TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, September 22, 2012

WSJ: Obama's 100% Capital Gains Tax Increase Won't Raise Revenue, But Will Hurt Economy, Jobs & Wages

WSJWall Street Journal editorial: A Capital Gains Primer:  Why a Tax Rate Differential Is Fair and Helps the Economy:

On Thursday the House Ways and Means and Senate Finance committees held a rare joint hearing on taxing capital gains in the context of tax reform. The timing couldn't be better because President Obama recently restated his support for lifting the top capital gains tax rate next year on those with earnings above $250,000 to 23.8%, or almost 60% above today's 15% rate. If Mr. Obama's Buffett Rule is also adopted, the rate would rise to 30% for those earning $1 million—the highest rate since the late 1970s.

The question is to what purpose? This won't raise much if any revenue for the government (see Obama's Revenue Soup, April 9, 2012). But it will impose a big cost on the economy. ...

The current Democratic obsession with raising the capital gains tax comes from a mistaken belief that the preferential rate applied to the sale of a family business, farm or financial asset is a "loophole" that mainly benefits the rich.

But that ignores the vital link between tax rates and capital investment. The lower the tax, the greater the incentive to take risks. ...Thanks to rate reductions in 1978, 1981, 1997 and 2003 (see chart), the statutory capital gains tax has fallen to 15% from about 40%. These rate cuts unleashed historic levels of venture-capital funding for business start-ups. ...

Far from being a loophole, the low tax rate applied to capital gains is beneficial and fair for several reasons.

First, under current tax rules, all gains from investments are fully taxed, but all losses are not fully deductible. This asymmetry is a disincentive to take risks. A lower tax rate helps to compensate for not being able to write-off capital losses.

Second, capital gains aren't adjusted for inflation, so the gains from a dollar invested in an enterprise over a long period of time are partly real and partly inflationary. It's therefore possible for investors to pay a tax on "gains" that are illusory, which is another reason for the lower tax rate.

Third, since the U.S. also taxes businesses on profits when they are earned, the tax on the sale of a stock or a business is a double tax on the income of that business. ...

The main reason to tax capital investment at low rates is to encourage saving and investment. Many economists believe that the economically optimal tax on capital gains is zero. ... Almost all economists agree—or at least used to agree—that keeping taxes low on investment is critical to economic growth, rising wages and job creation. ...

Democrats who argue for higher taxes on capital are advocating less investment and dooming workers to fewer jobs at lower wages.

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If we need any better proof of the truth of what the WSJ says, it would be the circumstance in the early part of the Reagan administration when there was no differential between capital gains and ordinary income.

The economy absolutely cratered! Oh wait, it didn't.

Posted by: Jim Harper | Sep 22, 2012 9:22:57 AM

In fact, it was the late part of the Reagan administration, following the elimination of the tax rate disparity between capital gains and ordinary income in TRA 1986.

A preferential capital gains tax rate, with all the complexities it brings, is not the only way to reduce a tax law disincentive to investment. Lowering the corporate tax rate to the OECD norm would achieve much the same result. But consider the implications for the long moribund accumulated earnings tax.

Posted by: Jake | Sep 22, 2012 11:58:25 AM

But, but...the tax increase wouldn't be for revenue; it's for "fairness." Makes sense...if you're into punishing people for being successful.

Obama: Let's Raise Capital Gains Tax Even if Less Revenue- Fairness

Posted by: Woody | Sep 22, 2012 12:17:39 PM

Could it be that the difference in tax rates causes changes in behavior? If there was no tax rate difference, why take all the costs involved in order to transform income to gains? I would expect to see a fall in capital gains and an increase in income if the tax rates difference was eliminated, all other equal.

Posted by: GSo | Sep 24, 2012 4:16:04 AM

The WSJ is bad. The first argument(which should be your strongest) is a disincentive to take risk. I guess we need to give investment banks incentives to take risk and if they lose the taxpayers will pay-if they win they pay little taxes.

Posted by: Nick Paleveda MBA J.D LL.M | Sep 24, 2012 8:48:24 AM

I think I understand how the WSJ makes money. Let's see if it will work for me too:

Taxes Bad. Tax Cuts Good. Oligarchs saving America.

Check from Oligarchs, please?

Posted by: Anon | Sep 28, 2012 3:23:39 AM