How I'd reform the capital gains tax

By Gil Johnson of Portland, Oregon. Gil describes himself as a "part-time chicken farmer and full-time martial arts instructor, and a former political hack."

Four years ago, having watched the stock market tank, I heeded Warren Buffet's advice and started buying securities (an odd name for something that basically involves speculation). Looking for long-term growth, I didn't do any in-depth analysis or fancy calculations; I just bought into companies that seemed stable enough to be around for the next few decades and didn't do heinous things to people or the environment. If I personally used the product, so much the better. Being a Baby Boomer, I figure there always are a lot of other people with the same tastes as me.

Now, when I look at my portfolio, my favorite stock symbol is SBUX. Funny, I hardly ever set foot into a Starbucks. I don't particularly like their coffee or their atmosphere. There are so many far better independent coffee houses in Portland that I wonder why Starbucks even exists here. But I can't complain. I bought SBUX at $7.28 a share and held on to it.. It's now trading at around $49 a share. If I sold it today, I'd make a 670% profit.

Whoo-hoo! I'm rich. Well, not really, since I only bought 100 shares of it.

The great thing, though, is if I do sell it, I will pay no more than a 15% federal capital gains tax on my profit. That means that after the federal tax, I still have a 570% return on my investment. All for about 10 minutes of tracking Starbucks past performance and 30 seconds of placing an order, along with a seven dollar Scottrade fee.

Meanwhile, taxes on income from my real work—which really is work—are almost double the capital gains rate. I'm not the first to observe that it's both absurd and unfair to tax work at a higher rate than taxing the gains from playing the stock market.

I think a case can be made for a low capital gains tax, however, as long as the investment is made in the primary market, where the money actually goes to the company. The primary market is typically an initial public offering (IPO), though also can include purchases of private stock in start ups. In the case of Starbucks, I bought its shares on the secondary market, specifically the New York Stock Exchange. Starbucks didn't get a dime of the $728 I invested, not that it needed it. The money all went to brokers, bankers and other investors.

For those kinds of capital gains, I say tax the hell out of them, at least twice the current rate. Playing the stock market is really just a sophisticated form of gambling.

But take the case of an investment I made a couple of decades ago. I ponied up a sizable (for me) chunk of change for a small piece of a brand new company. My money, mixed with that of the principals, other investors and a bank loan, capitalized the company, which hired over 20 employees at decent wages over the next two years. My motive for investing was the same as in buying SBUX, but my money actually was being used for something worthwhile. It was also closer to home. I personally knew the entrepreneur and admired what he was doing. That's usually the case in private placement offerings.

Unfortunately, the company didn't last past two years and I lost my entire investment, though I was able to write off the loss on my income taxes. Most new businesses don't last even that long and I knew it was a big risk going in. Had it survived and prospered, I probably could have sold my shares to another investor, or more likely, back to the principal owner. I might have made a fair profit, but nothing like the 570 percent that my SBUX holding has grown. Despite the high attrition rate for startups, recent research shows that new companies are the primary drivers of employment growth. For these kinds of investments, let's keep the lower rate, or at least keep the rate lower than on profits from secondary market investments.

Same thing for IPOs. Yes, that means the geniuses who stampeded into Facebook's IPO as it it were a Black Friday doorbuster, would pay the lower rate—if the stock actually ever climbs out of the abyss. The Facebook experience just shows there is a risk even for IPOs of famous companies. But remember that Facebook did fine on the IPO. It got the capital it needed for further expansion. And also remember that Facebook went from zero to 3,000 employees in eight years.

Back to Starbucks. Within months after I bought SBUX stock, the company announced it was closing a large number of stores and laying off thousands of employees. And yet its stock value increased. In fact, every time it closes stores and reduces its workforce, the stock price increases. Such are the ways of Wall Street: cut costs,make more profit.

As the so-called fiscal cliff approaches, Congress continues to argue over raising taxes on “job creators.” The obvious answer on this issue is, no, don't raise taxes on job creators, raise them on job destroyers. And know which is which.

Dec. 22, 2012 Posted in guest column.