There is a fairness issue to many in the capital gains tax. Earned income may be subject to a total of over 50% in tax when you include federal and state, Medicare and social security (both portions). Yet a wealthy person may make all of his money on capital gains and pay only 15%. It is hard to argue that this is fair or just.

Yet high capital gains taxes locks up capital. Investors will avoid paying the tax by deferring the liquidation of one stock to buy another. Both Clinton and Bush understood this, lowered capital gains rates and saw revenues in dollars increase as a result of lowering the capital gains rate.

Even Charlie Gibson noted this in his interview with Obama, and such economic understanding is unusually rare in the press corps.

Furthermore other countries with much lower capital gains rates may attract investment capital from high tax countries; China’s capital gains tax rate is zero.

So how do we balance the desire for fairness without a negative impact on the revenue dollars?

One idea is a progressive capital gains rate. Perhaps the first $100,000 would be taxed at a zero rate and the rest would be taxed at 20-25%, higher than the current rate. With this plan a retired couple would get a tax break who is living on such investment return, but the really super wealthy ( million dollars in income and higher) would pay a capital gains rate a little closer to earned income. This does not address the issue of competitive capital flow, and large incomes may still go to places with lower capital gains rates.

Another idea is to increase the required holding period or stagger it. Perhaps you would be required to hold for one year to get a 25% capital gains tax rate, but you could get a 10% tax rate for holding equity for 5 years. This would still impede capital flows more than the current system but it would create a much longer term outlook that would be much more beneficial that our short term horizons that place a greater emphasis on chance than on performance.

A combination of both may achieve a good balance.

The current debate is framed in terms of class warfare. We need an intelligent discussion considering what is fair AND what is effective.