Roundtable Question 3: Capital Gains Taxes

The debate sponsored by my publisher, Energion, has become a roundtable.  Joining Bob Cornwall and myself, in the discussion are Arthur Sido, Allan R. Bevere, and Joel Watts.  To all, welcome.  Also, if you have a question you would like the round table to address, these can be submitted to pubs@energion.com or via comments at Energion.net 

This week’s question is: Should the capital gains tax be changed (raised, lowered, eliminated)? In very general terms, how would this relate to your general view of tax policy?

From my perspective, this is pretty easy. It should be at a minimum lowered significantly, with serious consideration being given to eliminating it all together.   This is because economic growth requires investment, and investment, as the legalese of many financial commercials make clear, involves risk and the past performance is not indicative of future results.  It is the threat of loss that makes capital gains income different than regular wages and salary income.  

There is another factor that goes to the heart of the question:  What is the purpose of a tax?   Is it to raise the revenue needed by the Government; or should a tax serve some other purpose such as a means of social control, or social engineering.   I would argue that its purpose should be to raise money. Unfortunately this has not been the practice, and the results have been, in my opinion, harmful.

The problem with using a tax for other goals is that government’s need for money can never be truly ignored, and can result in unintended consequences.   For example, tobacco taxes were seen as a way of reducing smoking.  But as it became clear that tobacco taxes were relatively easy to raise, it also became an easy source of revenue.  Now that smoking has declined, the end result is that, because of the demographics of smoking,  it becomes a very regressive tax feeding off the addiction of those least able to afford it.  In addition, as smoking declines, government programs dependent on smoking taxes for their existence suffer as a result.  In short, governments become addicted to smoking taxes as much as smokers are addicted to cigarettes.   

So for me the primary question concerning any tax is how effective is it in raising revenue.  Since I am also a strong believer in liberty, I want taxes that will raise the most money with the least impact. Finally I have one additional criteria, equity; but this is a somewhat different concern than that summed up in the common question of whether some are paying “their fair share.”   Rather I am concerned that any given tax is applied equally. As I detail in chapter 2 of my book Preserving Democracy, one of the greatest dangers in a democratic form of government is the ability of the majority to impose tax burdens on a minority, burdens that they do not share themselves.

So how does this apply to the capital gains?  I believe capital gains to be one of the least effective taxes, when it comes to raising money.  This can be clearly seen in the example from my book concerning the cut in the capital gains tax from 20% down to the current 15% enacted under Bush. As a result of this tax cut, the CBO projected that revenues would correspondingly fall from $186 billion over the following three years down to $147 billion.  Yet instead of losing $39 billion as projected, the cut in taxes stimulated such growth in the economy that the government actually brought in $216 billion, $30 billion more than had been projected before the tax cut. 

In actual fact, the government revenues increased even more.  This is because the by freeing up investment the economy grew, and as a result all government revenues, not just capital gains revenues, grew.

This is why capital gains taxes are so harmful, and why serious consideration should be given to eliminating them all together. A tax on capital gains is a tax on investment, which is ultimately a limit on economic growth.  Limiting growth mean fewer jobs and lower pay.  A study done by the American Council For Capital Formation found that if Capital Gains tax rates were raised from their current 15% back to 20%, the result would be a further job loss of 231,000 per year.  If, on the other hand, it was eliminated the Economic growth would be 0.23 percent higher, resulting in an additional 1.3 million jobs per year.  Again this is right in line with the historical evidence of what happened with previous cuts in capital gains taxes.

The study did find that a complete elimination of the Capital gains tax would “cost” the government about $23 billion per year in revenues. But with that many additional jobs being created, I believe this would more than be made up by the reduced need for government services, as people moved into the workforce and up the economic ladder.

So again this is a pretty easy question, and we should cut if not eliminate capital gains taxes.