Why are short-term capital gains taxed as ordinary income (at higher rates than long-term capital gains)?

Question

First off, capital gains are already taxed at the corporate level. Stock is a share of a taxable firm. A firm’s shares trade at a multiple of forward earnings. If the Street thinks XYZ will earn $1/share before taxes in the next 12 months, and its P/E is 10, and it is taxed at 35%, then a share of XYZ will trade at $6.50, not $10. If XYZ announces a new contract and now the Street thinks it will earn $1.20 before taxes, the stock doesn’t go up $2/share – it goes up $1.30/share. The gain is already reduced by virtue of the corporate level taxed.

So there shouldn’t be any tax – but there is one, albeit a lower one.

But that lower rate applies only if you’ve held the asset for a year or more. Why?

This punishes people for doing their homework – it’s an efficient market and arbitrage opportunities don’t last a year. If you’re right that what you’re buying is truly undervalued, the market will figure that out in days or weeks, not months or years. Why should you have to wait and subject yourself to risks you didn’t intend to take on?

The excuse given is that they want to discourage quick buying and selling, get you to hold onto assets longer, to reduce price volatility especially on the downside - - - but for every sale there’s a purchase, and the more and the faster the buying and selling, the LESS volatile the market - - - everyone remotely connected to investing knows that volume REDUCES volatility.

Do we have unfair tax rates simply because not enough Congressmen understand elementary investing concepts?

John, there IS a double dip. The stock goes up because the Street figures out that its forward AFTER TAX earnings are higher than it had thought. Yes the tax on what the Street initially thinks forward earnings will be is factored in to the price of the stock when you buy it - - but when the earnings outlook SHIFTS, moving the price of the stock, the change in the stock price is reduced by a multiple of the taxes to be paid on that earnings increase.

cory yes it's stupid but it appears to be based on a misconception about investing and about markets. Congress appears to have believed that volume increases volatility when in fact volume reduces it.

During the Depression the top marginal corporate tax rate on undistributed earnings was 90% - - - - rendering the above discussion moot.

Adam do you think Congress should decide what is or isn't a quality investment?

Answer 1

Governmental avarice.

Answer 2

tma is correct for short term capital gains rate, and for long term also for most items. On collectibles, the max rate on long term cap gains is 28%. A couple kinds of business gains also have different lt rates than the 5/15%.

Answer 3

I don't understand most of what you wrote. So what I think- the tax policy for stocks and capital gains should encourage quality investment. Does it do that now?

Truth- does the US policy on investment taxes reflect a depression era mindset? or have the laws substantially evolved since then?

I see, I was just wondering if a lot of laws from the panic back then (to decrease volitility) were still on the books.

Answer 4

The taxes paid by the corporation are factored in by people who buy their stock. So, there is no double dip. The government wants to encourage long term investment so it gave long term capital gains a tax break.

Answer 5

If the money comes in during one year, it's income.

If it's split over several years, it's different.

You're right -- it's a stupid distinction. But so are most tax laws.

Answer 6

It is simple. The government can get more tax money from it.
They do it because they can.

Answer 7

politics?

Answer 8

Are you in B school?