The 15% income tax rate on long term capital gains is a very significant tax break for business owners and investors, including the very wealthy. It is a big part of the reason why Warren Buffet and Mitt Romney pay such a low rate on their income taxes. A capital gain is the profit made on investments such as stocks, businesses, and real estate. For tax purposes, a capital gain is considered “long term”, and receives the low 15% rate, if the asset was held for at least one year. (Short term capital gains, on investments held less than a year, are taxed at ordinary income tax rates – up to 35%.)
One justification for the lower tax rate is to encourage investment. In theory, if you lower the tax rate on certain investments, more people will put their money in those types of investments. But, people who save their money in a bank or who buy bonds also encourage investment, and their profit, the interest they earn, is taxed at ordinary income tax rates – up to 35%. It seems unfair to tax interest and capital gains at different rates.
Another justification for taxing long term capital gains at a lower rate is to account for inflation. If you doubled your money on an investment, your real profit, (adjusted for inflation), is quite different depending on how long you owned the investment. If you doubled your money in only one year, you did great. But if it took you 20 years to double your money, you did rather poorly. If your investment grows, but at a rate slower than inflation, then you are actually losing spending power. The fair way to tax capital gains would be to adjust the gains for any inflation that occurred while the money was invested. Then, tax the real gain, after adjusting for inflation, using ordinary tax rates – up to 35%.
Interest income could also be taxed the same way. If interest earned was for a period longer than a year, then it could also be adjusted for inflation and the tax would be paid only on the real earnings, after adjusting for inflation.
Capital gains and interest income would both be taxed at ordinary tax rates – up to 35%. That would be fair for everyone.