How Many Bites Of The Apple Does The Federal Government Really Get?

I’ve heard just about enough Leftist whining about how a lower rate on capital gains is an unfair tax break abused by the rich.

Let’s follow investment income and how it is taxed as it wends its way through the economy.

Individual investor A has earned $100,000 he’d like to invest. First, that income is taxed at (at least) 15% in Federal income income taxes, so Investor A has $85,000 left to invest. He buys stock in Corporation B.

Let’s assume that Investor A holds his stock for 10 years, and the average of annual net income is 10% of his initial investment, so there’s income of $85,000 over 10 years. Of this, 50% paid in dividends, and 50% reinvested in the company to grow it. At the end of the 10 years, Investor A sells the stock for 127,500, or a gain of 42,500, on which he pays individual income tax of 15%. Over the 10 year period, assume the dividends have also been taxed at 15%. Over 10 years of owning the stock, the individual investor pays 12,750 in tax.

But first, before any income is available for dividends or being reinvested to grow the corporation, corporate income taxes must be paid. So the 10% dividend/capital gain income Investor A has realized is after corporate income taxes. For the sake of keeping it simple, let’s say the average corporate tax rate in this case is also 15%. To net $85,000 gains/dividend income, the corporation would have needed to make $100,000 and paid $15,000 in corporate income taxes.

So to recap, starting with $100,000, getting $42,500 in dividend income over 10 years and $42,500 capital gain in the final year, revenue to the government consists of $15,000 individual income taxes before anything is invested, 12,750 in taxes paid on capital gain and dividend income over 10 year period by Investor A, and $15,000 income taxes paid by the Corporation B. So far, the government has taken a cut of $42,750 from $185,000 in income, or 23%.

That may sound low, but let’s remember, that’s over a period of 10 years. Capital gains don’t take inflation or the time value of money into account.

Also consider whether the corporation had employees. Suppose it took $200,000 in wages to make the $100,000 in net income. I think people sometimes forget that employers match the Social Security taxes paid by employees. At a rate of 7.65%, that’s another $15,300 in taxes collected by the federal government. But wait, that’s social security, not income taxes, I’m comparing apples and oranges. Am I really, as long as the Federal government raids the “Trust Fund” for general spending, leaving the “Trust Fund” with nothing but IOU’s?

If you do add the Social Security/Medicare taxes of 15,300, it raises the taxes to $58,050, or 31% of the income generated.

This is obviously a simplistic example. But it should serve as an illustration of how “rich” investors directly and indirectly pay taxes beyond a “preferential” rate of 15% on capital gains.

This doesn’t even begin the take into account the state and local taxes paid by corporations, the costs of compliance with government regulations, and the benefit to the economy of a business employing people and growing a business.

So let’s see a little respect and appreciation for the “investor class”, shall we?