Myth: Lowering capital gains tax rates will not help
the economy.
Fact: Cutting capital gains tax rates is the single
best tax policy to improve economic growth.
- Capital gains play a unique role in fostering economic activity,
especially by entrepreneurs in high-technology areas.
- In fact, many economists believe that the optimal tax rate on
capital gains is 0 percent.
- Because government first takes money through corporate income
taxes, taxation of capital gains (and dividends) represent
double-taxation of investment returns and should be eliminated.
Myth: If there is a capital gains tax cut, it should
be temporary and it should not be available to all investors.
Fact: Only a permanent capital gains cut available to
all investors - include those who invested long ago -- will stimulate
new investment and revive economic growth.
- A temporary cut will induce people to sell assets, but it will
not stimulate new investors who will face today's high rates again
in the future after the temporary reduction has expired.
- A temporary cut will "lock-out" new investment and will
hurt economic growth.
- The induced selling without incentives for new investment will
further depress stock and other asset prices and will not stimulate
new investment. By unlocking held assets and inducing people to sell
investments, a temporary cut may increase tax revenue - it may not,
though, because asset prices will be lower - but it will not help
stimulate economic growth.
- A permanent cut will provide the incentives for people now to
sell long-held unproductive assets and for people now and in the
future to make new productive investments.
Myth: Cutting capital gains tax rates will cause
stock markets to fall.
Fact: Cutting capital gains tax rates will, as it has
in the past, cause asset values, including stock markets, to rise.
- Some people claim that lowering capital gains tax rates will
cause the stock market to fall, because people would sell their
investments. By this silly logic, if people want to increase stock
market values, then there should be an increase in capital gains tax
rates, because, then investors would be less willing to sell
investments.
- In fact, lowering capital gains tax rates increases the prices of
stocks and other assets. Stock markets reflect the collective
actions of people looking forward.
- Lowering the cost of capital by decreasing tax rates on
investment returns will increase asset values.
- For example, the 1997 cut in the top capital gains tax rate from
28 percent to 20 percent increased stock prices by approximately 8
percent.
Myth: Capital gains tax cuts benefit the "wealthy."
Fact: Capital gains tax cuts improve the entire
economy.
- Capital gains tax reductions stimulate economic growth, which
benefits the entire country.
- Capital gains taxes disproportionately hurt the elderly, low and
middle-income investors who have less discretion over the timing of
their capital gains.
- Most people who report capital gains do not have high annual
incomes.
- People with high incomes are most sensitive to capital gains tax
rates, because they possess the most flexibility and means to avoid
high tax rates. When capital gains tax rates are high, people with
high incomes do not sell their assets and realize their gains.
- High-income people pay a greater percentage of capital gains
taxes when capital gains tax rates are low than when capital gains
tax rates are high.
- High capital gains tax rates make capital scarce. When capital is
scarce it goes to safe investments. Low capital gains tax rates make
capital abundant. When capital is plentiful it goes to "riskier"
investments - such as inner cities and disadvantaged areas.
Myth: Lowering capital gains tax rates will not lead
to more investment.
Fact: Taxpayers are very responsive to capital gains
tax rates. High capital gains tax rates punish and reduce investment.
Low capital gains tax rates induce more investment.
- Taxpayers have a choice over when to realize capital gains and
pay taxes. High capital gains tax rates lead people not to invest
and current investors to hold assets, increasing the "lock-in"
effect.
- Lowering capital gains tax rates increases new investment and
unlocks long-held undesirable assets, thereby increasing capital
gains realizations.
- High-income taxpayers, who have great discretion over the timing
of their investment decisions, are particularly responsive to
changes in capital gains tax rates.
Myth: Government cannot "afford" large and
permanent cut in capital gains tax rates.
Fact: Improving economic growth is the proper focus
of the debate regarding capital gains tax rates, and greater economic
growth increases federal tax revenue from many sources.
- The correct goal of tax policy should be to maximize economic
growth, not tax revenue. Consequently, the optimal tax rate is the
rate that is best for the economy, and this rate is lower than the
rate that provides the government with the most tax revenue.
- The government should not act like a business trying to maximize
revenue. Rather, the goal of tax policy should be to enhance
economic growth and raise only as much tax revenue as is needed, not
as much as is possible. More investment and greater realizations
caused by lower capital gains tax rates
- lead to increased capital gains tax revenue and more revenue from
other taxes such as corporate taxes, personal income taxes, and
payroll taxes. When predicting the budgetary effects of capital
gains tax rate changes, it is necessary to account for behavioral
responses by using "dynamic" rather than "static"
scoring.
Myth: Capital gains already receive preferential
treatment because they are taxed at lower rates than ordinary income.
Fact: Double-taxation of investment returns and
taxing inflation cause capital gains tax rates to exceed tax rates on
ordinary income.
- The government taxes investment returns - dividends and capital
gains - twice, first as corporate income taxes and then as personal
income taxes.
- This double taxation causes capital gains tax rates to exceed
ordinary income tax rates.
- For example when a corporation earns $100 profit, the government
takes $35 in corporate taxes, leaving $65 distributed to investors
taxed at 20%. The government takes another $13 (20% of $65) in
capital gains taxes, leaving investors with $52 and government with
$48 out of the original $100 profit. Thus, an effective tax rate on
capital gains of 48%. (Note: Since dividend are also subject to
double taxation, but are taxed at ordinary income tax rates, the
effective tax rates on dividends can approach 60%!)
- The most counterproductive and unfair characteristic of the tax
on capital gains is that it taxes inflation, because capital gains
are not adjusted for inflation. The example above does not even
include the fact that capital gains taxes include taxes on
inflation, and, therefore, actually tax investors at even higher
real tax rates - at times more than 100%!
- For example, if an investment of $1000 rises in value to $1100,
while prices generally have risen 10%, there is no real (after
inflation) increase in value. However, an investor who sold this
asset for $1100 would still have to pay taxes on the inflationary
gain of $100. At the current top statutory rate of 20%, this
investor would pay $20 in capital gains taxes on an investment that
produced no real gain. The result, in this case, is a tax rate of
infinity!
- The policy of failing to adjust capital gains for inflation
raises effective capital gains tax rates to levels substantially
exceeding statutory rates and often surpassing 100 percent.
- These high effective tax rates force investors to retain assets,
increasing the "lock-in" effect. Moreover, the policy
hurts economic growth by inhibiting new investments, because under
current law inflation is a risk investors must bear.
- The tax on inflation most severely punishes the elderly,
low-income, middle-income, and less successful investors, because
these people are less able to adjust the timing of their investment
decisions than investors with higher incomes.
- Indexing (adjusting) capital gains for inflation - as other
countries have done - would eliminate the unfair and harmful tax on
inflation.
