Capital Gains Inquiry

[BlueLesPaul]

This is more of a thought experiment than anything, but if I had $1 Million dollars in long term capital gains, would all of the gains in the first two tax bracket still be taxed at 0% at the federal level?  Basically is their any phase out for the 0% rate for the first two tax brackets? (outside of the phase out for the standard/itemized deductions and the personal exemptions)

[MDM]

if I had $1 Million dollars in long term capital gains, would all of the gains in the first two tax bracket still be taxed at 0% at the federal level?

Yes, if that is your only income.

No, if you have other income to fill the first two tax brackets.

[BlueLesPaul]

That is what I thought.  Pretty crazy that there is not some sort of phase out for this.

[forummm]

That is what I thought.  Pretty crazy that there is not some sort of phase out for this.

Each additional dollar you earn is taxed the same way for everyone. I think it makes sense. You want the tax rates to be predictable for people. And if you suddenly had your first $90k become taxable because you hit a certain threshold, then you might have a tax rate far exceeding 100% for that next dollar of income.

[BlueLesPaul]

That is what I thought.  Pretty crazy that there is not some sort of phase out for this.

Each additional dollar you earn is taxed the same way for everyone. I think it makes sense. You want the tax rates to be predictable for people. And if you suddenly had your first $90k become taxable because you hit a certain threshold, then you might have a tax rate far exceeding 100% for that next dollar of income.

That would be the point of a phase out, instead of a tax-cliff.  Not all $90k would be taxable all at once.  It would probably look something like the method employed by the US Corporate Tax code, which increases taxes once you get past a certain threshold so that all income is eventually taxed at the top marginal rate.

Taxable income over     Not over      Tax rate

          $            0        $     50,000        15%
               50,000               75,000        25%
               75,000             100,000        34%
             100,000             335,000        39%
             335,000        10,000,000        34%
        10,000,000        15,000,000        35%
        15,000,000        18,333,333        38%
        18,333,333         ..........             35%

[Druid]

When I was not educated on tax matters I wanted to reduce my hours at my job because I was close to the 25 percent bracket and thought every dollar of income would be taxed an additional 10 percent. Progressive tax rates reduce the incentive of people to work less to avoid tax cliffs. In theory the same applies to capital gains. The progressive nature gives the taxpayer more incentives to recognize gains and brings more revenue to the government.

[MDM]

Progressive tax rates reduce the incentive of people to work less to avoid tax cliffs.
The progressive nature gives the taxpayer more incentives to recognize gains and brings more revenue to the government.

Either I don't understand, or do understand and don't agree.  E.g., if progressive rates start low and increase toward 100%, how does that incentivize people to work more and recognize more gains?

[Cathy]

Progressive tax rates reduce the incentive of people to work less...

A progressive tax system is more likely to disincentivise work rather than incentivise it. The argument is simple. Let's suppose that the least you are willing to accept for your time is $50 per hour. If you cannot receive $50 per hour after tax, you will simply decline to work, because below that price point, you would rather relax than trade your time for money. Let's further suppose that on the free market your time is worth about $65 per hour. Thus, while the marginal rate is below 23%, you will be willing to work, but as soon as it goes above 23%, you will stop working. The result is that you will work until the marginal rate changes to be above 23%, and then you will stop working. Thus, the progressive tax system has artificially limited the amount that you are willing to work -- i.e. it has disincentivised work.

[Seppia]

I guess Druid means "it de-incentivizes it less than a tax cliff".
Any tax has an adverse effect on the utility of extra work, the point is just finding a fair balance.
 

[Druid]

Seppia is right about what my intent was, but my statement was poorly worded. Most progressive tax systems have a marginal tax rate where income in each bracket is taxed differently. My statement was focusing on the bracket component of our progressive tax system. I understand the theory behind people working less as the result of a progressive tax system as my original post suggests. Tax cliffs create a lot more incentive to stop the working than when a marginal tax rate is in place.