Wednesday, July 9, 2008

Capital Gains Tax Cuts Decrease Revenue over the Long Run and Hurt the Economy

With regard to Mark Thoma's July 9th post, "A Disgrcae?":

McCain: "Every time we cut capital gains taxes, there has been an increase in revenues."

This is false in the long run. It's very misleading. I have a short article explaining why, which I wish the Obama campaign management would read. Here is the abstract:

In the long run, and overall, capital gains tax cuts, do in fact cost the government a great deal of revenue, even though in the short run total revenue from capital gains taxes may go up. The first reason for this is that, unlike the income and payroll taxes working Americans pay, investors get to decide when they pay capital gains taxes. If Paris Hilton owns $100 million in Hilton stock, and it goes up to $120 million, she has a $20 million capital gain, but she will not pay taxes on this gain until she sells the stock, which may be many years later.

When there is a cut in the capital gains tax rate, there is an incentive to sell the stock then, and get the lower tax rate before a new administration raises it again. Thus, when the capital gains tax is cut, there is a rush of investors selling stocks to pay their capital gains taxes now, when the rate is law, rather than later later when the rate may be raised back up. Capital gains tax revenue to the government, thus, may go up now, but it will go down later, and it will go down overall.

In addition, when capital gains taxes are cut, there is an incentive to pay CEOs and top managers more in stock and options and less in regular dollar income, so as to capitalize on the lower tax rate. This would raise capital gains tax revenue to the government, but lower income tax revenue by a greater amount.

Finally, capital gains tax cuts tend to occur during periods of Republican control. These periods, unfortunatly, have been shown to result in drastic increases in income inequality – today there is more income inequality than at any time since the Guilded Age. With so much income shifted towards the wealthiest Americans, capital gains can increase, as they own the vast majority of stock, but at the same time these policies have resulted in stagnant or declining real wages for the rest of Americans, lowering income tax revenue, and contributing to the record budget defecits we have seen in conservative administrations.