Cap Gains Taxation: Less Means More

Published in Wall Street Journal

Congress is deliberating on what to do about the “Bush tax cuts”—the reductions in income, capital gains and dividend taxes legislated in 2001 and 2003—currently set to expire at the end of this year. The recession may officially be over, but what Washington does on tax policy still matters for an economy that’s creating very few net new jobs and is stuck with an unacceptably high unemployment rate and record-high federal budget deficits of over 9% of GDP.

Capital gains taxation is one area in which lawmakers can help jump-start the economy. Capital gains tax rates for taxpayers in the top four income brackets are set to move higher in a few months. My new study, “Capital Gains Taxes and the Economy,” published this week by the American Council for Capital Formation, shows that the net effect of lower capital gains taxation is a significant plus for U.S. macroeconomic performance.

The study simulated reductions and increases in capital gains taxes starting in 2011 and extending to 2016 to estimate the effects on economic growth, jobs and unemployment, inflation, savings, the financial markets and debt.

Here are a few of the relevant findings:

Hiking capital gains tax rates would cause significant damage to the economy

Raising the capital gains tax rate to 20%, 28% or 50% from the current 15% would reduce growth in real GDP, raise the unemployment rate and significantly reduce productivity. These losses to the economy outweigh any gains in tax receipts from the increase in the capital gains tax rate.

For example, at a 28% capital gains tax rate, economic growth declines 0.1 percentage points per annum and the economy loses about 600,000 jobs yearly. If the capital gains tax rate were increased to 50%, real GDP growth would decline by 0.3 percentage points per year, and there would be 1.6 million fewer jobs created per year. At a 20% capital gains rate compared with the current 15%, real economic growth falls by a little less than 0.1 percentage points per year and jobs decline about 231,000 a year. Smaller increases in the capital gains tax rate have smaller effects on the economy, but the effects are still negative.

Lowering capital gains tax rates would help grow the economy and jobs.

My study found that when capital gains taxes are reduced to below 15%, the after-tax return on equity rises, stock prices increase, household wealth rises, consumption moves higher, and capital gains can be realized. Capital gains tax receipts to the government increase and household financial conditions improve to provide a healthier basis for future consumer spending.

My study also found that a reduction in the capital gains tax rate to 5% from 15% raises real GDP growth by 0.2 percentage points per year, lowers the unemployment rate by 0.2 percentage points per year, and increases nonfarm payroll jobs by 711,000 a year. Productivity growth improves 0.3 percentage points a year.

Taken to its logical conclusion, moving to a zero capital gains tax rate would have an even bigger effect, increasing growth in real GDP by over 0.2 percentage points per year and approximately 1.3 million additional jobs per year.

Higher capital gains taxes will not substantially reduce the deficit.

The net impact on the federal budget deficit of a reduction in the capital gains tax rate to 0% is a decline in tax receipts of $23 billion per year after the positive effects of stronger economic growth on payroll, personal and corporate income taxes are taken into account. This is significantly less than the $30 billion per year static revenue loss estimate, which does not include feedback effects. A capital gains tax reduction to 0% produces new jobs at a cost of $18,000 per worker, far less than might occur from many other proposals.

The bottom line is that any capital gains tax increase is counterproductive to real economic growth. To the contrary, a reduction in the capital gains tax rate would be a pro-growth fiscal stimulus that creates new jobs and new businesses, funds entrepreneurship, reduces the unemployment rate, increases productivity, and in the long run brings in more payroll taxes. In the case of capital gains taxation, less means more.

Mr. Sinai is chief global economist, strategist and president of Decision Economics Inc.