Capital Gains, or How I learned to Stop Worrying and Love Tax Cuts

One of the anticipated bills to come from the new Republican Congress (I love the way that sounds) will be a reduction in the capital gains tax rate. Many of you are probably wondering why you should be interested in capital gains, since you have yet to experience them. Actually, they affect how you live in many ways.

First of all, a capital gain is one in which you have realized a gain in the value of a capital asset: a house or other real estate, stocks, bonds, etc. While many people feel that only the "rich" have capital gains, the majority of them go to the middle class. Mainly from the sale of a house or through pension/investment fund gains. That is the first reason why a cut in rates would be good. Houses and retirement plans are the most popular ways to save/invest for the middle class. By reducing the rate at which we tax them, we encourage more savings and investing. That means more capital for business to access, and thus more and better businesses for us consumers. For example, if you and some friends want to start a business selling combination pagers/rollerblades, you need access to capital. That capital will not be there if people are unwilling to change investments due to too-high tax rates.

Secondly, by reducing the rate at which we tax capital gains and index those rates to inflation, we ensure that we are not taxing "phantom" gains. A phantom gain is one in which the inflation-adjusted value of the asset is actually less than its original value. We have learned through study of tax returns that when inflation wipes out the real value, people start sitting on their investments, waiting for lower rates. Conversely, when tax rates are lowered, people more willingly engage in activities that result in tax payments when the rates are deemed acceptable. Historically, every capital gains tax rate cut has resulted in higher tax revenues, and most recently, the increase in the rate in 1986 has resulted in lower revenues. Arthur Laffer has a curve named after himself that describes this economic result. It is more commonly known as "the supply side" curve. It says that a cut in rates does not always mean a cut in revenues. Given the historical trend, there is no need to "pay" for this cut, as liberals try to insist. (Though it would ironic if we could use their own insistence on cuts to get spending even lower.)

As a third point, let's look at the behavior of the rich (fiscally speaking). If rates are deemed to be too high, they will simply shift their assets in to tax free bonds and/or capital assets that do not pay dividends. Not only does this lower the revenues the government receives (and likely increasing the deficit as a result), but instead of funding businesses and home loans with their capital, the government is the only one to benefit. Increasing the rates, or leaving them at too-high a level will only shrink the pool of capital that home buyers and businesses rely on. In addition, it makes borrowing by the government easier, since they have larger inflows of capital for their tax-free bonds. We simultaneously discourage saving and investing for the middle and lower classes while encouraging borrowing by the government.

Finally, a generation of Boomers before us have proven that the government can not take care of us by taking some of our money and redistributing it, and it's time that we start demanding a chance to do a better job with our own money. We've already paid income taxes on the money we invest and pay for our houses with, it's simply not reasonable to be taxed at high rates when we finally receive some benefit from our earned income.

Remember: lower rates can mean lower deficits, higher savings, and more businesses and homes.

Update (winter, 2003) as expected, capital gains receipts surged upwards after the rate was reduced. In 1995 the IRS collected $180 billion in capital gains and in 1998 they collected $455 billion in capital gains. The increase ($275 billion) was more than enough to bring the Federal Budget into balance, even with increased spending.

Source: http://www.irs.gov/pub/irs-soi/00in01si.xls

By reducing the rate at which we tax them [capital gains], we encourage more savings and investing.

We have learned through study of tax returns that when inflation wipes out the real value, people start sitting on their investments, waiting for lower rates.

Increasing the rates, or leaving them at too-high a level will only shrink the pool of capital that home buyers and businesses rely on.

...a generation of Boomers before us have proven that the government can not take care of us by taking some of our money and redistributing it...