One problem is that once one category of income is favored, there are incentives to somehow transform other income into that rubric.

When I was young, if a farmer raised a hog or steer and sold it, the net income was taxed at usual rates. However, money from selling a sow or beef cow "held for breeding purposes" was counted as a capital gain and taxed half as much. Selling breeding livestock for more than cost was like selling a tractor for a higher price than originally paid.

The IRS had to define just what constituted "holding for breeding purposes." For a time it meant animals 6 months or older that gave birth at least once. That opened a loophole for hog producers.

Sell a female hog directly from birth to market in five months and earn ordinary income taxed at one rate. Raise it, breed it and sell it as soon as its pigs were weaned, and the income would be "capital gains" taxed at half the rate.

Whenever market prices for butcher hogs did not exceed those for young sows, the capital gains treatment made it profitable to breed hogs once and then sell them.

This did not make any sense in terms of production efficiency. It helped wealthier farmers a lot. It helped young, beginning farmers very little. It wasted resources. But the federal tax code encouraged it.

Source: Twincities