Econintersect: A major contribution to wealth accumulation is capital gains. Someone starts a business in his garage and puts in every waking hour, puts back every penny available out of earnings and after 30 years has a corporation employing thousands of people and worth more than a billion dollars. When he finally sells the company and pays $150 million in federal long-term capital gains taxes and $70 million in state taxes, he retires to paradise with an after-tax “nest egg” of more than $800 million. Many feel this is the epitome of the American dream.
Then there is another way such wealth is accumulated. Another individual, who has accumulated several million dollars through investing activities, starts a hedge fund and manages to attract $2 billion in investors’ dollars to add to his few million in an investing venture. The hedge fund establishes long-term call option positions in a group of stocks with the payment of $40 million in premiums and the manager puts his money, say $4 million, into the same venture. Over the next 13 months the stocks more than quadruple in value and the hedge fund books a gain of $2.5 billion (and the manager makes $250 million on his own money). The manager also takes the standard 20% of the fund gain, so he has a total gain of $750 million from this part of his business. He does this sort of thing two or three times and he also has a total long-term capital gain of $1 billion or more and is in the same wealth position as the business builder discussed previously. There are some (probably less than for the first individual who built the company) who also would consider this an example of the American dream.
Note: The hedge fund calculation is an approximation is two regards:
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The 12-month holding period to achieve long-term capital gains tax rate is not necessary for some hedge fund manager “carried interest” income, which qualifies some types of income for the low rate.
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Tax accounting rules force a split in the assignment of open option interest partially to short- and partially to long-term status at the end of each tax year.
A Forbes article by Robert Lezner, posted at Yahoo.com, discusses the way in which the preferred tax treatment of capital gains has contributed to income disparity (and by extension) to wealth disparity in the U.S. Lezner wrote:
Capital gains are the key ingredient of income disparity in the US-- and the force behind the winner takes all mantra of our economic system. If you want even out earning power in the U.S, you have to raise the 15% capital gains tax
Income and wealth disparities become even more absurd if we look at the top 0.1% of the nation's earners-- rather than the more common 1%. The top 0.1%-- about 315,000 individuals out of 315 million-- are making about half of all capital gains on the sale of shares or property after 1 year; and these capital gains make up 60% of the income made by the Forbes 400.