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It seems like both are income based on any real definition of the word. Is there an economic or historical reason why capital gains are taxed separately from other income sources?

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Agreed. This is the type of "why" question not within the scope of SE. – JoeTaxpayer Dec 8 '11 at 17:41
(n.b. the above comment was posted when the question was at the Personal Finance & Money Stack Exchange, not Economics.) – Chris W. Rea Dec 13 '11 at 14:45

migrated from money.stackexchange.com Dec 8 '11 at 18:16

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The basic idea is that capital gains are a result of investment and investment promotes growth and employment. The end result is that favorably taxing capital gains increases growth by increasing investment.

Whether or not this is true is an entirely different matter but I think most politicians agree with this idea currently.

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I don't know which legislative regime the questioner is asking about, nor about which one you're replying about, but in the UK at least, dividends are not taxed as capital gains. Capital Gains are only taxed on disposal of an asset. – EnergyNumbers Dec 9 '11 at 6:52
you are right I wrote the wrong term. In the US dividends are taxed favorably as well. – Pablitorun Dec 9 '11 at 14:26
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The reason is that capital gains are by definition something different from income, and as such are taxed differently.

Income being money earned through wages or unearned income as interest from bond/stock.

Where as capital gains are the proceeds from selling an asset at higher price than was paid for it.

Capital gains are fairly rare for most people, and people want to be able to dispose of an asset without having a large tax burden. So they generally have a separate tax structure with a separate tax free allowance. Some countries do take into account people's income tax band when deciding at what percentage to tax the gains at.

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The people who earn most of their income from capital gains have lots of money and lots of political influence (at least here in the US). Any other "reason" is really an after-the-fact justification made up to allow the people with influence to do what they wanted, anyway.

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I think the first sentence has some merit, but the second sentence is an unproven hypothesis. – Owe Jessen Apr 14 '12 at 13:00

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