Wednesday, March 21, 2012

Will Lowering Capital Gains Taxes Help Fuel the Economy?

Could the U.S. light a fire under the economy by substantially cutting capital gains taxes?  All the Republican candidates think so.  (Could they all be wrong?)   Gingrich wants to get rid of the capital gains tax.  Romney wants to eliminate it completely for the 99%ers, individuals with less than $200,000 in adjusted gross income.  How could Romney say to get rid of the tax completely, given his tax returns?

Len Burman doesn't think there is any evidence that cutting the capital gains rate has a growth effect on the economy.  Burman is the Daniel Patrick Moynihan Professor of Public Affairs at the Maxwell School of Syracuse University. Previously, he served as Director of the Tax Policy Center and Institute Fellow at the Urban Institute, as Deputy Assistant Secretary of the Treasury for Tax Analysis from 1998 to 2000, and as Senior Analyst at the Congressional Budget Office from 1988 to 1997. He blogs at Tax Vox, the Tax Policy Center's blog. 

Burman did an analysis of the historic impact of dropping or raising the tax rate on capital gains and the resultant change in GDP.  Here is the start of his post:
If you read the editorial page of financial newspapers, you might conclude that no aspect of tax policy is more important for economic growth than the way we tax capital gains. You’d be wrong.
Here is the chart that Burman put together on his analysis:

Burman's conclusions:
The chart displayed above shows top tax rates on long-term capital gains and economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, you’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series.  The correlation is 0.12, the wrong sign and not statistically different from zero.  I’ve tried lags up to five years and also looking at moving averages of the tax rates and growth.  There is never a statistically significant relationship.
Does this prove that capital gains taxes are unrelated to economic growth? Of course not. Many other things have changed at the same time as gains rates and many other factors affect  economic growth. But the graph should dispel the silver bullet theory of capital gains taxes.  Cutting capital gains taxes will not turbocharge the economy and raising them would not usher in a depression.
Low capital gains tax rates do accomplish one thing: they create lots of work for lawyers, accountants, and financial geniuses because there is a huge reward to making ordinary income (taxed at rates up to 35%) look like capital gains (top rate of 15%).  The tax shelters that these geniuses invent are economically inefficient, and the geniuses themselves might do productive work were the tax shelter racket not so profitable.  And the revenue lost to the capital gains tax loophole adds to the deficit, which also hurts the economy.
So, if you aren't in a position to hire high-powered tax lawyers and accountants to shift the category of your income from ordinary income into capital gains (and lots of folks with $200,000 of AGI will be), the burden of running the country will fall disproportionately on you once the capital gains tax is eliminated or reduced

Elliot Spitzer argues for taxing capital gains at the same rate as ordinary income.

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