April 22, 2008

Gibson's capital-gains tax assertion during debate disputed

During the April 16 Democratic presidential debate, Charles Gibson asserted of capital-gains tax cuts that "in each instance, when the rate dropped, revenues from the tax increased. The government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down." In fact, economists dispute Gibson's assertion.

The most interesting thing about this is that it betrays a deep lack of knowledge both of economics and tax policy, a glib and remarkable naive view of what capital gains really represent. For one thing, capital gains are the gains made on assets held for sale. Homes, stocks, bonds and commodities are all examples of assets that can be sold at a capital gain. In other words, they aren't usually considered regular income which is why they are treated differently. Just like all taxes, capital gain taxes are subject to the Laffer Curve meaning that there is a sweet spot at which you maximize revenue to the government with a minimal impact on economic activity. Cut it too far and you're starving the government, our government, of the revenue it needs to be build roads, hire police and firefighters and provide that national defense people are all the time talking about. Increase it too much and you'll stifle economic growth and starve the government. Gibson's ridiculous question ignores this little fact which is understandable since the Republicans have been ignoring the reality of Laffer's research for more than 28 years.

Still, there is another problem with Charlie's little question in that it ignores the very real effect of ultra low cap gain rates, especially on short term profits. They make people more willing to report their income as a capital gain and they increase speculation to near epidemic levels. The same speculation that has helped to drive oil to $117/bbl. The same speculation this is raising prices on a broad basket of commodities. You and I get to experience that at the grocery store. Of course, there's also another behavior which explains Charlie's numbers, namely that when the tax is increased, immediately before the increase goes into effect, revenues shoot up as people take advantage of the old rate. When the rate falls, people hold off on realizing gains until the cut goes into effect. And there's your boost. Over time, though, the revenues always return to nominal levels.

The simple answer is the one from Warren Buffett. His solution is to raise short term capital gain taxes to a very high level in order to starve off speculation and short term thinking in the market. Of course, this would reduce income to the government but it would be offset by longer term employment and a more vibrant economy that is capable of growing faster with less inflation (less speculation = less inflation). Frankly, speculation and the resulting price fluctuations and increases cost American businesses and consumers far more than any tax.

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Posted by mcblogger at April 22, 2008 12:03 PM

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