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Investment Income Taxes (a Government Finance Issue)


Introduction

As individuals or businesses, we can invest our money by buying things like bonds, stocks, real estate, collectables, art, futures and numerous other things. In some cases, we will earn interest or dividends. In other cases we will eventually sell our investments. If we can sell our investments for more than we paid for them, then we can make a profit, otherwise we might suffer a loss.

The interest, dividends and profit from our investments would be Investment Income. This income differs in some significant ways from the income we would get from wages and salaries. The main differences are that our money is doing the work instead of us, and our governments need to protect and to regulate our investments differently than they would our employment. Therefore, we should handle the taxes on this income differently as well.

The first thing to consider is that people who have money to invest, would have already needed to earn, to inherit or to acquire in some other way the money that they invest. With wage and salary income, someone did not need to already have any money. In order to account for people who earned low wage and salary income and who might be just getting by, we allowed for some income to be earned without it being taxed. For high wage and salary earners, we make up for the non taxed income with higher tax rates in higher tax brackets.

Therefore, there should be no good reason to allow any investment income to be tax free. If an investment earns a profit, then the government should tax it in order to help pay for the services needed to protect and to regulate the investment businesses. Given this, we might just need to decide whether we tax it all the same or have different tax brackets and rates.

The next thing to consider is that interest and dividends are different than the capital gains from the sale of investments. With interest and dividends, we earn a profit without needing to sell our investments, so that income is all profit and we do not need to do any calculations to determine our profit like we would need to do with the sale of an investment.

Simplifications and Improvements

When we split the Investment Income Taxes from the other income taxes, there are a number of simplifications and improvements that we can make or at least considered. We get one significant simplification right of the bat. Since we are not trying to include our investment income with our other income, we do not need to do all the extra calculations to handle the different maximum tax rates on our investment income verses our wage and salary income.

For dividends and interest, we could handle it in a couple of different ways. We could sum up all the interest and dividends from all sources for the year, and have different rates for different income brackets. On the other hand, we could try to treat it similar to the way I suggested we do our wage and salary income. That is, tax it as we receive it with appropriate tax rates and brackets, but based on the average income per day for each income source.

The first method of taxing the interest and dividend income would still require filing a tax return. The second method would not require a tax return, since the appropriate tax would be taken out as the income was earned. The only issue with taking it out as it is received, is that some people who earn the same amount of interest and dividend income could pay different tax amounts. That is, someone with more sources of income could pay a bit less in taxes than someone with fewer sources.

For capital gains, and other earnings on the sale of investments. We again have a couple of options. We could sum up all the capital gains and other investment income for the year, and have different rates for different income brackets. On the other hand, we could tax the profit at the time of sale.

As with interest and dividend income, the first method of taxing the profit on the sale of an investment would still require filing a tax return. The second method would not require a tax return, since the appropriate tax amount would be calculated and be taken out of the profits. In both methods, we would allow for the ability to reduce the profit amount based on any past losses on the sale of investments, but only losses incurred within some specified number of years.

Another important component of the sale of investments is the time that an investment is held and in turn how long your money needs to work for you in order to earn a return on your investment. For example, there is a big difference in earning a 10% return on a stock you sold after owning it a year, and one you sold after owning it for 10 years. Therefore, this should be taken into account when determining your investment income tax.

Similar to what is currently done with short term verses long term capital gains, we want to adjust the tax rates based on how long the investment is held. However, I would make it more fine grained that just short and long term. That is, we should reduce the tax rate or amount based on the number of days that the investment was held, Although, we should cap the reduction so that the tax rate or amount is not reduced too much.

Tax Brackets and Rates

Since people need to already have money in order to earn investment income, we should not have a zero tax bracket. However, we do still want to encourage people without a lot of money to invest, so we do want to start out with a tax bracket with a fairly low rate. We could then have a moderate tax rate for the next tax bracket, and a higher rate for anything over some higher amount.

The exact tax rates and brackets would need to be determined based on what is needed to support the programs and agencies that need to protect and to regulate investments. If we had a wealth tax, as I think we should, then the investment income tax rates would be appropriately lower. Since a wealth tax would bring in more tax revenue the longer an investment was held, the reduction in the investment tax rate or amount based on how long an investment was held would also be correspondingly higher.

Foreign Investments

Foreign investments should be handled a little differently, since the government would not be able to protect and to regulate them in the same ways as investments in the United States. Most of the protection and regulations of foreign investments should be taxed accordingly by up to the country where the investments are located. However, our government may still need to work to protect our citizens' foreign investments, so an appropriate tax should be imposed to pay for that protection.

Our current income tax laws allow for some portion of foreign income taxes to be deducted. I believe that that should be eliminated. We want to base our taxes only on what tax revenue we need to protect and to regulate the investments, and not offer any type of reward for someone investing in a foreign country.

Next Section

Business Income Taxes - Making paying our Business income taxes simplier and fairer.

Last Updated:
Monday, January 03, 2022
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