Why Inequality Matters

Basically, what VexXtreme said, but the operative word is the "might" in

> the money used to buy a share has to go to the seller of the said share, who might in turn use it to consume

It's really simple:

1. When you spend your money on consumption, there is a guarantee that the money is used for real world economic activity.

2. When you spend your money on building your business (the restaurant example in my comment), there is a guarantee that the money is used for real world economic activity.

3. When you put your money into an index fund, there is no guarantee that the money is used for real world economic activity.

It might be used in this way via indirect channels, but there is no guarantee - after all, the money might just remain stationary in a bank account, of which there are many - and so the positive economic effect is most likely less than in the first two cases. (Again, the positive effect for me as an individual who saves is obvious; I'm talking about the effect on economic activity.)

The 20th century is also full of examples of better and worse ways of allocating capital that didn't go on in the Soviet bloc. Troll harder: there are more than two alternatives.

> Are you claiming that taking risk is a form of work?

Yes, because you have to decide what risk to take.

> it'd take a lot to convince me that buying shares of an S&P500 ETF is a form of work that I should be taxed on

It would take a lot to convince me that you should pay a lower tax rate than I do on the money you make, just because the work you do is trading the stock market. (Essentially all my income is ordinary income.)

You may have a theory that says that your expected return from buying ETFs right now is higher than your expected return from buying T-bills. But if so, you had to do some work to develop that theory. In the absence of that work, the best predictor you have of the future value of the ETF is its present value.

> There is a shockingly large body of evidence that excess returns, for the vast majority of people the vast majority of the time, are the spoils of luck

Fine. I have even less problem with taxing luck than I do with taxing work.

> In cases where people really are working for returns, I completely agree with you. This is income and should be taxed--as income. But in cases where someone is investing their own savings, they really are just trading a certain present value for an uncertain future value.

Making money consistently in the market takes work. If you don't believe me, ask a trader.

But again, I don't care about the distinction between luck and work. I don't care what your effective hourly rate is. Taxation is based on the amount of income, not on the amount of work it took to obtain it.

Let me make that concrete. I have a side business, with a partner, that brings in a mid-five-figure annual amount that we split roughly equally. (It's a support contract for a product we used to work on, sold to one of the last people in the world using that product; the company we worked for that produced the product is defunct.) In recent years I have needed to spend about 10 hours a year on this business.

I wouldn't call it life-changing, but it's a nice little piece of change and I feel very lucky to have it. But the IRS doesn't tax me at a lower rate just because luck was involved or because my effective hourly rate is so astronomical.

There is a big difference, of course, between this business and trading: I have no money invested in it that I could lose. But this points up what the real question here is: how much do we want to subsidize risk-taking as opposed to other kinds of productive activity? And I don't see why, at the moment, we would want to subsidize it at all. Our economy is already over-financialized, and this shows no sign of changing soon. I'm sure there are some macroeconomic circumstances in which incentivizing risk-taking would make sense, but the present day is not one of them.

Well, I was curious of what you mentioned, so I looked it up. Switzerland is a Federal multi-party directorial republic with elements of direct democracy.

I do recall reading up on that recent referendum they had about the capping of CEO wages that didn't go through. But thanks for the heads up, I'll look into what they have going on over there with their flavor of democracy.

Thanks for responding, I appreciate the interesting discussion. :)

You began this sub-thread by making the following claim:

> It's only at the risk-free rate of return that the two products you describe are of equal value. In order to realize returns higher than the risk-free rate, investors must do work. I think that the extra gain beyond the risk-free rate should be taxed as ordinary income, because that's really what it is: income produced by work.

With this in mind, look at the following table, based on historical returns since 1928:[0]

                Stocks  TBills  TBonds
    Arith avg.  11.50%  3.57%   5.21%
    Geo avg.    9.55%   3.53%   4.93%
    Std Dev     20.02%  3.06%   7.85%

Let's say your time horizon is 10 years. You have at least four options:

1. Buy $1000 worth of equity ETFs. Sell them in 10 years. Expected value: $2,489.57. Expected tax paid: $223.44 (22%).

2. Buy $1000 worth of T bill ETFs. Sell them in 10 years. Expected value: $1,414.69. Expected tax paid: $62.20 (6.2%).

3. Buy $1000 worth of T bond ETFs. Sell them in 10 years. Expected value: $1,618.07. Expected tax paid: $92.71 (9.2%).

4. Hold $1000 worth of cash. Expected value: $1,000. Expected tax paid: $0 (0%).

Do these four products have unequal present values? No, they are equally valued at $1000, despite the fact that stocks have a higher expected return, because people are risk averse.

Are some of these products likely to realize returns higher than the risk-free rate? Yes--riskier assets typically pay a risk premium.[1]

Does investing in stocks require more work than investing in T bills or bonds? No.

Does investing in stocks require more work than investing in bonds, where "work" is defined as "possessing knowledge of, and acting on, the fact that higher risk assets typically have higher returns"? No, such knowledge is neither necessary nor sufficient. Unnecessary because plenty of people invest in stocks without any underlying research because they've been told to do so, or pay someone else to manage their money for them. Insufficient because plenty of people prefer the stability of lower-risk assets to stocks' higher expected return.

Look, I don't work in finance either. I'm a software developer. I try to save money, and when I do, I throw it into an ETF that tracks the market as a whole. I don't try to time the market. I don't try to identify growth markets or over- or under-performance of asset classes. If I wanted risk-free returns, I could use the time I spend logging into my brokerage account and buying equity ETFs to instead... log into my brokerage account and buy bond ETFs. Or I could use that time to log into a savings account and transfer money over from a checking account. I completely reject the idea that my personal decision to purchase stocks instead of bonds is work.

If you want to change your position to claim that taxation should discourage risk-taking, I strongly disagree, but that's a different argument entirely.

[0] http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/...

[1] http://en.wikipedia.org/wiki/Risk_premium