Archive for October, 2009

New Reports Find Little Good News in Capital Gains Tax Rate Hike

Two new reports were released in the Capital Gains Series from the Institute for Research on the Economics of Taxation (IRET) sponsored by The Searle Freedom Trust. The papers in this series discuss the taxation of capital gains and use quantitative tools to examine the economic and budgetary consequences of changes in the capital gains tax rate.

In The Relationship Between Realized Capital Gains And Their Marginal Rate Of Taxation, 1976-2004, Ohio State University Professor Paul D. Evans of Ohio State University finds that taxpayers are still sensitive to the tax rate on capital gains, and would report fewer gains if the rate were raised. Based on 2004 data, the revenue maximizing tax rate may be just under 10%. Raising the capital gains tax rate from the current 15% to 20% or more would reduce federal capital gains tax revenue. Additional revenue would be lost from other parts of the income tax and from other federal taxes due to reduced investment, employment, and income. The optimal capital gains tax rate to maximize public welfare, and to help the federal budget, is surely closer to if not zero.

The second study, The Effect Of The Capital Gains Tax Rate On Economic Activity And Total Tax Revenue, concludes that the tax rate increases would not raise anticipated revenues. About 91% to 95% of the revenue gains expected from the imposition of the 20%, 24%, and 28% rates would be lost due to lower incomes. Instead of raising income tax revenue by $30.7 billion, $54.7 billion, or $77.5 billion, respectively, the net income tax increases would be only $2.5 billion, $2.9 billion, and $4.0 billion in the three cases.

Lower levels of output, payroll, and consumption would reduce payroll taxes, corporate income taxes, excise taxes, and tariff revenue, resulting in net revenue losses. There would be further revenue reductions due to the decline in the capital stock, which would decrease the amount of capital gains available to be realized. The combined revenue effect would be losses of $24.9 billion, $46.2 billion, and $64.8 billion in the three cases. Lower wage rates would reduce federal budget outlays, but the combined effect would be a significant increase in federal budget deficits. State and local government budgets would be similarly hurt.

This and our recent post on the CBO’s take on capital gains make a pretty compelling case for maintaining the current capital gains tax rate. Sadly, a plan on lower capital gains tax rates is noticeably absent from President Obama’s new plan to aid small businesses.

RIP Senator Cliff Hansen: Capital Gains Champion

Senator Cliff Hansen (R-WY), the quiet hero of the historic Steiger-Hansen 1978 capital gains cut, passed away peacefully this week at the age of 97.

As if it were yesterday, I distinctly remember turning to the modest soft-spoken to ask him to become the lead Senate sponsor of the capital gains effort after Senator Lloyd Bentsen turned us down. Hansen said, “By Gosh, I will do it.”

Working only from a handwritten 3 X 5 note card on reasons for cutting the kgs tax, he corralled 20 to 30 Senate sponsors within hours.

We leaked this rare achievement to Washington Post’s Bob Samuelson, but by the time he had already gone to press, Hansen had exceeded a veto-proof 60 co-sponsors.

The rest was history. “Heroic Hansen” was hailed by the Wall Street Journal, capital gains tax rates were lowered and a new era of pro-growth tax policy was born.
 
Senator Hansen who later joined the ACCF board told me it was the highlight of his decades in the US Senate.

On behalf of the ACCF, thank you Senator Hansen. Your service and contributions will always be remembered.

CBO: Revenue and Risk-Taking Could Be Tempered From Capital Gains Tax Hike

Congressional Budget Office Director Douglas W. Elmendorf recently responded by letter to an inquiry to Representative Brian Bilbray (R-CA) on anticipated revenue and other impacts of the 20% capital gains tax rate’s looming return in 2011. The CBO is a nonpartisan congressional research/analysis group that historically has been very skeptical about high capital gains taxes having a negative impact on government revenues and on innovation and economic growth.

Thus, its interesting that Elmendorf notes the distortionary impact of higher capital gains taxes on government tax receipts and on innovation and risk taking:

“Based on the historical experience, CBO anticipates that taxpayers will take steps to moderate the impact of the pending tax increase. One step will be to accelerate the realization of some gains into 2010 that otherwise would have been realized in 2011. In later years, we anticipate that taxpayers will realize fewer capital gains by holding assets longer, in some cases until death, when they can be left to heirs without any potential income tax on accrued capital gains. The shifting of gains from 2011 into 2010 will reduce revenues modestly over that two-year period, as well as speed up their payment. In later years, the reduced realizations will keep revenues from rising in proportion to the increase in the tax rate. On net, we project that federal revenues will increase in response to the higher tax rates, but that reduced realizations will temper that increase….”

“The higher capital gains taxes could have an additional effect by discouraging innovation and risk-taking, but there is insufficient evidence on which to base a quantitative estimate.”

Less revenue, less risk-taking. An administration interested in jump starting the economy should not put a chilling effect on entrepreneurship that has inspired the Silicon Valley boom and other Horatio Algers over the last several decades.