Most industrial and developing countries tax individual and corporate capital gains more lightly than does the United States, according to a survey of twenty-four industrialized and developing countries that the ACCF Center for Policy Research commissioned from Arthur Andersen LLP. The Center’s analysis shows that the United States taxes both short- and long-term capital gains more harshly than most other countries. High capital gains tax rates increase the bias against saving and investment, raise the cost of capital for new investment, and slow U.S. economic growth.

Individual Capital Gains Tax Rates

Both short- and long-term capital gains on equities are taxed at higher rates in the United States than in most of the other twenty-three countries surveyed. Short-term gains are taxed at 39.6 percent in the United States compared to an average of 19.4 for the sample as a whole (see comparison table, parts I & II, and accompanying notes [marked with asterisk]). Long-term gains face a tax rate of 20 percent in the United States versus an average of 15.9 for all the countries in the survey. Thus, U.S. individual taxpayers face tax rates on long-term gains that are 26 percent higher than those paid by the average investor in other countries. In addition, the United States is one of only five countries surveyed with a holding period requirement in order for the investment to qualify as a capital asset.

The reduction in individual capital gains tax rates in the Taxpayer Relief Act of 1997 lowered the cost of capital for new investment and thus will enhance U.S. productivity and economic growth. The 1997 reductions almost certainly contributed to the current budget surpluses. In addition, shortening the holding period for long-term capital gains from eighteen to twelve months, which was included in the IRS Restructuring and Reform Act of 1998, signed into law by President Clinton July 22, 1998, will be a further boost to investment.

Corporate Capital Gains Tax Rates

Similarly, short- and long-term corporate capital gains tax rates are higher in the United States than in most other industrial and developing countries surveyed. Both short- and long-term gains are taxed at a rate of 35 percent in the United States, compared to an average of 22.8 percent for short-term gains and 19.6 percent for long-term gains in the sample as a whole. In other words, U.S. corporations face long-term capital gains tax rates almost 80 percent higher than those of their competitors in other countries. The U.S. tax rate on long-term corporate capital gains is higher than that of all but two of the other countries surveyed (Germany [45 percent] and Australia [36 percent], and Australia provides for indexing the cost of an asset). In addition, only four of the twenty-four countries surveyed impose a holding period in order to be eligible for preferential corporate capital gains tax rates.

Conclusion

Sound tax policy and economic considerations, as well as revenue consequences, argue for further reductions in U.S. individual capital gains taxes. In addition, the U.S. corporate capital gains tax rate of 35 percent should be reduced, thereby creating a meaningful differential between the tax rate on ordinary corporate income and on capital gains. This would reinstate the historical U.S. treatment of corporate capital gains: an alternative corporate capital gains tax was part of the Internal Revenue Code from 1942 until its repeal by the Tax Reform Act of 1986.