Capital vs labor: who risks more?

October 16th, 2014

AFAIK, in the developed world, the income tax rate is often higher than the capital gains tax. In particular, income is taxed "progressively", meaning that higher income results in a higher rate – which doesn't always happen with capital gains. (It looks like it does happen in the US, but income appears to be taxed "more progressively".)

One justification for this is that investors risk losing much or all of their capital. Workers, on the other hand, are guaranteed their wages. To some extent, the difference in the tax rates compensates for the difference in the risks.

To me this is sensible at first glance but completely harebrained on second thought:

The latter point may not interest utilitarian economists focused on GDP "the greatest good for the greatest number" – for society as a whole, risk is always diversified, even if Joe Shmoe is stuck with the crummiest profession that looked really promising when he chose it. Moreover, an efficient market would provide a way to insure against the risk of poorly choosing your occupation. (I don't think real-life markets did provide such a thing, though I might be mistaken.)

But the first point – that the risk exists, and that it's more likely than not to be proportionate to the projected income – by itself kinda erodes the ground underneath an income tax higher than the capital gains tax, not? I mean, regardless of the motivation, it seems internally inconsistent. Unless the risks are all quantified and it all magically cancels out.

It's not that I'm complaining – unlike most professionals, we programmers get stock options. (Speaking of which - central bankers of the world, The Programmers' Guild says thanks a bunch for QE and ZIRP! Remind us to send some flowers.) I just honestly don't get it.

Econ-savvy readers: what do I miss?

(Please don't accuse me of failing to use the Google. Maybe I did so badly, but I did try using the Google. The Google told me, for instance, that the optimal capital gains tax is zero, because "you can't transfer from capitalists to workers", because the transfer depletes the capital pool or something. But I didn't understand how it accounts for the case where the workers are also capitalists because they invest their savings; and what if there's a progressive tax on capital gains? Is it, or is it not possible to "transfer from capitalists to workers" the flesh and blood people, as opposed to abstract categories, regardless of whether you'd want to? Or if that's all nonsense – then is the optimal income tax also zero, because, hey, you're actually taxing human capital gains? Bringing us back a couple hundred years ago where we just have a sales tax? And again, not that I'd complain, I just don't quite follow the logic.)

(Also from the Google there's the claim that since nominal capital gains are taxed, the tax rate is actually higher than it looks because of inflation. But then the solution would be to tax inflation-adjusted gains, not to lower the rate arbitrarily, not? Also, wages are AFAIK the last set of prices to rise upon inflation – the "stickiest" – so workers' investment in their skills is continuously nibbled at by inflation as well. And the point made about "discouraging savings" – well, a high income tax discourages costly education and the subsequent ongoing investment in one's skills, which is a form of investment/savings/call it what you like. Same diff.)

I think it's pretty obvious that workers risk much more than investors. Whether this should lower their taxes I don't know, but it sort of makes sense to me.