Thursday, September 24, 2009

Capital Gains Revenue optimized at 20% tax rate

Yesterday in my entry, Baucus Bill Increases tax on All Americans, a friend of mine on Facebook said that my assertion of "historically speaking, when taxes are raised, i.e. capital gains, the government realizes less revenue" was wrong because "simple logic tells us that is not true increasing taxes brings in more revenue that is EXACTLY what it does by definition." My friend pointed those on Facebook, myself included, to
website. The website states that "to raise revenue over the long run, capital gains tax cuts would need to have extraordinary huge, positive effects on savings, investment, and economic growth that virtually no respected expert or institution believes they have." The site further warns that "Especially when capital gains cut is temporary, like the 2003 tax cut that Gibson cited, investors have a strong incentive to sell stocks and other assets in order to realize their capital gains before the capital gains rate increases. This can cause a short-term increase in capital gains tax revenues, as happened after the 2003 tax cut."

In a Joint Economic Committee Study, chaired by Jim Saxton, in June of 1997, concluded that "The analysis that follows unambiguously concludes that the current capital gains tax rate is too high. Analysis of data from previous changes in the capital gains tax rates indicates that a reduction in the capital gains tax rate from 28 percent to 20 percent will result in a substantial increase in capital gains tax revenue in the short run. In the long run, revenue may either increase or decrease slightly. If there are any revenue losses in the long run, they will be exceedingly small because revenue reductions due to the lower rate will be offset by revenue enhancements resulting from increase capital gains realizations. A lower capital gains tax rate will both (1) release capital resources that many investors continue to hold in order to delay or avoid a tax liability and (2) reduce an impediment to the purchase and sale of capital assets. Both of these factors will improve the efficiency of capital markets and benefit the entire economy" (

The study goes on further to demonstrate, via a graphs, to display that lowering the capital tax rates over the 1970’s, 1980’s and 1990’s had higher revenue for the Federal government than when the tax rate was increased during the late 1980’s. The capital gains tax was cut in 1978 which saw a rise in tax revenue from $100.7B in ’’77 to $112B in ’78 and then in ’79 saw $139B in tax revenue per the Joint Economic Committee study. Then in 1986 capital gains tax was increased, that went into effect in 1987, resulted in a spike of tax revenue but, as the study points out, “When considering the long-run effect of capital gains tax rates on revenues, one cannot fail to be struck by the fact that, even though there were substantial income growth over that decade, the capital gains realization were lower in the early 1990s than during the early 1980s when capital gains tax rate was 20 percent.” The study concludes that “a lower capital gains tax rate of 20 percent would have produced about 43 percent more realized capital gains than the 28 percent rate.”

The claim that my friends source that “Capital gains tax cuts either make the nation’s daunting long-term budget problems even more severe or consume scare resources (primarily to the benefit of the most well-off) that could otherwise be used for purposes such as moving toward universal health coverage or improving the educational system.” I tried to find to see if the Joint Economic Committee Study had updated their information on capital gains tax but did not unearth one. The current capital gains tax rate is 15%. As the study pointed out, in a regression analysis, the optimal capital gains tax rate for long term investments is 20%. That being said, I can support an increase to 20% but the timing will be the question. The stock market is starting to gain steam and may fall short of 10,000 if a rate hike takes place. Unemployment is high and, although Paulsen say differently, America is in a recession. Although if Congress did raise the capital gains tax rate from 15% to 20%, maybe a similar increase in tax revenue would take place that took place back in 1986.