Yes it does.
OTOH, it doesn't make sense to not have a means of spreading out irregular income by recognizing it for tax purposes over several years in advance of realization if it can be anticipated, or deferring it over several years otherwise, in a progressive tax system. Which is why you should provide that, too (it applies to some subset of LTCG, especially that earned by the middle class, if taxing LTCG as income, but it would apply to lots of non-capital income, too—the income pattern for say, a novelist eho sends several years writing each book thar is a hit isn’t flat or steadily growing year-to-year, but spiky, and ir should be possible to smooth it for tax purposes.)
You don’t have to structurally preference capital income to deal with the fact that, as is true for other income, some capital income is the result of processes that the taxpayer can’t expect the same realized gain from year-to-year.
so let me rephrase my statement about capital gains. it doesn't make sense to treat LTCG as income unless we first make significant changes to the way we assess income tax in the first place. obviously this would be a lot more complicated. imo the existing cap gain rules is a somewhat reasonable solution for a tax system that mostly looks at each year in isolation. the 15% rate is really not much of a concession to a retirement saver who has held a lot of those assets for decades and has experienced meaningful inflation. but the whole system leaves a lot to be desired.
I disagree. LTCG as income without smoothing makes exactly as much sense as taxing regular income without smoothing does.
Yes, there’s a strong case for smoothing. There’s, independently, a strong case for not structurally favoring capital income and not structurally disfavoring labor income. While it is desirable to address both of those (and doing so simultaneously would be a good idea since there is no conflict), there is no dependency between them.
(Likewise, indexing capital asset basis values for inflation is a third thing that there is a good case for, but neither of the other two things depends on it to be a good idea; I’d oppose furthering the favoring of capital by doing it without first taxing capital income as income, though.)
> obviously this would be a lot more complicated.
Smoothing doesn’t have to add significant complication. The essence can boil down to:
(1) a taxpayer may freely recognize any amount of as-yet-unrealized income for tax purposes in any tax year and pay appropriate income tax on it. Any amount of the unused balance may be freely applied to reduce taxable income in any future year to no less than $0 (with one exception, see below.) Unused balances are indexed for inflation.
(2) a taxpayer may defer to the following year recognition of any amount of income over the greater of the top of the lowest marginal rate bracket or prior year taxable income (after applying any deferrals or advance recognition), with thr caveat that no more than 90% of any previously-deferred income may be deferred again.
(3) In final taxes after death, all remaining advance/deferred amounts are applied, with negative taxable income resulting in a refund calculated by applying the minimum marginal rate to the balance.
> Yes, there’s a strong case for smoothing. There’s, independently, a strong case for not structurally favoring capital income and not structurally disfavoring labor income. While it is desirable to address both of those (and doing so simultaneously would be a good idea since there is no conflict), there is no dependency between them.
in theory yes, in practice no. the current system treats the common case where wages slowly increase pretty well. people with highly variable income get screwed, but it's much more common to get a yearly 2-5% salary bump.
in contrast, assets are much more likely to be sold in chunks. I haven't realized any capital gains over $100 in the last five years. but soon I will have to liquidate a large portion of my holdings for a down payment on a house. having those gains taxed at my highest marginal rate would be far worse than the fact that I can't smooth out my yearly raises. it would almost double my taxable income for the year.
aside from that, I agree with what you wrote. I would certainly vote for your solution.
I should also note that even our current tax code admits that the setup with marginal taxes we have is kind of insane. See "Schedule J: Income Averaging for Farmers and Fishermen" which allows those occupations to do exactly what you suggest: average income over multiple years for tax purposes (can average with the previous 3 years). Why only farmers and fishermen? And why do you not get to do the averaging for AMT purposes? That's back to the "insane" part....
LTCG is simply any capital asset held for longer than 365 days. It makes perfect sense to tax gains on assets held for a year or two.
Moreover, capital assets include real estate and other items that appreciate faster than inflation. It absolutely makes sense to tax those assets, since those assets are generally not held for productive use. (See, for example, all the empty storefronts in NYC. Those properties are held with an eye toward making money on the eventual sale of the building without regard to ongoing income; the finances work out as long as incoming cash flow from rents in other units covers debt service payments.)
Indeed, not taxing long-term capital gains would be the biggest subsidy to the wealthy that the world has ever seen. It would encourage the wealthy to acquire assets en masse, hold them without use for long periods, and then sell them at appreciated and untaxed values despite having done nothing to earn the appreciated value.
unfortunately I don't write tax law. maybe I could get the tax prep companies to lobby on my behalf.
That would also incentivize companies to pay dividends, which I think is good for various reasons.
That’s not Biden’s plan. Biden’s plan is to limit the tax preference for capital gains by setting the top rate for LTCG equal to the top rate he has proposed for income taxes, with the top LTCG rate kicking in at $1 million+, while the same rate for normal income would at ~$400K.
> On the other hand, it disincentivizes long term investing.
Even if we assume an actual elimination of the preference, it would only “disincentivize” long teem investing to the same extent that taxes on normal income disincentivize income-producing activities generally, and still less than the even higher taxes on labor income (thanks to payroll/self-employment taxes) discourage labor and its employment.
And yes, I generally agree with your last paragraph. But that said, it is worth noting that taxes on normal income do discourage people from making money. (I'm not saying this to support a reduction in income tax, just as an interesting note.) So I think it is worthwhile to consider incentives. For example, income at x%, short term cap gains at x+10% and long term cap gains at x-5%.
Of course, if you really want to go all the way regarding fairness and incentives, you'll tend towards entirely different systems (Georgism, for example)