Workers today are not smarter than their ancestors, and there is no reason to think that they work harder. Yet today's workers earn many times more than people did when the average wage was a dollar a day. Today's workers earn more because they produce more, and they are more productive largely because of the existence of capital.
Two hundred years ago, the primary capital in America's dominant agricultural industry consisted of little more than a hoe, a plow and an axe. Today, people combine their labor with highly sophisticated electronic equipment in virtually every industry.
What Is Capital? The word "capital" means different things to different people. In the financial press, capital often means money or liquid assets. In the context of this report, capital means physical assets such as buildings, machines, equipment, etc. In terms of the economy's ability to produce goods and services, the constraint is not paper money, which we can print in unlimited quantity. The constraint is the number and quality of physical assets that labor can use in the production process.
Who Owns Capital? Aside from the ownership of houses and durable goods, most people do not own capital directly. Instead they own capital indirectly by owning financial assets such as stocks and bonds. A share of stock in a company entitles the stockholder to a share of the company's assets. A bondholder has a claim against the income from a company's assets. Most people are also indirect owners of capital through employer-provided pension plans.
"In this report, 'capital' means physical assets used to produce goods and services."
Considering both direct and indirect ownership, the ownership of capital in the American economy is widely dispersed. It is also closely connected with retirement. As Figure shows, about 40 percent of the nation's capital stock is owned by those 65 years of age and older and another 29 percent is owned through pension plans and IRAs. Thus more than two-thirds of the nation's capital stock is owned by the elderly or held for the purpose of providing people with an income during their retirement years.
Despite the fact that ownership of capital is widely dispersed, the wealthy tend to own more capital than the nonwealthy. On the average:
"Most proposals to 'tax the rich' are really proposals to tax capital." Precisely because wealthy people receive a very large share of their income from capital, most proposals to "tax the rich" are either necessarily or inadvertently proposals to tax capital.
How Is Capital Taxed? In the United States and in other countries, governments tax capital in one of three ways. Taxes are levied on (l) capital assets, (2) the output of capital assets and (3) the income of the owners of capital assets. Examples of taxes on capital assets are property taxes and wealth taxes. Examples of taxes on the output of capital are sales taxes and value-added taxes. Examples of taxes on the income from capital are corporate income taxes and personal income taxes on dividends, interest, rent and profit.
"More than two-thirds of the nation's capital stock is either owned by the elderly or held in a retirement plan."
Why Do Taxes on Capital Matter? The primary difference between rich and poor countries is the amount of capital per worker. The amount of capital determines not only a country's standard of living but also its rate of economic growth. Economists have long known that economic growth is the most effective antipoverty program and that the key to economic growth is capital formation. For example:
"The 10 principles explain how capital works in our economy."
Principle 2: More than 90 percent of the benefits of a larger capital stock go to wage earners rather than owners of capital.
Principle 3: The amount of capital is determined by investment.
Principle 4: The amount of investment is determined by the real aftertax rate of return on capital.
Principle 5: Because of changes in investment spending, the aftertax rate of return on capital tends to be constant.
Principle 6: Taxes on capital do not affect the aftertax rate of return on capital but instead affect the amount of capital available.
Principle 7: Taxes on capital raise the cost of capital to business and make U.S. industry less competitive in international markets.
Principle 8: The structure of U.S. capital taxes encourages investment in short-lived assets and discourages investment in long-lived assets.
Principle 9: Because capital taxes lower the nation's output, an increase in capital taxes almost always results in less revenue for government.
Principle 10: By moving to a more efficient tax system, the United States could collect the same amount of government revenue with much less harm to the private sector.
NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.
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