Why Doubling The Capital Gains Tax Is Enormously Stupid

On Tuesday evening, in the State of the Union Address, President Obama proposed raising taxes on the wealthiest among us to no less than 30% of their incomes. Put into context, this is directed towards the Capital Gains Tax, which currently stands at a rate of 15% for long term capital gains. This doubles the existing tax rate under the guise of “fairness”, but ignores empirical evidence showing that it would have economically disastrous consequences for our economy.

Here is the President’s actual quote:

President Barack Obama, 2012 State of the Union AddressBut in return, we need to change our tax code so that people like me, and an awful lot of members of Congress, pay our fair share of taxes. (Applause.)

Tax reform should follow the Buffett Rule. If you make more than $1 million a year, you should not pay less than 30 percent in taxes. And my Republican friend Tom Coburn is right: Washington should stop subsidizing millionaires. In fact, if you’re earning a million dollars a year, you shouldn’t get special tax subsidies or deductions. On the other hand, if you make under $250,000 a year, like 98 percent of American families, your taxes shouldn’t go up. (Applause.) You’re the ones struggling with rising costs and stagnant wages. You’re the ones who need relief.

Now, you can call this class warfare all you want. But asking a billionaire to pay at least as much as his secretary in taxes? Most Americans would call that common sense.

Full Text

Now, on the surface, it sounds perfectly reasonable, right? The problem is that it’s not. It’s actually incredibly stupid. Normally, I would say that a proposal like this is a thinly-veiled appeal for populist support, but in fact, it’s not veiled at all. Anyone with an IQ over room temperature can clearly see that this is an obvious attempt to gain popular support by appealing to those that believe in “fairness”, “economic equality” and “social justice”. In short, it’s nothing but politics.

So, let’s dispense with a few things.

First, Warren Buffett claims that he pays roughly 17% in income taxes and that he should pay more. However, the fact is that the profits on which he pays capital gains taxes have already been taxed at the corporate level, the result of which is an effective tax rate of around 52%, not 17%. He also fails to point out that his income is predominately taxed at the capital gains rate because he has intentionally set his compensation up that way. If he truly believes that he should pay more, then all he has to do is restructure his compensation to be taxed as earned income. Will he? I think we all know the answer to that question.

Second, to claim that the wealthy get “subsidized” is completely disingenuous. Taking less of someone’s money in taxes is not a subsidy. It’s not the Government’s money and the Government is not “giving” it to individuals as the term implies.

Lastly, the overall implication that the wealthy “don’t pay their fair share” is intellectually dishonest. If you listen to the President, you would think that the rich pay almost no taxes and the lower income folks shoulder most the burden, but that is absolutely false. In fact, it’s quite the opposite.

The IRS reported the following data for the 2009 tax year:

Those making $1,000,000 or more represented 0.17% of total tax filers (236,883 out of 140,494,127). They made 9.53% of the income ($726.9 billion out of $7.626 trillion). They paid $177.5 billion in taxes, 20.5% of the total tax burden, at an effective rate of 24.4%.

Those making over $100,000 represent 12.4% of tax filers, earned 49.4% of the income and paid 74.67% of the tax burden at an effective rate of 17.2%.

By contrast, those making under $75,000 represented 79.4% of tax filers. They earned 37.6% of the income ($2.87 trillion). They paid $138.9 billion in taxes, 16.0% of the total tax burden, at an effective rate of 4.8%.

Does anyone still believe that the rich don’t pay their fair share? (Don’t believe me? Look it up yourself on the IRS Tax Stats page.)

Now that we’ve dispensed with that, let’s take a look at Capital Gains. Whether the President and his base choose to admit it or not, there’s a reason why capital gains rates are lower. For the economy to grow, thereby creating jobs and a higher standard of living, two things are required. One is consumer spending and the other is investment capital to fund the businesses supported by that spending. A low capital gains tax goes a long way to stimulate the investment capital markets that businesses need for research, product development and expansion, which is how jobs are created.

The notion put forward by the President is that this should not be. The wealthier among us should pay more, because it’s “fair”. The wealthier among us should pay more because we need the additional revenue. The problem with that is simply that taxation is not a zero sum game. Raising rates does not result in a proportional increase in revenues and lowering rates does not result in a proportional decrease in revenues. Once again, go to the IRS Tax Stats page and you will find that to be correct. The reason for this is because current Government models use static projections. In other words, they don’t take into account the impact on economic behavior. You may be willing to pay 20%, 30% or even 40% in taxes, but at some point, you’re willingness will decrease and you will change your behavior accordingly.

Historical data shows that lower tax rates generally spur more economic growth which lowers unemployment and increases overall tax revenue. The left loves to claim that the Bush Tax Cuts benefited the wealthy and cost us over $1 trillion, but that is not just disingenuous, it’s actually a complete lie. The Bush cuts helped everybody. After the 2003 cuts (which included a reduction of the capital gains rate), over the next four years GDP grew by 25.9%, unemployment decreased by 23.3% and total federal income tax revenues grew by an astounding 44%. The economy grew, tax revenues grew even faster and oh, by the way, the top income earners’ share of the total tax burden grew as well. Much of this was driven by the reduction in capital gains. The 2001 cuts impacted mostly the lower income groups via credits and marginal rates, but it wasn’t until the capital gains rates were lowered that we saw a significant impact.

I’m generally not opposed to a tax cut, but we have to be honest and understand that all tax cuts are not created equal. The temporary payroll tax cut has done nothing to help job creation. Yes, it has helped workers by allowing them to keep more of their money, but that does little for creating jobs and since nothing was done to fix Social Security, it has only resulted in an increase in the entitlement program’s deficit. Not a wise financial move.

To illustrate this, let’s just look at the last 30 years. During this time, we have made four major changes to capital gains. We’ve lowered the rate three times and increased it once. Here are the results (Sources: IRS and OECD):

• In 1982, capital gains rates were lowered from 23.7% to 20.0%. By 1986, GDP has risen by 37%, the unemployment rate had dropped by 28% and federal income tax revenues from capital gains had almost tripled from $14.9 billion to $41.2 billion.

• In 1987, rates were increased from 20.0% to between 28.0% and 33.0%. From 1987 to 1991, GDP rose by a more modest 26.5%, unemployment increased by 11.3% and capital gains revenues decreased by more than half, from $59.3 billion to $28.4 billion.

• In 1997, rates were again lowered, this time to 21.2%. From 1997 to 2000 (when the dot-com bubble burst), GDP rose by a similarly modest 19.4%, unemployment dropped 18.4% and revenues increased from $97.9 billion to $161.0 billion.

• In 2003, rates were lowered to 16.1%. From 2003-2007 (just before the housing bubble burst), GDP rose by 25.9%, unemployment dropped by 23.3% and revenues from capital gains more than tripled, from $58.9 billion to $187.4 billion.

Now, I believe that when you look at the actual numbers, the evidence overwhelmingly supports the contention that lowering, not raising, capital gains tax rates is the better choice if we want to help our ailing economy. We certainly all need to understand that an economy is a very complex thing and there is no such thing as a silver bullet. The economy is affected by too many inputs to name and to a varying degree. Some things however, are just obvious. Can we say with certainty what the effects of lowering capital gains rates would be? Of course not. But, after looking at the preponderance of evidence, can we honestly say that raising rates would be a good idea?

The President is a fantastic speaker and nobody can say that he can’t deliver a speech with the best of them, but we need solutions, not campaign platitudes. The President either doesn’t really mean what he proposes and is just appealing to the “Occupy” crowd, or worse, he does mean it.


+Kevin A. Nye

“Taxes” Image credit: free pictures of money

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