Paul L. Caron

Friday, December 6, 2019

Capital Gains Taxation And Investment Dynamics

Sungki Hong (Federal Reserve Bank of St. Louis) & Terry S. Moon (University of British Columbia), Capital Gains Taxation and Investment Dynamics:

This paper quantifies the long-run effects of reducing capital gains taxes on aggregate investment. We develop a dynamic general equilibrium model with heterogeneous firms, which face discrete capital gains tax rates based on their firm size. We calibrate our model by targeting relevant micro moments as well as the difference-in-differences estimate of the capital elasticity based on the institutional setting and a policy reform in Korea. We find that the firm-size reform that reduced the capital gains tax rates from 24 percent to 10 percent for the affected firms increased aggregate investment by 2.6 percent and 1.7 percent in the short-run and in the steady state, respectively. Additionally, in a counterfactual analysis where we set the uniformly low tax rate of 10 percent, the aggregate investment rose by 6.8 percent in the long-run.

Taken together, our findings suggest that reducing capital gains tax rates would substantially increase investment in the short-term, and accounting for dynamic and general equilibrium responses is important for understanding the aggregate effects of capital gains taxes.

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The idea that lower taxes on capital gains spur economic growth has been around forever. For an exactly contrary view--the notion that growth might in fact be increased by higher capital gains taxes--look no further than this piece from the 12/6/19 New York Times:

Posted by: Gerald Scorse | Dec 6, 2019 8:47:55 AM

@ Gerald, a NYT hit piece hardly qualifies as academic research. While I agree with you on doing away with capital gain taxation, my motivation is different from yours. One, nobody can prove diddly squat about whether capital gains taxation hurts or helps investment. However, I do know from years of practice, capital gains taxation is a major cause of complexity. Anytime you have a 20 percentage point spread between tax rates, you're going to have a lot people spend a lot of time arbitraging that gap. Further, you're going to have a lot of people at the IRS pushing back. Because I'm all for simplification, my policy position we should tax capital gains as income and allow a deduction for capital losses.

Posted by: Dale Spradling | Dec 7, 2019 10:20:00 AM

Democratic presidential candidate Joe Biden spoke exactly to this point in his 12/6 interview with CNBC's John Hardwood. Here's the portion pertaining to capital gains:

"For example, there’s overwhelming evidence now that the idea that the capital gains tax is promoting growth is just not the case. We should charge people the same tax for their capital gains as their tax rate is. And I think we should raise the tax rate back to, for example, I take it back to where it was before it was reduced."

Posted by: Gerald Scorse | Dec 7, 2019 1:57:46 PM

Dale: "Because I'm all for simplification, my policy position we should tax capital gains as income and allow a deduction for capital losses."

I'm puzzled. I'm sure you know that capital losses in any tax year can be deducted from capital gains in that same tax year. In addition, any capital losses greater than capital gains can be carried forward and deducted year after year.

Posted by: Gerald Scorse | Dec 8, 2019 1:45:23 PM

Gerald, if you're going to tax capital gains at ordinary income rates, logic says capital losses should be fully deductible against ordinary income. For folks who have lost millions in the stock market, i.e., 2007/2009, a $3,000 a year limit is a joke.

Posted by: Dale Spradling | Dec 9, 2019 9:03:15 AM

Dale: Right, when total capital losses exceed total capital gains. But you can lose a whole lot more, and deduct it, if you have offsetting gains. Plus, as I'm sure you know, any non-deductible loss in excess of that $3,000 can be carried forward forever. I know $3,000 a year isn't much, but it's something.

To the main point: it seems fair to me that capital losses can be offset against capital gains (plus that $3,000). It doesn't seem fair to me that other taxpayers should bear the cost of losses in excess of capital gains. We likely disagree on that point, I know.

Posted by: Gerald Scorse | Dec 10, 2019 8:51:52 AM