Monday, April 21, 2008

Do Capital Gains Tax Cuts Raise Revenue?

John McCain was the guest on the April 20th program of This Week with George Stephanopoulos. As can be seen in this transcript of the interview, McCain made the following statement about Barack Obama's suggestion that the capital gains tax rate be raised:


And he obviously doesn’t understand the economy, because history shows every time you have cut capital gains taxes, revenues have increased, going back to Jack Kennedy.


It's unclear why McCain mentions Jack Kennedy since, according to this table, there was no change in the capital gains tax rate between 1942 and 1967, four years after Kennedy's death. In any case, George Will expanded on this theme just about one minute into the shows's roundtable segment. Talking about questions that Obama was asked in the April 17th Democratic debate, he said:


One was on capital gains where he conceded the premise of the question as he should because it's true that when you raise capital gains tax rates, you lower revenues from that and he said he'd do it anyway. Even if it reduced the return on American investment, even if it cost the government revenues, he'd do it out of some abstract commitment to fairness.


I thought it odd that Obama would concede that higher capital gains tax rates would bring in less revenues but that he would raise them anyhow. Hence, I checked a transcript of the debate and found the following exchange on page 3:


GIBSON: But history shows that when you drop the capital gains tax, the revenues go up.


OBAMA: Well, that might happen, or it might not. It depends on what's happening on Wall Street and how business is going. I think the biggest problem that we've got on Wall Street right now is the fact that we got have a housing crisis that this president has not been attentive to and that it took John McCain three tries before he got it right.


This is the only point where Obama directly addressed the contention that cutting the capital gains tax rate cause revenues to go up. There is no concession there. Hence, George Will was wrong on that point. What seems more important, however, is the fact that Gibson and Will state the contention that capital gains tax cuts increase revenues as though it is an established tenet of economic theory. Why else would two supposedly objective journalists state it as though it were an accepted fact?


I have previously looked at the effect income tax rate cuts on revenues. My analysis is at http://www.econdataus.com/taxcuts.html. However, I have not looked closely at the effect of capital gains tax rate cuts on revenues. In looking at existing studies, it becomes immediately clear that their positive effect on revenues is far from accepted. In fact, the majority of evidence suggests that they have a negative effect on revenues. An article from the Center on Budget and Policy Priorities list studies by the Congressional Budget Office, Congressional Research Service, and Treasury Department that conclude that capital gains tax rate cuts lose revenues. I did find this Treasury document that projects on page 128 that making the dividends and capital gains tax cuts permanent would cost $196 billion and $104 billion, respectively from 2009 through 2018. Finally, the following excerpt is from a summary of a paper co-authored by N. Gregory Mankiw, former chairman of President Bush’s Council of Economic Advisors and a Harvard economics professor:


According to the researchers, the neoclassical growth model and all of its variants indicate that the dynamic response of the economy to tax changes is substantial. In almost all instances, they find, tax cuts are at least partly self-financing. The authors conduct some simple calculations, plugging in numbers that approximately describe the U.S. economy. They find that, in the long run, about 17 percent of a cut in labor taxes is recouped through higher economic growth. The comparable figure for a cut in capital taxes is about 50 percent. This means that the true revenue cost of a cut in capital taxes is only half of the cost estimated with static scoring.


All of the studies of capital gains tax rate cuts that I've seen seem to agree that they lose revenue. If anyone has seen a study that suggests otherwise, please leave a comment with a link to it. In any event, it's clear that the claim that such cuts increase revenues is, at the very least, heavily contested. I hope that the media will start reporting this issue as such instead of parroting the claim that capital gains tax cuts raise revenue.


Do Capital Gains Tax Cuts Raise Revenue? (Part 2)


Do Capital Gains Tax Cuts Raise Revenue? (Part 3)

5 comments:

Anonymous said...

http://www.house.gov/jec/fiscal/tx-grwth/capgain/capgain.htm

Anonymous said...

You didn't accurately reference Obama's quote about capital gains and his reasoning...or for that matter Charlie Gibson reference only talking about the capital tax cuts under Clinton and Bush...Here is cut and paste from the transcript.

GIBSON: Senator Obama, you both have now just taken this pledge on people under $250,000 -- and 200-and-what? $250,000?

OBAMA: Well, it depends on how you calculate it, but it would be between $200,000 and $250,000.

GIBSON: All right. You have, however, said you would favor an increase in the capital gains tax. As a matter of fact, you said on CNBC, and I quote, "I certainly would not go above what existed under Bill Clinton," which was 28 percent. It's now 15 percent. That's almost a doubling, if you went to 28 percent.

But actually, Bill Clinton, in 1997, signed legislation that dropped the capital gains tax to 20 percent.

OBAMA: Right.

GIBSON: And George Bush has taken it down to 15 percent.

OBAMA: Right.

GIBSON: And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down.

So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?

OBAMA: Well, Charlie, what I've said is that I would look at raising the capital gains tax for purposes of fairness.

R Davis said...

Your quote is correct (as is mine). Still, Obama did not concede that "when you raise capital gains tax rates, you lower revenues from that" as Will said. He simply didn't address that contention in your quote above and said that he would look at raising capital gains rates for the purpose of fairness. And in my quote, he did say that it "might happen, or it might not".

Anonymous said...

Just look at regans cut of capital gains taxes. I believe
in the late seventies and early eightys. Revenue went up 90%. Some of that was coming out of recession but the facts show that a tax cut has never never lowered revenue. Ever. U can spin it anyway u want. Those are the facts
every business person I know is going to sell a lot of stock
this year because they know the tax rate is going up
doesn't take an economic genius to figure out that they will hold on to an investment much longer if rates go up. That is why revenues go down. DA

Anonymous said...

Any person with common sense understands that more volume and activity leads to bigger revenues. If one sold 100 widgets and made 15% on the sale, the revenue would be much larger than selling 10 widgets at 28% profit.

Similarly, if Obama raised the capital gains tax to 28% from 15% (nearly doubling it), capital investment would diminish by more than the same proportion (one-half) expecially of an extended period of years the higher tax rate would be on the books.

Lower profit margins on larger volumes ALWAYS beats higher margins on smaller volume due to removal of any ceiling on increased volume. Contrast to raising taxes so high to the point where all economic activity ceases. This is simple economics.


About Me

I became interested in U.S. budget and economic matters back in 1992, the first time that I remember the debt becoming a major issue in a presidential election. Along with this blog, I have a website on the subject at http://www.econdataus.com/budget.html. I have blogged further about my motivations for creating this blog and website at this link.