Why are capital gains taxed at a lower rate than normal income?
I think this question is very nearly off-topic for this site, but I also believe that a basic understanding of the why the tax structure is what it is can help someone new to investing to understand their actual tax liability. The attempt at an answer I provide below is from a Canadian & US context, but should be similar to how this is viewed elsewhere in the world. First note that capital gains today are much more fluid in concept than even 100 years ago. When the personal income tax was first introduced [to pay for WWI], a capital gain was viewed as a very deliberate action; the permanent sale of property. Capital gains were not taxed at all initially [in Canada until 1971], under the view that income taxes would have been paid on income-earning assets all along [through interest, dividends, and rent], and therefore taxing capital gains would be a form of 'double-taxation'. This active, permanent sale was also viewed as an action that an investor would need to work for. Therefore it was seen as foolish to prevent investors from taking positive economic action [redistributing their capital in the most effective way], simply to avoid the tax. However today, because of favourable taxation on capital gains, many financial products attempt to package and sell capital gains to investors. For example, many Canadian mutual funds buy and sell investments to earn capital gains, and distribute those capital gains to the owners of the mutual fund. This is no longer an active action taken by the investor, it is simply a function of passive investing. The line between what is a dividend and what is a capital gain has been blurred by these and similar advanced financial products. To the casual investor, there is no practical difference between receiving dividends or capital gain distributions, except for the tax impact. The notional gain realized on the sale of property includes inflation. Consider a rental property bought in 1930 for $100,000, and sold in 1960 for $180,000, assuming inflation between 1930 and 1960 was 70%. In 1960 dollars, the property was effectively bought for 170k. This means the true gain after accounting for inflation is only $10k. But, the notional gain is $80k, meaning a tax on that capital gain would be almost entirely a tax on inflation. This is viewed by many as being unfair, as it does not actually represent true income. I will pause to note that any tax on any investment at all, taxes inflation; interest, for example, is taxed in full even though it can be almost entirely inflationary, depending on economic conditions. A tax on capital gains may restrict market liquidity. A key difference between capital gains and interest/rent/dividends, is that other forms of investment income are taxed annually. If you hold a bond, you get taxed on interest from that bond. You cannot gain value from a bond, deferring tax until the date it matures [at least in Canada, you are deemed to accrue bond interest annually, even if it is a 0 coupon bond].  However, what if interest rates have gone down, increasing the value of your bond, and you want to sell it to invest in a business? You may choose not to do this, to avoid tax on that capital gain. If it were taxed as much as regular income, you might be even more inclined to never sell any asset until you absolutely have to, thus restricting the flow of capital in the market. I will pause here again, to note that laws could be enacted to minimize capital gains tax, as long as the money is reinvested immediately, thus reducing this impact.  Political inertia / lobbying from key interests has a significant impact on the tax structure for investments. The fact remains that the capital gains tax is most significantly an impact on those with accrued wealth. It would take significant public support to increase capital gain tax rates, for any political party to enact such laws. When you get right down to it, tax laws are complex, and hard to push in the public eye. The general public barely understands that their effective tax rate is far lower than their top marginal tax rate. Any tax increases at all are often viewed negatively, even by those who would never personally pay any of that tax due to lack of investment income. Therefore such changes are typically made quietly, and with some level of bi-partisan support. If you feel the capital gains tax rules are illogical, just add it to the pile of such tax laws that exist today. To me, the lower tax rate for capital gains is largely due to governments encouraging economic activity. Note that investments usually come from your normal income, which is already taxed. Capital gains tax is essentially punishing people who take the extra effort to put their money into work. If the tax rate is high, it would definitely cause people to rethink about investing, thus slowing the general economy down. Were capital gains taxes not lower, companies would have an incentive to minimize the portion of the value they create that materializes as capital gains. They would do this by using more debt financing (since interest is deductible) than equity financing. This would have a destabilizing effect on the economy. Low capital gains taxes help encourage investment over spending. This is believed to improve economic growth. Given these factors, it is generally believed that the current capital gains tax rate is very close to the optimal rate. That is, a higher tax rate would not result in greater tax revenue. Bluntly, a higher income tax rate on earned income does not really discourage people from working harder and earning more money. But a higher rate on capital gains does discourage investment. Essentially, it's because investment is more discretionary. Here are three key factors that you do not explicitly state: So while I cannot say exactly why the tax law is the way it is, I can infer that it encourages long-term investments rather than short-term, which would seem to be a good thing for society overall.  The fast that capital gains are taxed at all somewhat discourages cashing out investments (although I suspect it's more of a nuisance factor - the cash received is likely more on an incentive that the tax is a disincentive). There are two alternative explanations: Choose the explanation you prefer based on your level of cynicism. Every economy wants growth and for growth to come you need investments. So, you must provide some motive for people to risk their money (every investment has inherently a degree of risk or if you want uncertainty about the outcome). As a result the tax on capital gains is lower than on other types of income (because the risk is almost zero). The tax is considered in the calculation of the net interest rate. And you can see this as the interest which the investors demand in order to invest their money. Consider inflation. If you invest $10,000 today, you need to make a few hundred dollars interest just to make up for inflation - if there is 3% inflation then a change from $10,000 to $10,300 means you didn't actually make any money. There are many reasons, which other answers have already discussed. I want to emphasize and elaborate on just one of the reasons, which is that it avoids double taxation, especially on corporate earnings.  Generally, for corporations, its earnings are already taxed at around 40% (for the US - including State income taxes). When dividends are distributed out, it is taxed again at the individual level. The effect is the same when equity is sold and the distribution is captured as a capital gain. (I believe this is why the dividend and capital gain rates are the same in the US.) For a simplistic example, say there is a C Corporation with a single owner. The company earns $1,000,000 before income taxes. It pays 400,000 in taxes, and has retained earnings of $600,000. To get the money out, the owner can either distribute a dividend to herself, or sell her stake to another person. Either choice leads to $600,000 getting taxed at another 20%~30% or so at the individual level (depending on the State). If we calculate the effective rate, it is above 50%! Many people invest in stock, including mutual funds, and the dividends and capital gains are taxed at lower rates. Individual tax returns that contain no wage income often have very low average tax rates for this reason. However, the investments themselves are continuously paying out their own taxes, or accruing taxes in the form of future tax liability.
Are you in the US? Because if so, there are tax discrepancies. Gains from sale of stocks held for less than one year are subject to ordinary income tax, so probably around 30%. If you hold those stocks for a year or more, gains will be taxed as capital gains tax, 15%.  For Forex, taxes on your earnings will be split 60/40. 60% will be traded at the lower 15% rate, while the remaining 40& will be taxed at a higher rate, approximately 30%.  So purely short-term, there is a tax advantage to dabbling in Forex. HOWEVER - these are both incredibly risky things to do with your money! I never would recommend anyone invest short-term looking to make quick cash! In fact, the tax code DISCOURAGES people from short-term investments. Rich people use debt for various reasons. The question should not assume that billionaires don't use debt. They also pay lower interest rates on that debt because they have enough collateral that their debt is safer than a typical mortgage. Many rich people will use interest only mortgages on their primary residences so that they can keep their stock earning at higher growth rates than the mortgage interest that they are paying all while writing off a portion of that mortgage interest on their taxes.  Taking an artificially low salary and receiving equity for the larger portion of compensation is also a tax strategy to limit the amount of taxes owed on that income. If paid directly in stock grants, that will count as income, but if paid in options, then the purchased stock will only be taxed at the lower capital gains rates if the stock is held for a year after the options are exercised. Every billionaire will have complicated tax avoidance strategies that will require multi-year planning for the best long-term minimization of taxes. Debt is a strategic part of that planning. Also consider that a major part of that upscale lifestyle (corporate jets, fancy meals, etc.) is on the company dime because the CEO is always on the clock. As long as he is meeting with business prospects or doing other company business, those expenses will be justified for the corporation and not attributed as income. "A mutual fund could make two different kinds of distributions to you: Capital gains: When the fund liquidates positions that it holds, it may realize a gain if it sells the assets for a greater price than the fund purchased them for. As an example, for an index fund, assets may get liquidated if the underlying index changes in composition, thus requiring the manager to sell some stocks and purchase others. Mutual funds are required to distribute most of their income that they generate in this way back to its shareholders; many often do this near the end of the calendar year.  When you receive the distribution, the gains will be categorized as either short-term (the asset was held for less than one year) or long-term (vice versa). Based upon the holding period, the gain is taxed differently. Currently in the United States, long-term capital gains are only taxed at 15%, regardless of your income tax bracket (you only pay the capital gains tax, not the income tax). Short-term capital gains are treated as ordinary income, so you will pay your (probably higher) tax rate on any cash that you are given by your mutual fund. You may also be subject to capital gains taxes when you decide to sell your holdings in the fund. Any profit that you made based on the difference between your purchase and sale price is treated as a capital gain. Based upon the period of time that you held the mutual fund shares, it is categorized as a short- or long-term gain and is taxed accordingly in the tax year that you sell the shares. Dividends: Many companies pay dividends to their stockholders as a way of returning a portion of their profits to their collective owners. When you invest in a mutual fund that owns dividend-paying stocks, the fund is the ""owner"" that receives the dividend payments. As with capital gains, mutual funds will redistribute these dividends to you periodically, often quarterly or annually. The main difference with dividends is that they are always taxed as ordinary income, no matter how long you (or the fund) have held the asset. I'm not aware of Texas state tax laws, so I can't comment on your other question." The capital gains is counted towards your income. If you cash out 1 Million dollars, you have a 1 Million dollar income for that year, which puts you at the 39.6% tax bracket. However, because that 1 Million dollars is all long term capital gains, you will only have to pay 20% of it in long term capital gains taxes. The best you can do is to cash the 1 Million dollars through several years instead of just all at once. This will put in a lower tax bracket and thus will pay lower capital gains tax. "If you sell a stock, with no distributions, then your gain is taxable under §1001.  But not all realized gains will be recognized as taxable.  And some gains which are arguably not realized, will be recognized as taxable. The stock is usually a capital asset for investors, who will generate capital gains under §1(h), but dealers, traders, and hedgers will get different treatment.  If you are an investor, and you held the stock for a year or more, then you can get the beneficial capital gain rates (e.g. 20% instead of 39.6%).  If the asset was held short-term, less than a year, then your tax will generally be calculated at the higher ordinary income rates.  There is also the problem of the net investment tax under §1411.  I am eliding many exceptions, qualifications, and permutations of these rules. If you receive a §316 dividend from a stock, then that is §61 income.  Qualified dividends are ordinary income but will generally be taxed at capital gains rates under §1(h)(11).  Distributions in redemption of your stock are usually treated as sales of stock.  Non-dividend distributions (that are not redemptions) will reduce your basis in the stock to zero (no tax due) and past zero will be treated as gain from a sale. If you exchange stock in a tax-free reorganization (i.e. contribute your company stock in exchange for an acquirer's stock), you have what would normally be considered a realized gain on the exchange, but the differential will not be recognized, if done correctly. If you hold your shares and never sell them, but you engage in other dealings (short sales, options, collars, wash sales, etc.) that impact those shares, then you can sometimes be deemed to have recognized gain on shares that were never sold or exchanged. A more fundamental principle of income tax design is that not all realized gains will be recognized.  IRC §1001(c) says that all realized gains are recognized, except as otherwise provided; that ""otherwise"" is substantial and far-ranging." Capital gains taxes for a year are calculated on sales of assets that take place during that year.  So if you sell some stock in 2016, you will report those gains/losses on your 2016 tax return. "Hi, accounting major here!  A lot of people mentioned both tax advantages and ""cheap"" money (money you can borrow at a low interest rate).  Another reason businesses do this is to reward investors. Generally people with stock in a company want to see some of its operations financed with debt, instead of all of it financed from investors' money or profit. This way the company can grow more and still pay better dividends to its investors. However, you don't want too much debt either. It's a balance, and a way to see how much debt vs equity a company has is called a leverage ratio (leverage=debt). Hope this helps!" The tax is only payable on the gain you make  i.e the difference between the price you paid and the price you sold at. In your cse no tax is payable if you sell at the same price you bought at