One of the many false talking points of the Obama administration is that a rich man like Warren Buffett should not be paying a lower tax rate than his secretary. But anyone whose earnings come from capital gains usually pays a lower tax rate.
How are capital gains different from ordinary income?
Ordinary income is usually guaranteed. If you work a certain amount of time, you are legally entitled to the pay that you were offered when you took the job. Capital gains involve risk. They are not guaranteed. You can invest your money and lose it all. Moreover, the year when you receive capital gains may not be the same as the years when they were earned.
Suppose I spend ten years writing a book, making not one cent from it in all that time. Then, in the tenth year, when the book is finished, I may sell it to a publisher who pays me $100,000 in advance royalties.
Am I the same as someone who has a salary of $100,000 that year?
Or am I earning $10,000 a year for ten years' work?
It so happens that the government will tax me the same as someone who earns $100,000 that year, because my decade of work on the book cannot be documented. But the point here is that it is really a capital gain, and it illustrates the difference between a capital gain and ordinary income.
Then there is the risk factor. There is no guarantee to me that a publisher will actually accept the book that I have worked on for ten years -- and there is no guarantee to the publisher that the public will buy enough copies of the book to repay whatever I might be paid when the contract is signed.
Even the $10,000 a year -- which is less than anyone can earn on an entry level job -- is not guaranteed. If my years of work produced an unpublished manuscript, I would not even have been among the first thousand writers who met this fate.
Very similar principles apply to businesses. We pay attention to businesses after they have succeeded. But most new businesses do not succeed. Even those businesses that eventually turn out to be enormously successful may go through years of losing money before they have their first year of earning a profit.
Amazon.com spent years losing money before turning a profit for the first time in 2001. McDonald's teetered on the edge of bankruptcy more than once in its early years. Desperate expedients were resorted to by the people who ran McDonald's, in order to just keep their noses above the water, while hoping for better days.
At one time, you could have bought half interest in McDonald's for
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