Investment Income Taxes (a Government Finance Issue)
As individuals or businesses, we can invest our money by buying things like bonds, stocks, real estate, collectables, art, futures, and numerous other things that we expect to make a profit from. In some cases, we will earn interest or dividends. In many 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 income we earn from interest, dividends, and profit from the sale of our investments are types of Investment Income. Our investment income differs in some significant ways from the wage and salary income that we would get from working at a job. For instance, with investments our money is doing the work instead of us.
In addition, with wage and salary income, we do not already need to have any money, but we do need to have the time and skills to do some work. On the other hand, to earn money from an investment, we need to have enough money beyond what we need to live on so that we can invest. We may get that money from our wages or salaries, from an inheritance, from the income from our other investments, or from some other source. With investments, we also need to worry about losing money.
When we work for a wage or a salary, we are limited as to how much time we can work in a day or week, which can limit how much we can earn. To account for those of us who earn low wages or low salary income and who might therefore be just getting by, we allow for some income to be earned without it being taxed. For high wage and salary earners who are earning more than enough to do better than just getting by, we make up for the non-taxed income with higher tax rates in higher income tax brackets.
With investment income, we would already need to be doing well enough financially to have the money to invest. In addition, our investments are only limited by how much money we have available to invest. 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 to help pay for the services needed to protect our investments 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.
In addition, our governments need to protect and to regulate our investments differently than they would our employment. For our employment, our governments need to ensure that our employers pay us a fair wage and protect our health and safety. For our investments, our governments need to ensure that those with whom we invest are honest and that they treat us fairly.
Given the differences in how we earn our employment and investment incomes and the differences in how our governments need to protect those incomes, we should handle the taxes on these incomes differently as well. In addition, different types of investments may require different types and amounts of government regulation, which could mean different tax rates for some of them.
For instance, interest and dividends are different than the profit or 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 or loss like we would need to do with the sale of an investment.
The one real exception to taxing investment income is with some tax-free government bonds. In these cases, the federal, state, or local government may issue bonds instead of taking out a loan to pay for a government project. A government can issue these tax-free bonds with a lower interest rate than it can with taxable bonds, since those investing in these bonds will not need to pay income tax on the interest income they earn. This helps the government by getting the money at a lower interest rate and helps the investor by not taxing the interest income.
However, this can unfairly benefit high income earners by lowering their income taxes at a higher income tax rate than lower income earners. In addition, this can complicate our tax returns, since the interest is not taxable by the government that issued the bonds but is taxable by other governments. It may be best to phase out these tax-free government bonds. Interest rates would be higher on what would have been tax-free government bonds, but our income tax forms would be a lot simpler.
When we split the Investment Income Taxes from the other income taxes, there are a few simplifications and improvements that we can make or at least consider. 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 versus our wage and salary income.
For dividends and interest, we could handle it in a couple of different ways. One way would be to sum up all the interest and dividends from all sources for the year and tax it at a single rate or have different rates for different investment income brackets. On the other hand, we could try to treat it like the way I suggested we do our wage and salary income. That is, tax it as we receive it at a single tax rate or with different appropriate tax rates and brackets but based on the average investment income per day for each investment 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 of us who earn the same amount of interest and dividend income could pay different tax amounts. That is, if we have different tax brackets then someone with more sources of investment 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. One way would be to 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 investments 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 we hold an investment and in turn how long our money needs to work for us to earn a return on our investment. For example, there is a big difference in earning a 10% return on a stock we sold after owning it for a year, and one we sold after owning it for 10 years. Therefore, this should be considered when determining our investment income tax.
Like what is currently done with short term versus long term capital gains, we want to adjust the tax rates based on how long we held the investment. However, I would make it finer grained than 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.
Reducing the investment income tax rate based on how long an investment was held might be especially important if we had a wealth tax as I described in an earlier section. This is because the longer we hold an investment, the more wealth tax we would have paid. We would also need to make any needed adjustments to what we had paid in wealth tax. If we had fewer capital gains than the wealth tax had assumed, then we should get a refund on the excess amount we paid in wealth taxes.
In addition, we might also consider reducing the investment income tax rate based on the amount of inflation that occurred while we held our investment. This is because inflation would have reduced the actual value of our investment so our profit will not buy as much as it would have without that inflation.
Since we already needed to have enough money to invest and to earn investment income, we should be well enough off not to need a zero-tax bracket for our investment income. However, we do still want to encourage those of us without a lot of money to invest, so we could start out with a tax bracket with a 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 should also be correspondingly higher.
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 regulation of a foreign investment should be the responsibility of the country where the investment is located, so it would be up to that country to tax it. However, our government may still need to work to protect our citizens' foreign investments, so an appropriate tax should still 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 our investments here, and not offer any type of reward for someone investing in a foreign country.
To accurately tax our investment income, our governments must be able to confirm when we bought our investments, what we paid for them, when we sold them, and what we sold them for. To do that, our government must track the investments for which it will tax its income. What our government tracks should be certain types of investments and any high value investments. What we consider to be a high value investment would need to be determined based on whether the investment tax revenue would be more than the cost of tracking the investment or not.
For some investment property, our governments track their sale and ownership. For real estate, we are issued a deed for our property. For a car, we register it and are issued a title. Although most cars are not an investment, some classic cars are an investment. In these cases, our governments will know what they need to tax our investment income.
For some other investments, different companies keep track of our ownership of them. Banks keep track of our money in our checking and savings accounts and certificates of deposit. Financial institutions keep track of our stocks, bonds, and mutual funds. In these cases, our banks and financial institutions will report our investment income to the government.
For some investments like precious metals, art, and other collectibles, we are responsible for keeping track of what we own. We need to keep our receipts and bills of sale. If we want to protect our investments, we need to ensure them, so we get insurance and have the insurance company keep a record of our investments. In these cases, we usually need to report our own investment income, when needed.
Given that our governments do not currently track all the investments that they should, we need to implement a method to track them. The best way to handle this would be to implement a federal database, like what I suggested was needed for a wealth tax. In this case, the appropriate investment income taxes can be imposed when the investment records are updated for sales or other appropriate changes to the investments.
Business Income Taxes -
Making paying our Business income taxes simplier and fairer.
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