The new 30% capital gains rate would be the developed world’s third highest behind only Denmark and Chile, according to the American Council for Capital Formation. This is on top of the 35% corporate rate that is already the second highest rate in the world after Japan. That giant sucking sound you hear come January 2013 would be hundreds of billions of investment dollars fleeing to China, India, Korea and other U.S. competitors. Lower capital investment in the U.S. means less wage growth, and so the people hurt most by this tax hike would be workers, according to a study by the Institute for Research on the Economics of Taxation.

If Lady Gaga has her way, the tax man won’t see her “poker face”—but he will see the bleary eyes of another unhappy taxpayer who has to drink away IRS pain.

Last week, the international pop star admitted, “When I signed my tax returns this year, I had to get completely wasted. They were just holding me up. It’s unbelievable.”

If Lady Gaga recognizes and espouses the unfairness of our tax system, then the first drink is on me and the first shot is to make our tax system smarter, starting with rates.

A shift from progressive rates on an income tax base to flatter rates on a consumption tax base would allow for much greater savings and investment so that an earner would be taxed only on what he spends; simplifying his tax liability and giving him more control over his hard-earned income, retirement and college savings. Similarly, businesses would become more confident about putting profits and savings back into their companies and other incentives that spur growth and jobs.

Another critical ingredient to this cocktail is to keep capital gains rates low—or even lower them.

An econometric study by the highly respected economist Dr. Allen Sinai notes that the economic activity sparked by eliminating the capital gains tax increases GDP by a little over 0.23 percentage points per year. Jobs increase by an average of 1.3 million per annum while the unemployment rate drops 0.7 percent at its lowest point.  Conversely, Sinai found that raising the U.S. top individual capital gains rate from the current 15 percent rate to 20 percent, as suggested in several deficit reduction plans, would cut annual economic growth by an average of .05 percent per year and job growth would decline throughout the economy by an average of 231,000 from 2011-2016.

And here’s the tax system chaser: we should not be looking at paying more into the broken systems that have left us deeply mired in unemployment, wiped out nest eggs and have led many to lose confidence in our democratic institutions and their own individual future.  A sobering Gallup Poll released earlier this year found that only 44% of Americans believe it is “likely” that today’s young people will “have a better life than their parents, with better living standards, better homes, and better educations.” A poll from Wells Fargo found that just 74 percent of middle class Americans expect to work in their retirement years, with a total of four out of ten Americans saying they will need to work to make ends meet or maintain their lifestyles.

If this remedy doesn’t seem palatable, the alternative could be a very stiff shot of ouzo, the licorice-flavored liquor so popular in Greece. That nation’s shaky fiscal outlook could lead it into default, dragging down other European nations such as Italy and France with it. And as goes Europe, so goes the world economy in this case.

It’s clearly time to sober up and address our own economic situation.

If the President and Congress are unlikely to act on the Bush tax cuts before the election, there will be the introduction of a damaging tax increase on income in a likely weak economy. And another vote to increase the U.S. debt ceiling will be upon us as well.

These will be trying times, but we can’t allow ourselves to pull a Gaga and drink away our pain. If we don’t figure out a way to pay our national tab, the future truth includes higher tax rates, reduced economic activity, fewer jobs and a multi-decade hangover.

Mark Bloomfield is president and CEO of the American Council for Capital Formation (www.accf.org), a nonprofit, nonpartisan organization dedicated to public policies supportive of saving and investment to promote long-term economic growth, job creation and competitiveness.  Bloomfield also runs a blog, www.MrCapitalGains.com.

 Senator Jon Kyl (R-AZ), a committee member took issue with proposals in both the Bowles-Simpson plan and the Domenici-Rivlin plan to tax capital gains and dividends at the same rates as labor is taxed.   “My observation is you could do great harm by effectively doubling capital gains and dividend taxes because those represent areas of capital formation and investment in our economy.”

Indeed, great harm could come from raising tax rates on savings and investment as I pointed out today as a panelist on National Journal’s Policy Summit on tax reform.

I participated in the expert panel discussion along with Scott A. Hodge, President, Tax Foundation, Elaine Kamarck, Ph.D., Lecturer in Public Policy, Belfer Center for Science & International Affairs, Harvard Kennedy School and Martin A. Regalia, Ph.D., Senior Vice President for Economic & Tax Policy, Chief Economist, U.S. Chamber of Commerce.

I reinforced the importance of pro-growth tax policy to help encourage and stimulate savings and investment again.  Unlike many other countries, the current U.S. tax codes provides many disincentives to investment and capital formation that are needed to spur growth and create jobs.  I reminded the audience of the events that led to the historic 1978 capital gains tax cut–a down economy, populist uprising and an administration that wrongly views capital gains as a benefit for “fat cats.”  An effort led by President Carter to raise capital gains taxes was overturned by a bipartisan coalition that recognized the importance of lower capital gains rates to stimulate growth.  The dynamics are very similar today.

I agree with Senator Wyden, the one policy option not yet tried to achieve economic growth is tax reform. Although most of the tax reform talk today is about lower rates, equally important is shifting the tax base from income to consumption.  Thus, don’t pay for lower individual tax rates with higher taxes on capital gains and dividends or cutting back on IRAs, Keoghs and 401(k).  Don’t pay for lower corporate tax rates by lengthening depreciation or eliminating other current provisions which reduce the cost of capital.  Yes, look at consumption taxes to pay for lower tax rates and reduce the deficit once spending has been reduced as much as possible.

There is a consensus among mainstream economics that a flat consumption-based tax system would facilitate great economic growth over an income tax structure and of course be a tremendous improvement over our current bankrupt system.  Mainstream economist Allen Sinai analyzed the impact of lower and higher capital gains taxes with his microeconomic model  A zero capital gains tax would result in an average increase of 1,322,000 jobs annually at a cost of $18,000 a job  compared to a very conservative estimate of $92,000 a job from the recent stimulus program.  Conversely, an increase from the current 15% to 20% capital gains tax rate results in an annual decrease of 231,000 jobs.

You can watch today’s event here:

Want to Create Jobs? First Cut Capital-Gains Taxes: Amity Shlaes
By Amity Shlaes – Oct 26, 2011

Along with jobs, raising taxes on the rich is one of things the Wall Street protesters feel strongly about, as Andrew Cuomo, the Democratic governor of New York, is learning all too well.

Cuomo has become a target for activists because he’s refusing to fight to extend a state-tax surcharge on the wealthy that expires soon. Cuomo’s insistence on protecting the rich is causing fellow Democrats to ask whether he has forgotten that he stands for workers.

But Cuomo’s insistence is born of experience. Higher taxes can destroy jobs. As data from the Tax Foundation show, New Yorkers are net migrants to Connecticut. Both Cuomo and various jubilant governors in Connecticut have attributed the shift to taxes. Cuomo has said that he aims to ensure the tax regime in the Empire State stops driving others away. “I think you are kidding yourself if you think you can be one of the highest-taxed states in the nation, have a reputation for being anti-business and have a rosy economic future,” Cuomo said recently, according to the Daily News.

He may also have looked at weightier studies surveying the treatment of capital nationally. These suggest that sparing the rich from paying taxes creates jobs. This is especially true for the capital-gains tax, the levy that defines the rentier class that the protesters resent.

Modeling Rates

Evidence for this began to accumulate in the 1970s and ’80s, when Wall Street forecaster Allen Sinai was assembling models to simulate the effect of public-policy changes for Data Resources Inc. and Lehman Brothers Holdings Inc.

Sinai moved on and developed succeeding mega-models, the most recent being the Sinai-Boston macroeconomic simulation program. Early on, Sinai and his colleagues noticed that changes in the capital-gains tax rate affect economic growth. And for decades, Sinai has been analyzing rate changes to forecast for Democrats and Republicans alike. He told me this week that his overall conclusion is: “Lower capital-gains taxes help to grow the economy at relatively low cost to the deficit and debt.”

The American Council for Capital Formation, a Washington-based group that lobbies for lower taxes on investments, asked Sinai to model how the economy might perform if the current capital-gains levy of 15 percent were changed. He estimated how fast the economy would grow over five years, using rates ranging from 0 percent to 50 percent, relative to probable growth under the current law.

Dramatic Results

The study was published in 2010, and Sinai says he still stands by it. The results are dramatic. Right now, economists say the economy needs to create about 2.4 million jobs a year. Sinai found that eliminating the capital-gains tax alone, with no other policy change, would create 1.3 million per annum, or more than half the total sought. Real gross domestic product would increase by 0.23 percentage point a year. The jobless rate would drop by as much as 0.7 percentage point in a year. And productivity gains would increase by 0.5 percentage point a year.

This change would bring the U.S. much closer to the growth levels to which we were once accustomed. And it wouldn’t damage the budget nearly as much as simply calculating the amount of revenue foregone would suggest.

Cheap Capital

That’s because the growth created would generate other kinds of tax revenue. Without a capital-gains tax, the official numbers suggest the government would lose about $451 billion. But Sinai, like many economists, likes to use a method called dynamic analysis, which takes into account benefits or damage to the rest of the economy that a rate change would cause.

By Sinai’s dynamic analysis, the actual revenue loss “ex post,” after including the other consequences of the rate change — such as the increased hiring and business formation that occurs when tax systems are friendlier to capital — would be only $8.2 billion. Employers, finding capital cheaper, would have more cash to hire. Cutting the rate to even 5 percent would still add 711,000 new jobs per year.

By the same logic, an increase in the capital-gains tax rate, even a small one, can do damage. Today, many economists talk about increasing the top rate to 20 percent from 15 percent, and note that President Ronald Reagan himself signed legislation that raised the rate to 28 percent from 20 percent in 1986. Yet that small change, which sounds like a perfect compromise, would cost 602,000 jobs annually, according to Sinai’s model.

Zero Percent

The idea of a 0 percent levy might sound absurd to ears ringing with Wall Street protest, but the idea has been around for a while, and has gained support in a number of places. Former Federal Reserve Chairman Alan Greenspan has often spoken out for it. Numerous other countries have experimented with a 0 percent capital-gains rate over the years. Hong Kong officials swear by it.

What about the fairness the protesters chant for? Sinai says he favors raising taxes on one kind of capital gain, carried interest, to treat it as ordinary income. But the bigger picture is that lower taxes on capital are good for workers, a group that includes protesters and their siblings. They will have to decide whether they care more about punishing the rich or about increasing the number of jobs on offer to their friends. It’s a tough call. My guess is, as the temperature drops, the protesters will take jobs over rage.

Here’s my take.

Indeed, the growing income inequality is a legitimate concern. The issue is why? Many respected economists attribute it to global labor markets, the U.S. is no longer the dominant economic power, education is in decline, and our government’s fiscal policies are a train wreck and the real culprit in our income divide–not capital gains tax rates.  Can anyone say with a straight face really say that an unemployed Detroit auto worker lost his job because of capital gains tax rates. Rattner, for one should know better than all as President Obama’s former automobile czar.

Economic growth is the cure to income inequality.  All economists agree that the US is suffering from a tremendous lack of saving and investment. Our global competitors are smart in taxing tax saving and investment less harshly. Let’s generate economic growth first and then debate how that wealth should be distributed.  Rattner should explain to the unemployed or less fortunate how a higher capital gains tax rate is going to generate a job for them.

As Uncle Joe said there is a long history of strong bipartisan support for lower capital gains tax rates. If Joe wants to throw them overboard and go with Rattner’s point of view then fine,  I will stick with JKF and Reagan.