Newt Gingrich : Capital Gains Tax: An Argument for Repeal

President Obama recognizes the powerful positive economic impact a capital gains tax cut would have for small business owners—so why not give it to every American family and business in order to encourage growth and success?

President Barack Obama’s budget for 2010 presented a number of tax cuts to spur economic growth. Most notably, his budget called for a reduction of the capital gains tax for small businesses. Apparently, President Obama recognizes the powerful, positive economic impact a capital gains tax cut would have for small business owners.

Since the cut would be good for small businesses, why would President Obama not give it to other businesses too? Businesses large and small across the United States are struggling in the current economy. Businesses large and small are cutting jobs because of unfavorable economic conditions made worse by burdensome government policies like the capital gains tax. President Obama should extend this pledge to eliminate the capital gains tax on small businesses to every American family and business in order to encourage economic growth and competitiveness.

The capital gains tax is an unequivocal burden on the capital we need to grow, prosper, and compete in a 21st century global economy. Any American or business that sees an appreciation of the value of their income (capital) must pay up to 39.6 percent in additional taxes on this appreciation (depending on the length of the investment and the marginal tax rate of the individual or business). Considering inflation, the effective rate paid on investments is even higher. As we are coming out of the recession, the United States should do everything within its power to create a financial environment that allows businesses to rapidly grow and prosper.

Part of our economic problem is that the United States has one of the highest tax rates on capital gains in the world. Many industrial countries have no taxes on capital gains including Austria, Belgium, Germany, Greece, Luxembourg, Mexico, New Zealand, Portugal, and Turkey. Countries that do not impose capital gains taxes on stocks include Argentina, China, Greece, Hong Kong, Israel, Malaysia, Mexico, the Netherlands, Pakistan, the Philippines, Poland, Singapore, Spain, Sri Lanka, Taiwan, and Thailand. In order to compete with economic growth in Shanghai, America must match China’s 0 percent capital gains rate.

Moreover, the actual revenue received from a capital gains tax is disproportionate to the burden imposed. The Congressional Budget Office (CBO) reports that in 1990 capital gains tax receipts totaled $32 billion, making up just 6.8 percent of total individual income tax receipts. By 2000, this number rose to $119 billion, making up 11.8 percent of the total. Notwithstanding the current economic meltdown, CBO estimates that for 2008, capital gains tax receipts will be close to $106 billion, making up 9.2 percent of the individual income tax receipts. While discouraging economic growth and driving investors across the Atlantic, receipts from the capital gains tax are barely making a dent in government revenue.

Past efforts to decrease the capital gains tax rate have been influenced by convincing evidence that a cut would increase economic growth. The investor class is integral to a functioning economy and investors’ decisions are influenced by the tax system in which they operate. Likewise, assets are in part priced with the calculation that if the stock is sold, the investor will have to pay tax on realized capital gains. As a result, buyers, knowing that they have to pay taxes, reduce the price that they are willing to pay for assets, thus driving down stock prices.

With a capital gains tax cut, the value of the stocks will see an immediate boost. This increase in value is known as “the capitalization effect.” The capitalization effect then explains how a capital gains tax cut will increase the stockholders’ after-tax returns on traded assets. Leading economists, such as Douglas Shackelford, have found that the capitalization effect would set in almost immediately after a capital gains tax cut, meaning that prices for investments would rise as investors capitalize on the reduced tax rate.

Some analysts have suggested that the immediate increase in stock values would be offset by an economic principle known as the “lock-in effect.” This effect occurs when investors, recognizing that they have to pay taxes on their gains, will lock in and hold rather than sell their assets. After a capital gains tax cut, we could see a potential sell-off of stocks, increasing trading volumes and leading to a temporary fall in asset values. However, we have seen through market observances that the capitalization effect is likely to have a more permanent impact than the lock-in effect. In other words, the lasting impact of a capital gains tax cut is likely to be an increase in asset values.

Additionally, because investors have to pay a tax on their gains, they often are penalized for diversifying their investment portfolio with a wide range of investment products. The capital gains tax distorts what the investors’ pre-tax optimal allocation of assets would be, potentially creating more challenges in investment for Americans. Taxing investment gains clearly raises the opportunity cost of asset transactions, leading to various inefficient outcomes.

Given the capitalization and lock-in effects, the current tax regime is distorting the true value of assets. Of course, there may be other unknown factors that could influence the prices of stocks, but our research indicates that the overarching impact of a capital gains tax cut would be an increase in stock values.

Proponents of the capital gains tax argue that the tax is another way for the government to obtain revenue. These advocates argue that any income gained from investments should be taxed the same way that wages and gross yearly income are taxed. The problem with this argument is that in most cases capital gains are not traditional income. And in effect, the income that will give rise to the capital gains will be taxed as income and so the capital gains tax is a second level of tax. In other words, a higher capital gains tax rate discourages saving and investment.

In fact, Americans who set aside a portion of their after-tax income for savings in investments are the main victims of a capital gains tax. Individuals may intend to draw on these gains to finance the purchase of a new home or automobile, to pay for college tuition, or to supplement their Social Security income during retirement.

As a result, many economists refer to the capital gains tax as a “double tax.” Economist Bruce Bartlett argues that this penalizes many stockholders:

The fact is that capital gains arise only in the case of an income-producing asset. The value of the asset is simply the discounted present value of the future flow of income associated with that asset (rent in the case of real estate, interest in the case of bonds, and corporate profits in the case of stocks). Thus, if the income stream (rent, interest, profits/dividends) is taxed, then any additional tax on the underlying asset (real estate, bonds, stocks) must necessarily constitute a double tax on the same income.

A double tax is a destructive and unfair way for the government to gain additional revenue. Moreover, in some cases, the capital gains tax unfairly taxes investment gains that may not be gains at all. The capital gains tax, as written, does not account for changes in the price level. The result of this is that an individual may be unfairly taxed on gains that merely reflect the rise in the general price level, or may even reflect a real loss of value on an investment. To illustrate, consider an example where an individual purchases property for $100 in 1950 and proceeds to sell it for $500 in 2000. Looking at this without any other factors, the government would tax the $400 profit at a rate of 15 percent. The problem is that in these 50 years, the investor actually lost money on this investment because the inflation rate over 50 years was much higher than the 400 percent increase in the value of the property. That is, the $100 in 1950 would have grown to $714.61 in 2000 due to inflation. Thus, we can see that the investor is penalized for investing by both losing real purchasing power and by being taxed due to a nominal increase in income. While taxing individuals at progressively higher rates for higher income is a controversial topic, this act of taxing people even when they have a real negative income from investment is clearly unfair.

Beyond the theoretical justifications for cutting the capital gains tax, how much wealth would actually be added to the economy? The Treasury Department conducted a study examining the economic consequences if we preserved President Bush’s tax cuts by ensuring that capital gains were taxed at 15 percent. The Treasury’s study found that if we made Bush’s tax rate permanent on capital gains and dividends, we would see an increase of national income of 0.4 percent. If we went one step further and eliminated the capital gains tax, we could potentially see an increase in gross domestic product of twice that amount. Dustin Chambers of Salisbury University argues that the increase in stock prices would be profound, ranging from an increase of 9.2 percent to 20.5 percent.

I think he’s chosen the wrong tax. Right now there is a double tax on capital, with one being the corporate income tax and the other being the capital gains tax. The capital gains tax is paid for by the owner of the capital. Nobody knows for sure who pays the corporate income tax, whether it be the owners, the employees or the customers.

We should eliminate the corporate income tax, and treat capital gains the same way we do other sources of income.

Nobody knows for sure who pays the corporate income tax, whether it be the owners, the employees or the customers.

I've owned and run several corporations and been involved in the management of a couple of other corporations. I assure you all taxes are ultimately paid by the consumer. Corporations, and businesses in general, don't have a magical pot of money sitting around they can dip into to pay whatever tax the gubmint thinks it should pay at any given moment in time. Similarly, unlike the gubmint, corporations don't have printing presses in the basement churning out dollars to pay additional expenses (taxes) as they pop up. When the gubmint increases taxes on businesses it is ultimately reflected in the price of the goods or services the corporation provides. Might not happen immediately, but ultimately the consumer always pays....

The capital gains tax will never be repealed and probably increased. (You can’t have evil rich people having more than others, dontcha know?)

/s/

As a former small businessman, now retired, I don’t understand how eliminating the capital gains tax would help the typical small business. Perhaps I am missing something but there are far better ways to help.

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