Myth 2: If there is a capital gains tax cut, it should be
temporary and it should not be available to all investors.
Fact 2: Only a permanent capital gains cut available to all
investors - include those who invested long ago -- will stimulate
new investment and revive economic growth.
Myth 3: Cutting capital gains tax rates will cause stock
markets to fall.
Fact 3: Cutting capital gains tax rates will, as it has in
the past, cause asset values, including stock markets, to rise.
Capital gains tax reductions
stimulate economic growth, which benefits the entire country. As
President Kennedy noted, "A rising tide lifts all boats."
Capital gains taxes
disproportionately hurt the elderly, low and middle-income
investors who have less discretion over the timing of their capital
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 6: Government cannot "afford" large and permanent
cut in capital gains tax rates.
Fact 6: Improving economic growth, not increasing federal
tax revenue, is the proper focus of the debate regarding capital
gains tax rates, and greater economic growth increases federal tax
revenue from many sources.
Too often politicians incorrectly
concern themselves with the effects of policy changes on the
federal budget rather than on the national economy. As James
Carville said in 1992, "It's the economy, Stupid." (Note: He didn't
say, "It's the budget, Stupid.")
The correct goal of tax policy should
be to maximize economic growth, not federal 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 federal revenue from
other taxes such as corporate taxes, personal income taxes, and
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"
The 1997 tax cut dramatically
increased capital gains realizations and federal revenue.
Capital gains taxes comprise only a
minor part of federal tax revenue.
Official government forecasters (CBO
and JCT) consistently have overestimated the revenue "losses" from
capital gains tax rate reductions, because they use "static" rather
than "dynamic" scoring.
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
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
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
Indexing (adjusting) capital gains
for inflation - as other countries have done - would eliminate the
unfair and harmful tax on inflation.