Mike Kueber's Blog

February 7, 2012

Is the capital-gains tax bad for the economy?

Filed under: Economics,Issues,Politics — Mike Kueber @ 10:52 am
Tags: , ,

There is general agreement amongst Republicans that the current capital-gains tax is a jobs-killer because it discourages investment.  Furthermore, they assert that the tax amounts to double taxation because investors have already paid income taxes on the money they are investing.  To encourage jobs-creation, Mitt Romney wants to eliminate capital-gains taxes on anyone who makes less than $200k a year.  Newt Gingrich wants to go further and eliminate the tax for everyone.

My position regarding taxes runs counter to most conservative thinking.  For one thing, I understand that all taxes are job killers because you are taking money away from an efficient private sector and shifting it to an inefficient government sector.  But sufficient tax receipts are essential to pay for the services that we require government to provide unless you want to pass government debt onto your descendants. 

The conservative argument that capital-gains taxes are especially bad for jobs-creation is based on the assumption that individuals will be less likely to risk their money in an investment if they know that the government will confiscate a larger percentage of their profit – e.g., 35% instead of the current 15% for long-term capital gains.  That assumption doesn’t make sense to me because I would rather keep 65% of the profit on my money instead of sticking the money in a mattress (or some low-yielding government bond) and making no profit.  An analogous falacious argument would be to say that individuals will quit going to work if the government raises their marginal income tax rate from 35% to 39%.  I doubt it.

Instead of relying on my intuition, I decided to read a little more about the effect of capital-gains taxes on jobs-creation.  According to Wikipedia, the conventional wisdom is that capital gains are taxed at a preferential rate in comparison to ordinary income in order to provide incentives for investors to make capital investments, to fund entrepreneurial activity, and to compensate for the effect of inflation and the corporate income tax.  There are, however, a plethora of news articles challenging this conventional wisdom.

According to a 2011 article in the Washington Post:

  • Advocates for a low capital gains rate say it spurs more investment in the U.S. economy, benefiting all Americans. But some tax experts say the evidence for that theory is murky at best. What is clear is that the capital gains tax rate disproportionately benefits the ultra-wealthy.  While it’s true that many middle-class Americans own stocks or bonds, they tend to stash them in tax-sheltered retirement accounts, where the capital gains rate does not apply. By contrast, the richest Americans reap huge benefits. Over the past 20 years, more than 80 percent of the capital gains income realized in the United States has gone to 5 percent of the people; about half of all the capital gains have gone to the wealthiest 0.1 percent.

According to a more in-depth 2011 article in the NY Times:

  • The conventional wisdom.  The notion that low capital gains tax rates are a good thing because they promote investment, lead to job creation, encourage people to sell assets without fear of tax consequences and actually raise total tax revenue is so entrenched in both parties that the idea of equalizing capital gains and ordinary income rates is barely mentioned or, when it is, is quickly denounced. It’s become a third rail of tax policy and electoral politics. “It’s now so woven into standard thinking that it’s become a cultural norm,” a prominent hedge fund official told me this week.
  • New research casts doubt on the conventional wisdom.  Is that so unthinkable? It does seem intuitive that lower taxes and thus potentially greater rewards would encourage risk-taking and investment, and surely at some rate high taxes can discourage any endeavor. But even some hedge fund and private equity officials concede that the argument for lower capital gains rates rests more on faith than science. “I’ve seen study after study that says lower capital gains rates have no impact on behavior,” the hedge fund official told me.  That view is also backed by a growing amount of academic research questioning the premise that lower capital gains rates promote growth. The evidence “is murky, at best,” said Leonard E. Burman, the Daniel Patrick Moynihan professor at the Maxwell School of Syracuse University. Mr. Burman is also a former deputy assistant Treasury secretary for tax policy in the Clinton administration and author of “The Labyrinth of Capital Gains Tax Policy.”  “It’s not the panacea for economic growth that advocates make it out to be,” he said. Mr. Buffett himself lent empirical support to this view in his column. “I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off,” he said.
  • Tax simplification.  Whatever benefits lower capital gains rates might generate, they indisputably complicate the tax code and have spawned a multibillion-dollar industry in tax avoidance. “Every imaginable individual income tax shelter is driven by the differential,” Mr. Burman noted. He added that the tax code was needlessly complex. “Have you looked at the alternate rate schedule on the back of Schedule D? It’s so complicated. It’s insane. That alone is a really good argument for change.”
  • Increased revenue.  But the biggest reason for equalizing capital gains rates may be that it would generate a vast amount of additional revenue for the Treasury. The Internal Revenue Service reports that for taxpayers with the top 400 adjusted gross incomes, capital gains in 2008 amounted to an eye-popping average of $154 million for each of those taxpayers, or 57 percent of their adjusted gross income, and this in a year when the stock market plunged. In 2007, it was $229 million each, or 66 percent. Much of the windfall from higher capital gains rates could be offset by cutting the rate on ordinary income. For antitax zealots who vow they won’t accept one more penny of federal tax, all of it could be offset by lower rates on ordinary income. And for advocates of reducing the government deficit at least in part through higher taxes, tax reform is an appealing approach.
  • Inequitable treatment of workers vis-à-vis owners.  Proponents of lower — even zero — capital gains rates have some academic research and statistics to support their claims. Still, there’s no doubt that the root of the problem highlighted by Mr. Buffett is the disparity between tax rates on capital gains and ordinary income. Were these rates the same, the debate over how to treat carried interest would vanish, along with much of the disparity between tax rates for the rich and people like Mr. Buffett’s secretary.  In the end, the most compelling argument for equalizing tax rates on capital gains and ordinary income may not be economic efficiency, growth incentives, higher tax revenue or reducing the deficit. It’s simple fairness. It’s hard to quantify or put a dollar value on a just society. “I’ve earned both, and in my experience earning income from capital gains is a lot easier than earning ordinary income,” Mr. Burman said. “Why not tax both at the same rate? It only seems fair.”

The Washington Post and New York Times, bastions of the liberal press, have persuaded me that the American tax system should stop distinguishing between capital gains and earned income.  They should both be taxed at the same rate.  But I endorse Mitt Romney’s plan to exclude the capital-gains tax on individuals who earn less than $200k.  This would be the proper type of incentive for individuals in the wage-earner class (proletariat) to become a part of the ownership class (bourgeoisie), and that would be a great thing.


1 Comment »

  1. Very good content, With thanks.

    Comment by http://openmedia.ca/memberind/adrenal-fatigue-basic-data — November 5, 2012 @ 11:56 pm | Reply

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