Paul Craig Roberts
Tuesday, April 15, 2003

Generally speaking, the higher your income, the less you own of yourself. A person with $300,000 in taxable income will discover that government in the year 2002 has a claim to about one-third of his labor – the maximum tax that could be levied on a medieval serf.

If you have a low income or work primarily off the books, you will be rewarded with an "earned income tax credit" – that is, you will receive a tax "refund" even though you paid no tax. You not only own all your own labor, you also have legal claims to the incomes of higher-income persons.

Democracy produces the opposite results of feudalism. Instead of an upper class living off the sweat of a lower class, the lower class lives off the sweat of an upper class. Philosophers such as John Rawls created a philosophy to justify the latter as "moral" and the former as "immoral," but it all comes down to the same thing: Some people live off other people's activities.

Income taxes are not the only taxes. There are property taxes, wealth taxes, excise taxes and sales taxes. If you add together all the taxes you paid, you might find that you own no more of your own income than a 19th century slave. (A slave owed his master about half his work product, the rest being necessary for his own maintenance.)

Some of the taxes we must pay are not really taxes. Capital gains and estate taxes are confiscations. A capital gains tax is a tax on the rise in the price of an asset. A home or land rises in value because of inflation and supply and demand. A person who sells his home or land has no real gain, because he cannot repurchase the home or land at a lower price. A capital gain tax simply confiscates a percentage of the asset.

If the asset is a commercial asset such as plant and equipment or stock shares, a rise in value reflects a rise in projected earnings. The increased earnings from the assets will be taxed as business and personal income. To tax the assets themselves is a confiscation.

For example, if you sell 100 shares of stock and pay a capital gains tax of 20 percent, you are left with the replacement cost of 80 shares of stock. Where is your gain?

Capital gains can produce 100 percent tax rates and higher for investors in some circumstances. In the year 2000, stocks peaked early in the year and then collapsed. Investors in mutual funds and investment partnerships ended up paying large taxes on losses, otherwise known as "phantom profits."

The Internal Revenue Service created phantom profits by pretending that investors in mutual funds and investment partnerships realize capital gains every time a fund manager sells stock at a higher price than the fund paid, even though the "earnings" are ploughed back into the fund and are not realized by the investor unless he cashes out.

Early in 2000, funds managers, expecting the stock market's decline, sold shares to protect the values of their funds. The "capital gains" realized by the funds on the sales are attributed to the funds' investors by tax law. However, no investor realized the "gains" unless he cashed out of the mutual fund or investment partnership when the fund manager sold the shares.

Few did. By definition, such investors rely on professional management and are less attuned to adverse developments. Moreover, exit from investment partnerships is only permitted on a quarterly basis with 30 days' notice. Otherwise, the investment partnership would have to keep large cash reserves to meet withdrawals and, thereby, produce a poor return on overall investment.

By the end of the tax year, the vast majority of investors had large unrealized capital losses in their mutual fund and investment partnership holdings. However, the IRS forced individual investors to pay personal income taxes on the "gains" that occurred within the funds early in the year prior to the collapse of the stock market.

In other words, in a year when people suffered a large decline in wealth, they were forced to pay large taxes on phantom gains that they did not realize.

Capital gains should not be taxes at all, as they are not real. If they are to be taxed, however, they should be taxed only when the investor himself realizes a gain by cashing out of a mutual fund or investment partnership. The way the IRS imposes capital gains taxation is nothing but robber barony.

Dr. Roberts' latest book, "The Tyranny of Good Intentions," has been published by Prima Publishers. Copyright 2002 Creators Syndicate, Inc.

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