those wages (which would fall into the 24% ordinary income bracket). How can that be right?


Obviously, though, that’s not what the Axios tweet says. It says the capital gains rate will be 43.4%—a higher rate. It reaches this higher percentage by bundling in a 3.8% Medicare surtax (known as the NIIT) that applies to high earners’ investment income. Investment income includes capital gains, so the addition of the two rates makes some sense viewed in isolation. However, it’s not the whole truth, and it tangles everything up. The NIIT also applies to rental income, interest, and some other components of ordinary income. Moreover, there’s a whole other 0.9% Medicare surtax (known as the Additional Medicare Tax) that applies to high earners’ wage or self-employment income. A more complete version of the Axios approach might therefore say that Biden’s proposal results in taxes on investments, including capital gains, at 43.4% and employment income at 40.5%. For my part, I think it’s a far greater aid to understanding the situation to say that Biden’s proposal is to (i) tax capital gains at the same rate as other income and (ii) restore the top marginal rate from the Obama and Clinton years.


Or 23.8%, if we’re including the Medicare surtax on investment income.


Or 37.9%, if we’re including the Medicare surtax on wage income.


John Stuart Mill wrote in Principles of Political Economy (1848):

Unless … savings are exempt from tax, the contributors are taxed twice on what they save, and only once on what they spend. … To tax the sum invested, and afterwards tax also the proceeds of the investment, is to tax the same portion of the contributor's means twice over. The principal and the interest cannot both together form part of his resources; they are the same portion twice counted: if he has the interest, it is because he abstains from using the principal; if he spends the principal, he does not receive the interest. Yet because he can do either of the two, he is taxed as if he could do both, and could have the benefit of the saving and that of the spending, concurrently with one another.


Back in 2010, James Surowiecki published an excellent description in The New Yorker of the carried interest loophole (emphasis added):

In a typical private-equity fund, the managers get paid two per cent of assets as a regular fee, plus twenty per cent of the fund’s profits. They pay regular income tax on the two per cent. But on their share of the profits, which is called “carried interest,” they usually pay only long-term capital gains—even though they put up hardly any of the fund’s actual capital, most of which comes from outside investors. The difference in tax rates saves private-equity managers billions of dollars a year, and means that they pay taxes at a much lower rate than, say, your average lawyer. It also means that their taxes are lower than those of people who do the same kind of work, or get the same kind of pay, as they do.