Charlie Gibson and the Capital Gains Tax

Jonathan Cohn reports that Charlie Gibson did ask one policy question – albeit one that Charlie gets wrong:

Charlie Gibson really hammered the candidates–both candidates–over their proposals to raise the capital gains tax. Why woudl they do that, he asked, when lowering the cap gains tax during the 1990s raised revenue? My recollection was that Gibson’s premise was wrong, but I couldn’t remember the details of why. Fortunately, I know a few economists. Here’s one of them–Jason Furman of the Brookings Institute–with the story:

Joint Committee on Taxation and Treasury both score raising capital gains taxes as raising revenues. There is some behavioral response but much of that is timing and doesn’t affect the medium-to-long term revenue loss. Note that the experience after the 1997 cut and the 2003 cut is not a meaningful way to assess the impact of capital gains tax cuts on revenues because so many things were happening simultaneously. The JCT score of the capital gains cut in 1997 was a few billion dollars annually. The 2003 cut was something like $5 billion annually. But capital gains revenues can go up or down by tens of billions annually. So it is hard to look at the noisy data and infer ex post the revenue impact of these changes.

Or, to put it more simply, Gibson’s logic was flawed.

Another economist – Dean Baker has more:

the apparent increase is likely due to timing: investors delay selling stock when they know a tax cut is imminent. After the cut takes effect, they then declare their gains and pay taxes at the lower rate. But this is only part of the story. As President Reagan noted when he signed the 1986 tax reform, taxing capital gains at a lower rate than other income gives people enormous incentive to game the tax code. If the tax rate on ordinary income for high-income taxpayers is 35 percent, and the tax rate on capital gains is 15 percent, then these folks can get a 20 percent return if they can make wage, interest, rent or dividend income appear as capital gains income. This can fuel a lot of creative tax shelters. This gap will also lead to an increase in capital gains tax collection – at the expense of ordinary income tax collections. There is one other important point worth noting about the capital gains leads to more taxes story. Presumably the greater collections are supposed to come from people selling their stock or other assets more frequently. This means more fees for the financial industry, but is this what we really want to promote. The fees from these trades are a drain on people’s investments. There is a lot of research showing that active traders typically lose money. Is it good policy to promote more active trading (that is, if you don’t work on Wall Street)?

But doesn’t reducing the tax rate on capital gains lead to more investment? Well maybe not:

The effect of taxation of capital gains on the decision to purchase a risky asset is explored within a theoretical framework similar to that of the capital asset pricing model. Tax rate reductions have two offsetting effects. One is to raise the after-tax expected return while the other is to increase the amount of risk borne by private agents. Conditions for determining which effect dominates are derived.