Why the Capital Gains tax breaks are misdirected

For fifty years economists and politicians have pushed lower tax rates for Capital gains as a measure that encourages investment.  Does it?   Or is it an example of politicians and economists who have very simplistic and fuzzy notions about motivating people (which notions often incidentely happen to serve their own self interests.)

Quick review on what the discussion is about.  Money you are paid for doing a job is taxed as ordinary income.  The current effective Federal income tax rate for most of us is probably about 25% or so, and many who make more money 30% or more.   On the other hand, if your income comes from investments, either from buying and selling stocks, bonds or real estate, or from "qualifed" corporate dividends, you will often pay about half the tax rate paid by someone working for a living.

Now just on basic instinct it seems like folks who are making money because they own things and don't need do to much of anything to receive their income should, if anything, perhaps pay a little higher tax than folks who are working hard, and perhaps incurring some physical risk from the act of working.  Just as a matter of fairness.  So there must be some good reason why tax policy has the opposite effect, right?  It must be set up to reward people for investing, right?

Lets see if this works by considering a hypothetical.

Richie Rich inherited property from which he makes $220,000 a year from capital gain and qualified dividends.  He spends the entire $220,000 a year on living expenses, plays a lot of golf, travels and generally enjoys life because he doesn't need to work.   

Hard working Harry makes $220,000 from working hard for long hours.  He spends about $120,000 a year on ordinary living expenses and the other $100,000 a year he invests.

Assume both Ricky and Harry won't have to pay much tax on the first $20,000 they make (which is true for all taxpayers) , but on the remaining $200,000 they will pay an average of around about 30% on ordinary income and about 15% on capital gain.

The result?  Richie Rich will pay about $30,000 tax on his $200,000 since it is all capital gain.  Hardworking Harry on the other hand, will pay about $60,000 on his $200,000.

So Harry pays twice as much tax as Richie, even though Richie never worked a day in his life, didn't invest a dime of his income, while Harry works hard at building society and actually invested $100,000.

This hypothetical reveals the fatal flaws of the Capital Gains tax.  

1.  It looks at where income comes from, rather than where it goes.
2.  It often rewards the non-productive rather than the productive.

When enough voters figure this out, perhaps the politicians and economists will also figure it out, so pass it on.