|
The major
explanation for the lower tax collections at higher tax rates is the
lock-in effect. The lock-in effect is generally conceded even by
opponents of a capital gains tax cut. The realizations of capital gains
decline when tax rates on gains are increased. When the capital gains
tax rate is low, the ratio of unrealized capital gains falls (i.e.,
investors are more likely to sell their assets). After the increases in
the capital gains taxes, the unrealized capital gains ratio rises.
Clearly, investors are highly sensitive to the rate of capital gains tax
when determining whether to sell stock holdings and other assets.
Since selling is taxed and possessing is not, high capital gains taxes
encourage investors to hold rather than sell - thereby avoiding the tax
indefinitely. Assets that are held until death avoid capital gains taxes
altogether.
When investors lock in their assets this way, government loses revenue
it would have gotten if tax rates were lower, and the capital market
loses efficiency because the flow of assets to those who value them the
most is impeded.
Economic Effect: More Investment
Capital gains taxes affect investment decisions. In particular, they
reduce the amount of capital available for investments with higher risk
potential, such as new start-ups and companies in emerging sectors. As a
result, the capital gains tax tends to be a direct tax on the
entrepreneurship that all economists recognize as essential to growth.
The Case for Lower Tax Rates
The vast majority of assets have value only because they are expected
to produce future income. For example, bonds will produce interest
income and stocks will produce dividends and retained earnings. Since
this income will be taxed as it is realized, there is no need to tax the
owners of these assets at the time the assets are bought and sold. It
impedes the efficient transfer of assets from those who value them less
to those who value them more, and it makes investments in all
income-producing assets less attractive.
In sum, if one accepts the notion that a capital gains tax cut promotes
economic growth then even the most pessimistic possible fiscal scenario
is no loss of tax revenue from a tax rate cut. The more likely effect
would be a substantial and permanent rise in revenues.
|
