The most dominant form of income is the wage or salary. This is what we "take home" from our daily work. Other types of income would be "interest" and "rent". Interest is the return from Capital itself, or most commonly "money". When you earn interest, it is because your money has financed the Capital expenditures of someone else. They are willing to pay you a portion of the return on your Capital, so they can engage in a Capital investment. Rent is simply return on a Capital product. So when you receive rent from a building, you are receiving a return on your own Capital investment in that building.
In fact, the more you peer into the workings of Capital, the more you realize how it is all related and intertwined. For instance, when you receive a "dividend" on a stock, you are receiving a portion of the earnings of the company. The stock certificate entitles you to an ownership "share" of the company and by contract, you are entitled to a proportionate share in the revenue of the company. So, the dividend is essentially a return on your Capital investment in the company.
On the other hand, it can be argued that unless you own 51% of a companies stock, you have very little say in the workings of the company, especially if it is incorporated. The board of directors, any majority share owner and the CEOs are calling all the shots and certainly don't need someone who owns .01% share to offer their opinion. With this argument, your purchase of stock is simply a low cost loan to the corporation in exchange for a small "interest" payment each year and the hope that some other investor will come along later and purchase the certificates from you at an even higher price. No matter, any dividend from a company or corporation is considered income.
As we have mentioned, the worker receives his income in the form of a wage. He goes into work for a period, it may be a day or a week or even a month, and "loans" his labor to the employer. At the end of the period, the employer reimburses the worker for the work he has done.
While at his job, the worker is engaged in productive activity. His work will produce a product or provide a service to others. The result of his work falls into two categories. If he is producing something that is used rather quickly, for instance apples or printing paper, he is said to be producing an item for "consumption". These products or services, are used very quickly and are considered consumed. If he is involved in the building of a factory or hospital, then he is producing a Capital product. Basically, this is a product that is not immediately consumed but instead is used for production in the future.
The analogy of the farmer's field is helpful. The grain a farmer grows for his family or for his neighbors to use that year is grown for consumption. Yet, the same grain that is "extra", that is saved to be planted the next year is Capital production. The farmer "saving" that grain could be called a Capital investment. When all is said and done, the next year's crop harvested, any amount above the amount of grain saved is the "return" on his Capital investment. He now has a Capital gain.
When you tax Capital gains are you inhibiting economic growth?
We have determined that taxing is a "taking" of economic value. It would follow that taxing Capital gains would be removing value from the Capital, or the farmer's saved grain, and would have a diminishing effect on future growth. But, our answer cannot be that simple.
Taxing "any" income is a taking of value. Labor is highly taxed, much higher than Capital gains. When labor is taxed, it must either cost more to the employer or the worker must accept less wage. The difference goes toward the tax. The worker must work harder and longer to make the same amount or the employer must pay the worker more, which will raise the price of the product or lower the wage of the employer. As you can infer, either less Capital is produced during the process or the Capital has a greater cost.
Income on interest may or may not be taxed, depending on what our Government "thinks" of the interest. For instance, the interest from your bank deposit is taxed, that is unless you declare it to be for your retirement, an IRA account, then miraculously the interest is tax "deferred". If you loan your money to the Federal Government by purchasing a Treasury Security, the Feds will charge you income tax on the interest but won't allow the States to do the same! When "interest" is taxed, either the "cost" of borrowing Capital, borrowing the farmer's extra grain, becomes higher or the return to the owner of Capital is lower. Again, the difference is the tax and goes to the government.
Any rent you receive is also income. When rent is taxed, the product that is rented, whether it is a house or a commercial building or a machine, must either cost the tenant more or return less to the landlord or as we mentioned, a little of both. The cost of doing business goes up along with the tax. The product must cost more or the wages and profit must be less to compensate. Even higher house rental prices due to taxation cause the wage earner who rents the house to need a higher wage or to work harder to earn the same amount of income to afford the higher rent.
The marketplace determines what portion of our economic equation will bear the brunt of the tax. To return to our farmer's field, if he has a very good year with lots of extra grain production [Capital], he may bear the cost of the interest tax and hesitate to pass it on to those who wish to borrow his Capital. But if there are many people who wish to borrow his Capital that same year [which is less likely but possible in a high Capital producing year], then the competition for his surplus grain will cause the borrowers to bear the cost of the tax in a higher interest rate. The same would apply to the worker, when many workers vie for the same jobs, the tax falls hard on their shoulders and in contrast, with low unemployment, the employer must give up more of the tax cost in higher wages.
All in all, if we study the interaction that takes place when value from the economy is removed through taxation, we realize that no matter where it is removed from the economy, the entire economy is affected and economic growth is inhibited in some area, which in turn effects all other areas. So the ideal situation is that of no tax. The economy would then be completely free to function in its most efficient manner.
If this is not possible and it is determined that an "income" tax is necessary as it was determined in 1913, coincidentally just months after the creation of the Federal Reserve, then the tax should be as low as possible to sustain government services and should be applied at exactly the same rate across the board, irregardless of the type of income. This will instill a balance that is theoretically similar to zero tax, allowing both Labor and Capitol to interact in a free manner.
When this is not done, when Capital is advantaged through a lower tax rate than that of wages, interest or rent, over or bad investment in the Capital sector occurs. We have a crystal clear example of this in our current economy. A good deal of our fiscal problems are due to too much of the economic product being funnelled into the financial sector, which is the sector that routes Capital. When Labor is taxed at a much higher rate, investors will go to great lengths to avoid investment in labor and will instead seek their return from Capital investment. This leads to over building as we have witnessed and investing in Capital projects that are ill advised. Assets, which for the most part are simply Capital investments, take on inflated values due to this bad investment, and eventually the cost of doing business reaches unsustainable levels. Then, we are in a pickle! A correction must and will occur. We are in the middle of one today.
To attain a balanced economy, all forms of income, Capital, rent, interest and wages, should be taxed at the same rate, preferably as low as possible. This will remove the "tax incentive" for investments and leave everyone to make economic decisions based on economic conditions rather than the bottom line on their tax forms. A beneficial side effect would be simplification of the income tax form. Perhaps, the greatest hindrance to this concept coming to fruition, is also its greatest benefit; it is a simple solution that would advantage no particular group but would level the playing field for all. As good for "business" that a more equitable income tax rate would be, it certainly isn't the way we are used to "doing business"!