Don't Believe the Budget Bashing, Barack Obama's Capital Gains Tax Won't Harm the Economy

Along with his budget, President Barack Obama has proposed that the capital gains tax be raised to 20% after sitting at 15% due to President George W. Bush's lowering of it early in his first term. It's unlikely to pass in Congress, but there is an ongoing debate about what a hike would do to the economy. It seems that the evidence is that the economy as a whole would be largely unaffected, and that those who were most affected would be wealthy.

Some extremists maintain that reducing the capital gains tax will increase revenue due to a massive surge in realizations of capital investments. However, there is little evidence (FYI, great report) of this and as more refined data has become available, more estimates have indicated that reductions in the capital gains tax rate reduces revenue and that increases are revenue positive. Furthermore, even estimates that show high increase in capital realizations due to lowered capital gains tax rates are exaggerated, because people may be shifting other income into capital gains, meaning they are paying less in taxes elsewhere.

The other argument against raising the capital gains tax has to do with investment. If investing is, as it were, “punished” by being taxed at a higher rate, then it stands to reason that innovation in the economy will decrease. However – and I was surprised to learn this – most venture capital money comes from pension funds and universities which are exempt from the capital gains tax. In 2003, only 10% of VC money came from individuals.

Thus, if one is dissatisfied with Obama's tax plan, it's likely because one has an opposition to increasing taxes on the wealthy. One might get the sense that this tax is a type of class warfare, and for that, there is plenty of evidence. In Obama's budget, one of the priorities is “progressivity” and there is a sentence that indicates that the Obama administration would like to either repeal the Bush tax cuts, or do something comparable. The budget proposal reads in part: “Reform should cut the deficit by $1.5 trillion over the next decade through tax reform, including the expiration of tax cuts for single taxpayers making over $200,000 and married couples making over $250,000. And it should do this while keeping the tax code at least as progressive as if the high-income 2001 and 2003 tax cuts were eliminated, as the President proposes.”

Furthermore, the wealthy pay a large percentage of capital gains taxes. In 2004, the wealthiest fifth of Americans paid 86% of all the capital gains dollars that were paid out. Furthermore, in 2007 more than half of all assets that were be subject to capital gains taxes were owned by the top 5%.

So in sum, it seems that Obama's capital gains tax proposal is not likely to damage investment excessively and is likely to generate some revenue. However, it is also designed to generate a certain level of progressivity in the country, and this I don't understand. The goal should be a more prosperous America, not a pre-judged level of progressivity. Raising the capital gains tax might be a way to reach greater prosperity, (it will take money from those who can more easily do without it and will finance a smaller deficit than would otherwise exist), but if it is, then it's a good policy for that reason, and not because it constricts society into some proper pattern of income distribution. On the other hand, if we can raise the revenue in a better way or cut inefficient programs, we should do that.

Photo Credit: Senator Mark Warner