Thursday, January 26, 2012

A Quick Note about the “Benefits of lowering the capital gains tax.

The argument in favor of lowering the cap gains tax because, in the past, it has shown to result in an increase in government revenues, is faulty on its premise and in its time horizon.

First, there are a wide variety of reasons why someone sells a capital asset. I am not arguing that, in the past, IRS collections have gone up after a decrease in the rate. But it's not about capital generations, new jobs, and all the nonsense behind the arguments. It’s because, with a lower rate, the value of your asset went up in the moment, and you are more likely to sell, which sets off a higher rate of collections.

The problem, which most economists make, is that they fail to look beyond what happens after the first year as far as collections. They also fail to see that capital gains collections are subject to countless variables other than the tax rate, perhaps, above all, the stock market.

But talk is talk. Below are two tables showing the effect of two recent reductions in the cap gains tax rate. The first table shows the rate of increase or decrease in percentage terms in IRS cap tax collections. The other shows the change in GDP as a proxy for the multivariate elements that go into capital gains tax collections.

All changes to IRS revenue and GDP occur one year after the tax act.

Long term capital gains tax rate       GDP         IRS Collections

Previous      New   Year        Percentage Δ          Percentage Δ

                             1996                     4%                   4.5%

28%  20% passed in 1997                    5%                     4.4

in effect                 1998                     4%                     4.8

                             1999                      5%                    4.1

                              2000                     4%                     1.1

                              2001                      1%                    1.8

                              2002                     2%                    2.5

20%  15% passed in 2003                      3%                    3.5

in effect                  2004                      4%                      3.1

                              2005                       3%                      2.7

                               2006                     3%                       1.9

                              2007                     2%                       -0.3

                              2008                     -3%                       -3.5

                             2009                      -4%                        3.0

                             2010                       3%                          3%

Sources: Congressional Budget Office

Bureau of Economic Analysis

Consider years 1996, 1997, and 2003. There were no tax policy changes that went into effect in these years. And yet, the increases in each of these years are among the highest in the table. More importantly, look at the years AFTER the first year of the tax cut. The best example is the cut passed in 2003 and in effect in 2004. In 2004, collections did rise by 4.1%. Then look at the next four years—so much for the long-term impact of a one-time change in the capital tax rate.

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