Why Vanguard Founder John C. Bogle Is Wrong on Taxes
Bogle is calling on Congress to raise capital gains taxes to the rates that apply to ordinary income.
The founder of the Vanguard group of mutual funds, John C. Bogle, who says he is a lifelong Republican, is calling on Congress to raise capital gains taxes to the rates that apply to ordinary income.
"As a general policy, equalize the taxes, raise the taxes on capital gains," Mr. Bogle said earlier this month in an interview with Bloomberg Television's Betty Liu. "I look at this position as just simply logic, with maybe a touch of concern for our fellow human beings who aren't doing as well as we are all doing."
"There should be no tax rate that is lower than the earned income tax rate that people earn by the sweat of their brow or the burrows of their brain. That should be the regular tax rate," Mr. Bogle said. "I am arguing for a capital gains rate taxed at ordinary income."
Mr. Bogle has a lot of wisdom about investing, which is one reason I originally invested in Vanguard funds back when he was running the company in the 1990s. But on this tax question, I think Mr. Bogle's got it wrong, for the following reasons.
First, it's not entirely accurate to say that the current long-term capital gains rate of 15% is really lower than the 35% top rate on ordinary income. In many cases, the capital gains come on money that's already been taxed at least once, when it was earned as individual income. If the money was then invested in shares of a publicly traded corporation, the corporation also probably paid tax at the corporate level. Any capital gains come on top of those other layers of taxes.
Here's an example: Jack and Jill both earn $100 that is taxed at the ordinary income rate of 35%. They both have $65 left over. Jack spends his $65 on things that aren't subject to sales tax and has paid a total of $35 in taxes. Jill invests her $65 in one share of stock for a year. The company she buys makes a pretax per-share annual profit of $100, on which it pays 35% tax, or $35 a share. The $65 in after-tax profit helps increase the per-share price to $130 a share. Jill sells her share and pays capital gains tax of 15% on the $65 gain, or $9.75. Jill has paid a total of $79.75 in taxes ($35 in income tax, $35 in corporate tax, and $9.75 in capital gains tax)—more than twice as much as the $35 Jack paid.
Second, that distinction Mr. Bogle makes between money "people earn by the sweat of their brow or the burrows of their brain" and money subject to capital gains tax isn't always as neat as he implies. Not all capital gains are made by people lounging on the beach as their money magically creates capital gains for itself. If a person founds a company like Microsoft or Google, the founder's stock is subject to capital gains treatment, even though it is earned by sweat or brain work. Choosing investments that make money over the long term can often require considerable thought.
Third, the American capital gains tax rate doesn't exist in a vacuum. Raising the top rate to 35%, as Mr. Bogle suggests, would immediately put American investors at a competitive disadvantage to those in Singapore and Hong Kong, neither of which tax capital gains at all.
Raising the capital gains rate would encourage spending rather than saving, since no state or local government has a sales tax as high as the top 35% federal capital gains tax rate that Mr. Bogle proposes. It'd make more sense for government to be neutral on the save-or-spend question, or, if it must take sides, to encourage saving and investment rather than spending.
Mr. Bogle, born May 8, 1929, is 82 and, like many of the others now urging higher taxes—Warren Buffett, George Soros—made his money while taxes were low enough to encourage growth.
In Mr. Bogle's case, he seems to have forgotten some of what happened. "Even the great conservative Ronald Reagan made sure in his first tax cut, the numbers were the same for both" income and capital gains tax rates, Mr. Bogle claimed, in a line that Bloomberg excised from the transcript of highlighted excerpts it distributed. In fact, Reagan's first tax cut took the top income tax rate down to 50% and the capital gains rate down to 20%. The thirty percentage point difference is even wider than the gap that exists today between 15% and 35%. The two rates didn't both go to 28% until 1988, the last year of the Reagan presidency.
Mr. Bogle, however, isn't talking about following Reagan to a rate of 28% on both income and capital gains, or, for that matter, pursuing the "same for both" principle by lowering the ordinary income tax rate to the 15% rate that applies to long-term capital gains. He instead wants to raise taxes.
The implication is that government can somehow use the money more wisely than individual Americans can. That's where Mr. Bogle's line about "maybe a touch of concern for our fellow human beings who aren't doing as well" really grates. What's better for "our fellow human beings who aren't doing as well"? A tax system that sends more money to Washington to be spent on dependence-producing, incentive-reducing welfare programs or wasted on bridges to nowhere? Or one that keeps more money of the hands of those who earned it, and allows those individuals to invest or spend or donate the money carefully themselves in ways that might create even more jobs and growth and widely shared prosperity?
Ira Stoll is editor of FutureOfCapitalism.com and author of Samuel Adams: A Life.
