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What is Capital Income?

By Brendan McGuigan
Updated May 16, 2024
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Capital income is income that comes from capital, which is to say, comes from wealth itself, rather than any specific production or direct work. Examples are stock dividends or any sort of capital gains, as well as income an owner gets from a business he owns but not from the work he does there. The phrase may also be used to mean any revenue that is used for capital expenditures, although this sense is not as commonly used.

As defined by the United States' Internal Revenue Service (IRS), income can be classified either as a capital gain or capital loss, depending on whether there is a net gain or loss. For example, if a piece of land is purchased for $500,000 US Dollars (USD) and a year later is sold for $600,000 USD, the seller has a capital gain of $100,000 USD, which is included in his or her capital income for that year. If, on the other hand, the land was sold for $400,000 USD, a capital loss of $100,000 USD is said to have occurred.

In the United States, this form of income is actually taxed significantly less than ordinary income, which is to say, income that is derived from hourly labor or salary. This is believed to help create an incentive for capitalists to invest more heavily. In fact, there are frequently suggestions put forward to eliminate taxes on capital gains altogether, replacing them with a consumption tax. Under a consumption tax, only the purchasing of goods and services would be taxed, so that people would be taxed on however much they use, rather than how much wealth they generate.

Traditionally, the difference between capital income and regular income was phrased as a difference between unearned and earned income. The concept behind that phrasing was that income from capital, derived as it was simply from the ownership of wealth, was not earned in a strict sense of the word. Labor, on the other hand, was looked upon as earned income. In the 19th century, particularly, there was a strong backlash against unearned income, which saw voice in many anti-Capitalist ideologies of the era.

In the United States historically, unearned income was actually hoped to be taxed at a significantly higher rate that earned, or regular, income. When the original proposal for the federal income tax was put forward in the latter-part of the 19th century, it included a higher tax on unearned income. In 1913, when the modern income tax was passed, a provision was introduced to tax earned income at a lower rate than capital income, but this was not accepted. Later, such a provision was passed, but it was repealed a year later.

One argument against allowing the proliferation of capital income is that it tends to build upon itself, leading to a greater and greater imbalance in the distribution of wealth. Since capital is allowed to generate more capital, any block of starting capital, such as that derived from inheritance, will create more capital, increasing exponentially over time. On the other hand, earned income, since it is limited by wages and the amount of hours a person can work, will increase at a much slower rate.

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Discussion Comments
By anon232996 — On Dec 03, 2011

@ GraniteChief: It's not the making of money that "isn't fair". It's the ability to participate in the first place. More and more hours worked is netting less and less income. Costs of living are increasing, but pay has been stagnant - possibly less than - pay from 30 years ago. Educational inflation means you're paying more for school now in term of the level of degree you need (not just in costs). Food. gas. Taxes. How is a person supposed to do more than save and small-time invest when they barely earn more than what's needed to live? (And I do man small time. Capital gains and the like are only "equal" opportunity in that you can try and play that game. It's actually more costly to be an everyday investor than it is to be a wealthy one.)

When a small fraction of a fraction of us can completely exempt themselves from the system, and not contribute to it, they become a fairly expensive parasite in terms of economic and social issues. That money does not "trickle down" it's saved and reinvested and reinvested. And it's used to buy advantages to continue to profit from their position through lobbyists and the like.

Outside of the the percent of the "1 percent", it's the mindset that fires employees then re-hires them as contractors or part-time workers to avoid paying for things that cut into profits. It's the mindset that allows lawmakers to create insider trading loopholes for themselves. It's the mindset that unethically denies coverage for health problems because it cuts profits. It's the mind set that only presents sub-prime loans as options to many (minority) customers because that will make more money.

I think we could all be a bit more human, instead of relying on what the laws say we get to do. The moral and economic costs of these of doing otherwise are all around us.

By NightChef — On Oct 05, 2010

GraniteChief makes some excellent points about society taxing capital income as a means of helping to distribute the wealth in our nation.

Despite this generous taxation of capital income and other "rich" related financial gains there is still a huge gap between the poor and rich in America. As conservatives and liberals pull back and forth on the rope of socioeconomic equality we will see a fluctuation in these policies.

By GraniteChief — On Oct 05, 2010

@JoseJames, I think you do have some valid information contained in your response to this article but I think some very important concepts were missing in your analysis.

First off, this is America. This is the land that people are capable of working, saving and creating capital that they can then invest to create more capital. Sure, there are people who inherit riches but that is why our society takes certain measures to somewhat level out the playing field.

Capital gains taxes are a prime example of how the population of our country and our lawmakers have decided to deal with the glut of capital income. By placing these taxes onto the profits of capital income then we are saying that these capital holders are held to a higher tax rate and standard then people who are not earning capital income.

Another form of this rich and poor gap control is seen in the use of inheritance taxes. The government will tax the riches passed along from generations in an attempt to help spread out the wealth.

While the term, "spread the wealth" is seen by some as not only not fair, but wrong. This concept is a key in much of our society's laws that try and deal with social inequalities.

Many forms of government intervention in the rich and poor gap exist in our everyday workings. A prime example is the use of property taxes to fund local school districts. By taxing property we are saying that those with higher-valued property should pay more then others for the schooling of our nation's children. A poor family and a rich family in the same neighborhood will get the same schooling for their children at the local public institution but they will pay a different rate for this education based on the amount and value of the property they own.

By JoseJames — On Oct 05, 2010

Capital income is the very concept that allows for the rich and poor gap in an economy to grow larger. This concept of having your capital able to grow and make more is a very lovely one indeed. The only problem is that people who don't have capital are then facing a situation where they cannot create cash to make more cash. All the while this is happening, those with cash continue to become richer and have a higher advantage over those that still trying to create capital.

This unfortunate gap widening is bad news for everyone involved. Obviously the poor and capital-less struggle for an existence and those rich in capital will face a world that a huge percentage of the population is unhappy, sick and disgruntled about the rich's accumulation of capital.

Eventually you will have a situation where violence might ensue and revolution of the society could occur.

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