Taxes: Capital Gains / Dividend / Inheritence vs. Income, Monetary Policy vs. Fiscal Policy

Disclaimer: I am not an accountant, lawyer, financial adviser, genius, clown, etc. Based on my stupidity, please don't do anything like use this blog post as a guide to anything but your funny bone. I only know this stuff as an autodidactic businessman. When I want real advice, I go to a lawyer or an accountant. Please do the same.

Ok, I'm getting tired of hearing about taxation and the various, high on opinion yet low on facts, rants based on misinformed and unverified (read: unsupportable) data. So lets begin with some basic definitions.

Income Tax

This one is pretty obvious as it is mandatory for employed people to report and pay this tax. The main points to know about it are that there is the average tax rate, and then there is the marginal tax rate. The average tax rate is exactly what it sounds like: tax owed divided by taxable income. The marginal tax rate is the tax rate on the next dollar of income earned. The effective tax is either the average or marginal rate after offsets (and any other esoteric rules) are applied.

Capital Gains Tax

Tax that is paid based on the profit resulting from the sale of a Capital Asset. What is a capital asset you ask? Well Toto, that's a relatively easy answer! (on the surface at least) A capital asset is any asset that's used to make money in the future, an Investment. The opposite of this would be something purchased for enjoyment (known in microeconomics as Utility). Stocks, Bonds, and Real Estate are all considered capital assets in the context of this post. That is, capital gains tax rules apply to those assets. The idea is that the longer the investment is held, which in the US is demarcated at one year, the lower the capital gains tax rate on the profits earned from the eventual sale of the asset. If you hold stock in a company for less then a year, it's taxed at your ordinary rate of income. If you hold it for longer then a year, it's taxed at a lower capital gains rate. Capital gains tax is a hot topic among the general public, politicians, and the super-wealthy. A significant portion of total income earned by the super-wealthy comes in the form of capital gains via investments, while the middle-class worker has a large portion of income originating from income via labor. This is one of the reasons you see a lot of super-wealthy individuals claim low income.

Dividend Tax

Simply the tax imposed on dividends payed to shareholders in a company. This is similar to the capital gains tax, with the primary difference arising from the source of investment income. Dividends are a decision taken by the board of directors of a company, so you get to retain the stock and the claims on future dividends. Capital gains however are based on your decision to sell the stock at a premium.

Inheritance Tax, Estate Tax

Out of the terms listed here, these two are the ones with which I am least familiar. Commonly, the estate tax refers to the federal-level tax while the inheritance tax refers to the state-level tax. The basic gist as I understand it is that the federal estate tax is imposed in a flat manner on the total value of the estate, while the state inheritance tax varies based on the receiving party.

Fiscal Policy

Policy as decided and implemented by Congress that dictates federal spending and revenue collection.

Monetary Policy

Policy as decided upon and implemented that controls the National Money Supply. The Federal Reserve mainly performs Open Market Operations to try and target a desired the Federal Funds Rate. The Federal Reserve can also set the Discount Rate or alter the Reserve Requirement for banks. However, the latter is a much rarer occurrence (although it does happen).

Now that the definitions are out of the way, the next post will be my opinions on the economy in terms of those definitions.