In his new State of the Union address, the President plans to introduce several new economic proposals that are designed to create revenue to pay for a series of breaks toward boosting stagnant middle and low incomes. One such proposal would raise the current capital gains tax from its current level of 23.8 percent to 28 percent, which the administration is hoping could raise around $320 billion in the next 10 years to fund these tax credits for the middle and low class.
While there are aspects to this economic plan I like, especially the child care tax credit and a $2,500 per year tax incentive for up to five years for students getting a college degree, I don’t think that the administration will have any money to pay for these great reforms. A raise in the capital gains tax will fail to generate any revenue for the federal government, as most tax increases do.
While many House and Senate Democrats believe that raising tax rates — especially capital gains tax — would create revenue, studies suggest otherwise. According to a 2013 study by the U.S. Treasury department, capital gains tax and revenue seem to have an inverse relationship of .39. In years where the capital gains tax were anywhere from 28.66 percent to 29.13 percent, the average tax revenue as a share of the Gross Domestic Product was only 0.38 percent to 0.6 percent. On the converse side, in years such as early in Reagan’s presidency and the second Bush era — when the rate on capital gains was anywhere from 18.26 percent to 20 percent — the revenue percentage was a strong 0.62 percent to 0.77 percent.
According to the Heritage Foundation, taxation of capital gains is different from taxation of most other sources of income because people have more control over the timing of the realization of capital gains. More investors choose to recognize capital gains when tax rates are low rather than high. Who would want to pay higher taxes?
For example, in 1986 when the tax rate increased from 20 to 28 percent, there was a major surge in revenue of $328 billion before the rates went into effect. In 1991, once the rates were high, an utter loss in revenue of $112 billion occurred. How then can the administration claim to generate $320 billion in revenue over the next 10 years? While the Obama administration would see a revenue increase prior to the raise to 28 percent, in years afterward there would be major systematic losses in money that would lead to the government being unable to cover the costs for these planned tax credits to the low and middle class.
While there is no evidence to indicate what is the right tax rate to generate the most revenue is when it comes to the capital gains tax, even though a professor from Ohio State University finds that the revenue maximizing rate might be just under 10 percent, there is strong evidence to support that it is indeed under the current 23.8 percent that it is now. I feel that the Obama administration is making a grave mistake because there will not be enough money to cover these tax breaks and credits, leading to a continuation of costly government spending.
The aforementioned Heritage study suggests that the reduction in rates between 1996 and 2000 had such an impact on the economy that there was an overall 91 percent increase in tax receipts during that time. The fact is that capital gains tax cuts have the power to not only increase the value of assets, but also lead to great increases in private sector productivity.
Reach the columnist at ndsmit12@asu.edu or follow @noahsmith1996 on Twitter.
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