Tax Preference for Capital Gains Doesn’t Make Sense

January 23, 2012 at 5:20 pm

Great blog posts by our colleague Jared Bernstein and by Syracuse University professor Len Burman explain why the preferential tax treatment for capital gains — the gains from selling stocks, bonds, and other assets, which face a top tax rate of 15 percent, well below the top rates for ordinary income — is unjustified.

In two posts, Bernstein demonstrates that there is no convincing evidence that the preferential capital gains rate encourages investment or productivity growth.  First, he shows that there is no clear correlation between the capital gains rate and the amount of real business investment.  Then, he shows that the size of the difference between the capital gains rate and top ordinary income tax rate does not correlate with either real investment or investment growth.

Preferential Tax Rates for Capital Gains and Dividends Mostly Benefit the Very Wealthy

Len Burman explains that the preferential capital gains rate fails miserably on other grounds as well, such as equity and efficiency:

  • Citing Tax Policy Center data, Burman explains that fully 97 percent of reported gains in 2010 went to millionaires.

    That’s one reason why, as we show in this chart, tax rates for capital gains and dividends are highly regressive, lifting after-tax incomes by a tiny fraction of a percent for the vast majority of households but by about 8 percent for the top 0.1 percent of households.

    And, as we’ve explained, the preference is a reason why the current tax code violates the so-called “Buffett Rule” – that people making more than $1 million a year shouldn’t pay taxes at a lower rate than middle-income families.  High-income taxpayers who receive a large share of their income from capital gains and dividends taxed at the preferential rates benefit much more from those rates than other taxpayers do.  Consequently, a significant group of them pay a lower share of their incomes in federal income and payroll tax than do many middle-income Americans.

  • Burman also notes that “taxing capital gains at much lower rates than other income creates a ginormous loophole that leads to a tremendous amount of inefficient tax shelter activity,” as filers seek to reclassify other income as capital gains.

At a time when we need to raise revenues responsibly to help address long-term deficits, the preferential tax treatment of capital gains — which costs the Treasury billions of dollars each year — makes no sense.

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More About Chye-Ching Huang

Chye-Ching Huang

Chye-Ching Huang is a tax policy analyst with the Center’s Federal Fiscal Policy Team, where she focuses on the fiscal and economic effects of federal tax policy. You can follow her on Twitter @dashching.

Full bio | Blog Archive | Research archive at CBPP.org

4 Comments Add Yours ↓

Comments are listed in reverse chronological order.

  1. 1

    For lots more on this point, see http://www.sharedeconomicgrowth.org/enforcingprogressivity/capitalgainsrates.html . Special capital gains rates are a terribly inefficient subsidy, which could be replaced with a plan that would make America the best place on the planet to have high-value operations and high-wage jobs.

  2. 2

    Public deficits increase financial private savings – as a
    matter of accounting, dollar for dollar. Imports are a benefit,
    exports a cost. We do not borrow from China to finance our
    consumption: the borrowing that finances an import from
    China is done by a U.S. consumer at a U.S. bank. Social
    Security privatization would just reshuffle the ownership of
    stocks and bonds in the economy – transferring risky assets
    to seniors and safer ones to the wealthy – without having any
    other economic effects. The Federal Reserve sets interest rates
    where it wants.

    Nor is the public debt a burden on the future. How could
    it be? Everything produced in the future will be consumed
    in the future. How much will be produced depends on how
    productive the economy is at that time. This has nothing to
    do with the public debt today; a higher public debt today
    does not reduce future production – and if it motivates wise
    use of resources today, it may increase the productivity of the
    economy in the future.

    Modern money is a spreadsheet! It works by computer! When government spends or lends, it does so by adding numbers to private bank accounts. When it
    taxes, it marks those same accounts down. When it borrows, it
    shifts funds from a demand deposit (called a reserve account)
    to savings (called a securities account). And that for practical
    purposes is all there is. The money government spends doesn’t
    come from anywhere, and it doesn’t cost anything to produce.
    The government therefore cannot run out.

  3. 3

    At the federal level, taxation only serves as a stabilizer, like interest rate policy to achieve public and private spending targets which manage aggregate demand.

    What these scholars avoid is the discussion about the U.S, being a sovereign currency nation, the sole issuer of the currency unit of account, the currency monopolist. They avoid the reality that the Fed and Treasury can create all of the currency unit of account needed to fund the federal government’s acquisition of goods and services. It doesn’t need to raise revenue to spend. It must first spend before it can tax. We are no longer bound by the pre-July, 1971 rubrics of fixed exchange rates or the gold standard.

    When the Federal Government taxes income at any level, individual or corporate, it simply takes back dollars it’s already spent into the economy, thus reducing spending, it does not raise revenue.

    The other, nefarious, reason for taxation is to force consumers and businesses into debt by offering access to credit after having taken away some of their disposable income that otherwise could have precluded the need to go into debt.

  4. David #
    4

    I’m curious, you focus on capital gains, though you do mention dividends in a couple of places as well. Do you believe that the tax code should treat both types of income in the same manner, and does your analysis apply to both capital gains and dividends?



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