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Source link: http://archive.mises.org/14534/thinking-clearly-about-capital-interest-and-income/

Thinking Clearly about Capital, Interest, and Income

November 8, 2010 by

Capital and interest theory, and its relation to income, is a very complex area of economics. It is also one in which the Austrians have made major contributions, and these unravel current confusions. FULL ARTICLE by Robert P. Murphy

{ 9 comments }

greg November 8, 2010 at 10:46 am

This is a good article that points to an impossible fight, should interest and capital gains be counted as income? As someone that lives off of capital gains and interest, I vote that they should not be income. But in reality within the system we live in, they are and I must accept it. So lets look within the system to see how you can get ahead or beat the system.

Not all income is equal. For example a small business operating as an S-corp has a yearly personal income of $100,000. Because of the tax advantage, limited FICA expenses, limited medicare expenses and general business deductions, a person working for a wage would have to earn about $150,000 to equal the small business owner. The bottom line is not what you make, but how much you have in your pocket when the day is done.

Chris November 8, 2010 at 12:05 pm

Summary of the article: getting paid for deferred consumption is still getting paid. Duh.@Greg: I think the entire point of the article is that you cannot dismiss the fact that interest and capital gains are income. People go that route because of the incentive. What incentive? The incentive of additional income through deferred consumption. What you are arguing is not whether or not interest or capital gains are forms of income, but whether or not they should be taxed. I’d agree that they should not be taxed.

Greg Ransom November 8, 2010 at 11:58 pm

Awesome.

Scott Regener November 9, 2010 at 5:00 am

Missed here is the reason why capital gains are taxed “twice” so to speak: government actually wants to discourage investment. How often are we told in the news that “consumer spending makes up 70% of GDP” as though this is right, good, and as it should be? And when consumer spending drops, the assumption is that the economy is now worse off and that “something must be done” to increase aggregate demand. The tax codes are based on Keynesian thought, so we should expect Keynesian answers to the question “why?”

Unless or until it is widely recognized that the person earning an income by just and moral means (i.e. without fraud) is actually doing the rest of us a favor, whether that income is “earned” or “capital gains”, we’ll continue to have this mess. As long as income is thought to be something gained by luck, chance, and a general unfairness (or even by immoral means), it will continue to seem just to take from the winners and give some of it to the losers in order to make the “game” of life more fair.

The system is biased towards consumption, whether that be of current income or accrued capital. We have Keynes and his followers to thank for that foolish notion.

Andy November 9, 2010 at 5:23 am

We don’t all start out the same as every example given suggests.

gene November 9, 2010 at 2:34 pm

Is the goal of economists to make what is simple complex?

Income is what “comes in”.

How much simpler can a word be. whether you earn your “income” digging ditches or loaning out your capital, what you receive in excess to what you started with is “income”. what you already had, has already “come in”.

the ditch digger has started digging the ditch with zero dollars and left with say ten dollars. his income is ten dollars.
the creditior starts with ten dollars and is left with eleven. his income is one, since he already had ten “come in” and only banks count the same money twice.

the landlord rents his house for twenty bucks, he started at zero, his income is twenty.

there’s absolutely nothing “progressive” about that, just simple common sense.

Jim Caton November 9, 2010 at 3:34 pm

Robert,

You might be interested in debating Krugman, but Roubini is throwing his hat in the ring against the Austrians. He claims that gold is inherently unstable and that a lack of liquidity is the cause of extreme movements in the business cycle. The article ends with this:

Historically speaking, Roubini says, during the days of the gold standard economies were constantly imperiled by spasmodic cycles: “When you had a traditional gold standard, boom and bust with severe swings in economic activity were the norm—really big ones. It was only once we moved to fiat money that central banks were able to smooth the business cycle, and make it less volatile, as we did during the financial economic crisis.”

Of course, this directly contradicts Austrian business cycle theory, which argues that boom-bust cycles are caused by central banks departing from the gold standard.

In short, Roubini views challenge the Austrian economists where they live: at the intersection of monetary policy and the business cycle.

We eagerly await the response. Over to you Ron Paul and the Mises Institute!

http://www.cnbc.com/id/40088925

That sounds like a challenge!

Pratyush February 3, 2011 at 2:29 am

Strictly in the technical sense, you absolutely right. What comes in is more for Freddie. However, when it comes to taxes, shouldn’t it be net income.. That is the ‘net’ amount which comes in from the economy.. So, when Frugal Freddie goes and deposits his first salary as it is to the bank (that is giving it back to the economy), his net income should be termed 0, rather than 100k.
In that case, Paul has income 100 k in the first year..
While Freddie has total income of 5k from the second year to the 50th year.. And in the 50th year, he gets 100k extra.
In today terms, Freddie income will amount to 5k {(1/1.05) + (1/1.05)^2 .. + (1/1.05)^50} + 100000 / (1.05 ^50) = 100000 (assuming banks pay the same amount as inflation)
Thus, the net amount coming in from the economy to Paul and Freddie is same. In fact, as it is the case with most economies today, inflation is strictly greater than interest rate, and in that case, freddie’s net income would be lower than Paul’s.
I haven’t read Sumner’s article, but I suppose this why he says, that Freddie is being taxed twice on his net income, while you are happy considering only income

Pratyush February 3, 2011 at 2:36 am

“Person A goes to work, and spends his entire income on goodies each year. Because the government imposes a Scott-Sumner-approved 11 percent tax on consumption, this man pays $10,000 to the government, and actually only consumes $90,000 worth of goodies.[2]

On the other hand, person B decides to be a drifter. He only works occasionally at odd jobs; he spends most of his days hitchhiking, watching the sunset, and working on his great American novel. He doesn’t cheat on his taxes, though: out of the $10,000 in annual income that he earns, he saves none of it, sends $1,000 to the government, and consumes the remaining $9,000 in goodies.”
I again, don’t know what Sumner has eventually said, but when you are taxing A on 100k, you are taxing him on income tax again and not consumption tax. So, if he decides to go and invest 90k back to the bank or invest this to some place xyz, he ‘consumes’ only 10k and thus, should be liable to tax only on 10k.
Basically, all I want to opine is, taxes should be considered only the income (not net income) after reinvestments…

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