One of the many false talking points of the Obama administration is that a rich man like Warren Buffett should not be paying a lower tax rate than his secretary. But anyone whose earnings come from capital gains usually pays a lower tax rate.
How are capital gains different from ordinary income?
Ordinary income is usually guaranteed. If you work a certain amount of time, you are legally entitled to the pay that you were offered when you took the job. Capital gains involve risk. They are not guaranteed. You can invest your money and lose it all. Moreover, the year when you receive capital gains may not be the same as the years when they were earned.
Suppose I spend 10 years writing a book, making not one cent from it in all that time. Then, in the 10th year, when the book is finished, I may sell it to a publisher who pays me $100,000 in advance royalties.
Am I the same as someone who has a salary of $100,000 that year? Or am I earning $10,000 a year for 10 years' work?
It so happens that the government will tax me the same as someone who earns $100,000 that year, because my decade of work on the book cannot be documented. But the point here is that it is really a capital gain, and it illustrates the difference between a capital gain and ordinary income.
Then there is the risk factor. There is no guarantee to me that a publisher will actually accept the book that I have worked on for 10 years -- and there is no guarantee to the publisher that the public will buy enough copies of the book to repay whatever I might be paid when the contract is signed.
Even the $10,000 a year -- which is less than anyone can earn on an entry-level job -- is not guaranteed. If my years of work produced an unpublished manuscript, I would not even have been among the first thousand writers who met this fate.
Very similar principles apply to businesses. We pay attention to businesses after they have succeeded. But most new businesses do not succeed. Even those businesses that eventually turn out to be enormously successful may go through years of losing money before they have their first year of earning a profit.
Where a capital gain can be documented -- when a builder spends 10 years creating a housing development, for example -- then whatever that builder earns in the 10th year is a capital gain, not ordinary income.
If a country wants investors to invest, it cannot tax their resulting capital gains the same as the incomes of people whose incomes were guaranteed in advance when they took the job.
It is not just a question of "fairness" to investors. Ultimately, it is investors who guarantee other people's incomes in a market economy, even though the investors' own incomes are by no means guaranteed.
Reducing investors' incentives to take risks is reducing the jobs their investments are likely to create.
The biggest losers from politicians who jack up tax rates are likely to be people who are looking for jobs that will not be there, because investments will not be there to create the jobs.
Thomas Sowell is a senior fellow at the Hoover Institution, Stanford University.