{"id":502,"date":"2024-05-13T12:00:00","date_gmt":"2024-05-13T12:00:00","guid":{"rendered":"https:\/\/moneywithkatie.com\/three-grind-mice\/"},"modified":"2025-09-03T18:49:38","modified_gmt":"2025-09-03T18:49:38","slug":"three-grind-mice","status":"publish","type":"essays","link":"https:\/\/moneywithkatie.com\/essays\/three-grind-mice\/","title":{"rendered":"Maybe We\u2019ll Cool It on Thought Experiments for a While, Because I\u2019m Tired"},"content":{"rendered":"
\n

Listen, Rich People, something you should know about me is that my brain is owned and operated by a trio of opposing, hustling forces (the Three Grind Mice, if you will), constantly grappling with one another for control. <\/p>\n

The first mouse is Curiosity, genuinely open-minded and steering me in the direction of truth, no matter how inconvenient to my preexisting beliefs. <\/p>\n

The second is Greed, tracing her grubby little paws through the tax code line by line on April 14 wondering just how<\/em> frowned upon it is to fib about what constitutes business travel. <\/p>\n

And the third is Pride, who\u2014regardless of evidence presented to the contrary\u2014will steer my attention to whatever validates my point of view.<\/p>\n

So you can imagine the chaos amidst my little cerebrum rodents when Curiosity was like, \u201cWhat if we challenged our thinking about capital gains taxes and incentives?\u201d while Greed put a hex on a tiny IRS voodoo doll under the table and Pride was like, \u201cGirl, have you seen this chick\u2019s YouTube channel? She calls tax avoidance \u2018her Superbowl.\u2019 We can\u2019t start poking holes in capital gains. The readers will revolt.\u201d<\/p>\n

Three Grind Mice HQ after hitting \u201cpublish\u201d<\/span><\/a> last week:<\/p>\n<\/div>\n

\"\"\/<\/p>\n

\n

And revolt the readers did, which inspired even more melee for my head hamsters, who had already reshuffled to accommodate their new positions: Pride ready to defend the new conclusion (it might make sense to tax capital gains like labor), Greed relieved of its regular duty and taking a breather in the back seat, and Curiosity half-asleep at the wheel. Get in, losers, we\u2019ve got bias to confirm.<\/em><\/p>\n

But I shook Curiosity awake and strapped Greed and Pride to the spinning wheel of terror, so I\u2019m ready to chat about your feedback. Many of you raised points I either hadn\u2019t considered or had<\/em> considered, but ultimately dismissed. For example, one reader wrote that they\u2019d expect to be rewarded<\/em> for the risk<\/em> of investment (in the form of a tax break).<\/p>\n

\u201cIs the risk I take worth the advantages I have with capital gains (vs. ordinary income)?\u201d This sentiment came up a few times\u2014that is, It\u2019s a risk\/reward calculus. I\u2019m taking <\/em>risk by investing, so I should be <\/em>rewarded with a tax advantage. <\/em><\/p>\n

As your friendly neighborhood 401(k) advocate who will be the first to tell you that you should avail yourself of a tax deduction eight days a week, the more I think about this line of reasoning, the more I wonder if it\u2019s a flawed application of our understanding of risk and reward in capital markets. <\/p>\n<\/div>\n

\n
>
\n \u201c<\/span>The more I think about this line of reasoning, the more I wonder if it\u2019s a flawed application of our understanding of risk and reward in capital markets.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
\n

The risk you\u2019re taking is already<\/em> being rewarded (maybe) by the return you\u2019re receiving in the market, irrespective of how light (or heavy) the government touch is, right?<\/p>\n

Perhaps it\u2019s useful to return to the capital gains tax\u2019s beginnings to understand the original intention: In the late 1800s<\/span><\/a>, when the United States was just getting comfy for the first time with taxation, political economist Henry Carter Adams (you should see the mutton chops<\/span><\/a> on this man) argued that income derived from labor was truly \u201cearned,\u201d while income from capital represented the \u201cunearned\u201d returns from the \u201caccumulated wealth of the idle rich,\u201d and should be taxed differently. One point for Curiosity! Or is it Pride?<\/p>\n

At the time, though, the rates were so low and exemptions so generous that basically nobody paid taxes (a few readers who make frequent appearances in my inbox who would enjoy a vacation to this time period)\u2014only 2% in 1913, and up to 20% by 1919, thanks to World War I. <\/p>\n

The idea to treat earned income and investment gains differently originated with a dude by the name of Frederick Kellogg (perhaps an early ancestor of Big Cereal fame), who was a hot shot corporate lawyer in the early twentieth century. In 1920 and 1921, he testified before Congress that all Americans \u201crefrained from transacting\u201d in the face of high taxes. They weren\u2019t going to buy or sell assets, and this was allegedly constipating the economy. <\/p>\n

After the war, lawmakers struck a compromise with disgruntled businessmen who were grumbling that taxes were too high: They\u2019d retain a progressive income<\/em> tax, but throw the boys a bone and grant capital gains a preferential rate. <\/p>\n

In that sense, it had next to nothing to do with rewarding or incentivizing risk at all, but rather, the \u201cfluidity\u201d of money. <\/p>\n

Relatedly, one reader brought up inflation: \u201cOne thing that\u2019s never pointed out is that long-term capital gains are not adjusted for inflation. It\u2019s possible to pay heavy taxes on an investment that didn\u2019t keep up with inflation. If capital gains taxes are raised, they should be adjusted for inflation.\u201d<\/p>\n

In other words, because gains aren\u2019t indexed to inflation, it\u2019s possible that what looks like a gain on paper still has the same or less purchasing power than it did before\u2014creating what feels like an unnecessary taxable event. <\/p>\n<\/div>\n

\n
>
\n \u201c<\/span>Because gains aren\u2019t indexed to inflation, it\u2019s possible that what looks like a gain on paper still has the same or less purchasing power than it did before.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
\n

I wonder if this isn\u2019t a funky little portal to a larger question more broadly: The 4% interest you generate in a savings account this year might merely help your savings preserve purchasing power amidst 4% inflation\u2026but it\u2019s still going to be taxed (like ordinary income). Your income might be raised by 4% to keep pace, too\u2014but that doesn\u2019t mean the increase won\u2019t be taxed. All the tax brackets do<\/em>, however, adjust upward for inflation every year, so that helps offset this effect to some degree.<\/p>\n

(As fate would have it, that litigious king Kellogg argued this, too: \u201cIncome from capital gains also deserved preferential treatment because inflation reduced the real value of capital gains, even before taxes were paid.\u201d)<\/p>\n

Other readers were quicker to accept that maybe the argument was potent, but hey, what about all those damned real estate investors? <\/em>Were we planning to come for their lavishly tax-advantaged, levered-up winnings, too?<\/p>\n

\u201cWith all these talks about capital gains tax, how come I don\u2019t hear people talking about eliminating things like the section 121 exclusion or 1031 exchanges? If people really want to make things \u2018more equal,\u2019 they should be okay with paying these taxes, too, because if I\u2019m punished for investing my capital successfully, why shouldn\u2019t someone who makes money on a house pay up? I mean, a $250,000 or $500,000 exemption on a personal residence\u2026is that really necessary?\u201d<\/p>\n

It\u2019s worth noting that, actually, the new proposal<\/span><\/a> for the 2025 budget does<\/em> propose getting rid of the 1031 exchange. For the uninitiated, this is a piece of the tax code that advantages real estate investment<\/span><\/a> in a way that no other asset class benefits from. <\/p>\n<\/div>\n

\n
>
\n \u201c<\/span>Maybe radical simplicity is the real (and least objectionable) answer.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
\n

The use of the word \u201cpunishment\u201d interests me (here, I am going to psychoanalyze this poor, dear reader). Maybe the problem is that the tax code is so dang complicated<\/em> and summons loophole exploiters so readily. Maybe radical simplicity<\/em> is the real (and least objectionable) answer.<\/p>\n

In a 2012 episode<\/span><\/a> of Planet Money<\/em>, they interviewed a team of economists all over the political spectrum, and regardless of where they landed, they were all in agreement that the best way to standardize things was to\u2026eliminate all the deductions. Yup, simplify it. No standard deduction, no itemized deductions, no nothin\u2019\u2014just revisit the brackets and treat all income from any source the same way. For obvious reasons, you can imagine how that would go over politically: with a sound barrier-disrupting thud. It would also put people like me out of work, so let\u2019s wrap this thing up before Greed untethers herself from the exercise wheel and steers this draft to the trash bin.<\/p>\n

Another reader pointed out that the investor in my hypothetical is still<\/em> paying net-more in taxes than the laborer: \u201cI think your Amazon example is incorrect. What did the Amazon investor do for the intervening 20 years [after they graduated and invested their $10,000 gift]? They worked, and were taxed on that income. All the while, their $10,000 investment was used by Amazon to invest in their operations and to pay those who took an unguaranteed chance and invested in the company and used to offset salaries with stock options. If we assume both workers paid the same income tax, the investor paid more in actual taxes and also as a percentage. Should they be punished for that?\u201d<\/p>\n

There\u2019s that word again! \u201cTaxes as punishment\u201d strikes me as a uniquely American perspective, almost as though there\u2019s a tiny Boston Harbor tea-tosser inside each one of us. I can\u2019t imagine a Swede or a Norwegian describing their taxes as punishment. (Scandinavians, weigh in.)<\/p>\n<\/div>\n

\n
>
\n \u201c<\/span>Is it because, in order to invest at all, one must sacrifice, and labor in a new, different way?\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
\n

I can see this reader\u2019s point of view, though, much to Pride\u2019s chagrin\u2014that any <\/em>incremental tax money paid on capital gains will be \u201cnew,\u201d so to speak, so in this case, the investor has paid $30,000 more<\/em> into the tax system than their only-laboring counterpart. My core curiosity remains, though: Why do we tax income derived from financial capital more preferentially than income derived from human capital?<\/em><\/p>\n

Is it because, in order to invest at all, one must sacrifice, and labor in a new, different way? <\/strong>The words I write on this page are technically \u201cwork,\u201d but when I receive my paycheck and choose to do the hard work<\/em> of saving a portion such that it may be invested and go on to more productive use, that\u2019s more laborious, more productive<\/em>, than blowing it on, say, strippers and cocaine? <\/p>\n

Still, the phrase \u201cidle rich\u201d feels inescapably relevant. As we\u2019re all well aware, there comes a point where your money is multiplying faster than you can use it (like the households the government is proposing we tax at parity with ordinary income: those with $1 million or more in realized capital gains per year). What of them, Kellogg? Who\u2019s constipated now?!<\/p>\n

I\u2019ll close with thoughts from a reader who took umbrage at the idea that any<\/em> of us should be forking over more of our Chuck-E-Cheese tokens to the rusty animatronic band<\/span><\/a> of our federal government:<\/p>\n<\/div>\n

\n
>
\n \u201c<\/span>While bailing out the sinking ship might feel like decidedly not our job, the alternative is going down with it.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
\n

\u201cWhat are we adding to the deficit at this point? A trillion every 100 days or so? Our interest on our debt is closing in on what, a trillion a year? The argument that the most productive [people] should try to bail out this sinking ship is a bit of a stretch. There is a systemic issue that needs to be addressed first, at the top, before trying to pass the buck on to us individuals.\u201d <\/p>\n

Reader, I don\u2019t disagree. But it\u2019s worth remembering that while bailing out the sinking ship might not be our job, the alternative is going down with it. <\/p>\n

Maybe we\u2019ll cool it with thought experiments for a while\u2014my mice are tired.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

Listen, Rich People, something you should know about me is that my brain is owned and operated by a trio of opposing, hustling forces (the Three Grind Mice, if you will), constantly grappling with one another for control.  The first mouse is Curiosity, genuinely open-minded and steering me in the direction of truth, no matter […]<\/p>\n","protected":false},"featured_media":2505,"template":"","meta":[],"categories":[12],"tags":[],"class_list":["post-502","essays","type-essays","status-publish","has-post-thumbnail","hentry","category-economy"],"yoast_head":"\nMaybe We\u2019ll Cool It on Thought Experiments for a While, Because I\u2019m Tired - Money with Katie<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/moneywithkatie.com\/essays\/three-grind-mice\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Maybe We\u2019ll Cool It on Thought Experiments for a While, Because I\u2019m Tired - 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