Do capital gains taxes help or hurt our economy?

Sep 12, 2011

Those in favor of lowering, or even eliminating, capital gains taxes say it will spur more investment in the U.S. economy. But the growing gap between America's rich and poor has given a new voice to advocates of raising captial gains taxes, which is seen by some as a major income divider.

Chat with economist Leonard Burman about the advantages and disadvantages of capital gains taxes. Ask questions and share your theories about whether capital gains taxes are good or bad for the U.S. economy.

Read: Capital gains tax rates benefiting wealthy feed growing gap between rich and poor

"only half of gains would be included in income": sounds like a great way to combine progressivity with lower effective rates for cap gains overall. Is such a proposal on the table?

Welcome to chat.  I'm happy to answer your questions about capital gains taxation (and related subjects).

I believe that is a myth that only rich people benefit from gains in capital gains. Can you please explain how anybody who has access to a brokerage account or sells a house with a gain over 200k would also be affected by increasing capital taxes gains.

It's true that not only rich people have capital gains, but the overwhelming majority of gains are earned by people with very high incomes.  70 percent go to those in the top 1 percent.  Most middle income people hold stocks through 401(k) plans, which are not affected by capital gains tax.

I've not heard any discussion on the effect on workers of this consequence of capital gains preferential treatment: Withdrawals of gains from 401K's, IRA's, and the 403b's and 457 retirement accounts are taxed as ordinary income: Isn't this another whammy on workers, too?

Actually, no.  Those plans get a tax deduction up front so effectively the capital gains and other returns are tax-free.  You're just paying back your initial tax break with interest.  (Roth IRAs and 401(k) plans don't allow an up front deduction, but there's no tax on withdrawals.  Economically, these are very similar.)

We will always have the haves and have not's. However, why do we continually want to punish those who are successful and pander to those that are not. One works hard and and raises his/her life style - why should that person have to not only support his/her family, but also those that were not as successful.

We have an income tax, which includes tax on the returns to savings of all forms (except through 401(k) plans and such).  Some economists think that a better system would be a consumption tax, which wouldn't tax savings.  The drawback is that it is much less progressive.  Some people earn returns to capital because they are very thrifty, but a lot of the returns are attributable to luck.  I think taxing the lucky makes sense.

Where does Capital come from? doesn't it come from earned income to start with, and therefore already taxed once at those higher rates? If what we want to is to get the wealthiest to pay more, why not introduce an annual estate tax?

Valuing assests annually would be extremely burdensome on businesses.

Were jobs created during the Bush administration when the capital gains tax was lowered?

It's hard, if not impossible, to sort out the effects of capital gains tax cuts from all the other things that happened at the same time.  I looked at the relationship between capital gains taxes and economic growth over many decades and the two time series are uncorrelated.  That doesn't mean there isn't a relationship, just that it's not easy to see in the data. 

As for the effects of lower capital gains taxes during a recession, they might actually be counterproductive if they encourage more saving.  Right now, we need more consumption.

How many people pay capital gains taxes, vs income taxes?

According to the Tax Policy Center, about 5.9% of tax units had capital gains in 2010.  The percentage of income taxpayers would be a little higher because some tax units do not owe income tax.

The Redskins looked like a real football team yesterday and I couldn't be happier. But I still have a great distaste for Dan Snyder. Do you think if capital gains tax rates were increased that Snyder would be impacted to the point where he would have to sell the team? Or would the increased rates discourage him from selling because he wouldn't want to pay the additional fees on the appreciated value of the team?

That is one question I never thought of.

It seems like it would benefit U.S. competitiveness (and still address the double taxation issue) if we were to reduce the corporate income tax and increase in the tax rate for capital gains and dividends. What are the problems with this approach?

Rosanne Altshuler, Ben Harris, and Eric Toder have a nice paper making just this suggestion.  You can find it on  Their suggestion is to fully tax dividends (as before 2003) and tax capital gains at rates up to 28% (as before 1997).  I think it's a good idea. 

Should capital gains be taxed at the same rate as ordinary income?

I think it's a good idea, especially if we used some of the revenue raised to lower top ordinary income tax rates?  The problem with taxing gains at a much higher rate than other income is that it creates a huge incentive to engage in tax sheltering.  If you can turn a dollar of wages (taxed at rates up to 35%) into capital gains (top rate 15%), you save 20 cents in tax.  That motivates many extremely inefficient tax shelters.

The problem with taxing gains at 35% or 39.6% (if the Bush tax rates expire) is that those rates may discourage so much selling that the Treasury would love revenue.  (I don't think that would happen, but JCT, which scores tax changes for Congress, believes that maximum rate is around 28%.)

How does wealth distribution in the US stack up against other OECD or other highly industruialized nations? Is the wealth disparity in the US wider, about the same, or less?

The US has a far less even icnome distribution than OECD countries.  There's a nice paper on this by Tony Atkinson, Thomas Picketty. and Emmanuel Saez.  I think the same is true of wealth, but don't have a reference for that.

The capital gains tax is also related to the carried interest loophole, which allows hedge fund managers to pay almost nothing on incomes of billions of dollars. How do we eliminate this massively unfair loophole?

You're right that many extremely wealthy folks on Wall Street earn a large share of their income from capital gains.  They get a carried interest, typically 20% of the value of the investment they manage, and any capital gains are taxes at a 15% rate.  The best solution to this would be to tax capital gains like other income, but if that is not feasible, it would make sense to tax carried interest and hedge fund profits as ordinary income.

Shouldn't there be some favorable treatment for truly long-term gains? I don't mean a year, which is hardly long-term investment, but rather tens of years or more. If I start a business today and sell it at my retirement in 30 years, much of the "gain" will actually be inflation. Likewise for any stock investment or other types of capital investments. There's no good reason to tax inflation.

A lower rate on gains on assets held more than 5 years was actually part of the 1997 capital gains tax cut.  (Rates on gains helds at least 1 year were 20%, but the rate fell to 18% for assets held at least 5 years.)  I didn't think this was a good idea because you actually want investors to sell if they think assets are overvalued.  Otherwise, you may fuel asset bubbles (which we've seen can work out badly). 

why not introduce brackets for capital gains rates, just as with income taxes? you pay little/ no taxes for capital gains or less than $20k, 10% for less than $40k, 20% for less than $80k, and so on

I think Canada had a lifetime exemption for gains up to a certain amount for a while, although I think they abandoned that because it was hard to administer.  A small annual exemption might be a good idea just to simplify the tax system.  However, I think the best way to achieve progressivity (assuming we decide to continue taxing gains at lower rates) would be to replace the current system of alternate rates with a partial exemption for capital gains, as had been in place before 1987.  In other words, only half of gains would be included in income (for example).  That would be much simpler than the current system.

Capital gains involves double taxation. Do you believe there is a fairer way to tax capital gains?

There is double taxation to the extent that corporate income has already been taxed.  However, lots of corporations manage to avoid much of their corporate tax and many capital gains are on assets other than corporate stock.  The best way to deal with this would be to "integrate" the corporate and individual income taxes.  Basically, shareholders would pay tax on income as it accrues, rather than when they sell an asset.  Alternatively, they could get a tax credit for the taxes already paid by companies. 

Capital gains taxes are said to spur investment but with so little demand, is there any point in widening the deficit for this purpose? Or would such a reduction spur anything if no-one is making a lot of money through capital gains?

Cutting gains tax cuts would not spur the economy during the recession.  You're right that we need to boost demand.  To the extent that a capital gains tax cut encouraged more saving, it could actually be counterproductive, at least in the short run.

I am sorry I worked hard and took risks big time and now have capital gains. Why should I pay more taxes then some lazy good for nothing who cant show up for work on time and hold a job. And I can move my capital easily where i can get a more favorable tax situation. Problem with most economist like you is they live in academia and not the real world. What this country needs is one tax rate for all Americans and not the cureent tas rates that tax success and risk. W/o investment job growth is stagnant or worse and GDP tanks. Federal, state and local spending just isnt there to bail the economy out. And govt spending is inefficient and riddled with corpuption. Stop taxing success.

I applaud you for working hard and taking risks.  However, a lot of the difference in income is due to luck.  I'm paid way more than my dad because I had great parents and was smart enough to get a lot of education.  Other people aren't born with those advantages.  I'm perfectly happy to pay higher taxes so that hard working people without my advantages can get a break.

I think dividends derived from stocks that are reinvested into purchasing additional shares of those stocks should be exempt from the capital gains tax. Any chance of that happening?

I don't think you necessarily want to encourage people to plow money back into the same companies.  They should be able to reinvest where they expect the highest return.  That keeps pressure on managers to perform well.  A better approach to dealing with dividends is some form of integration (see above) or cutting the coporate tax (after closing loopholes).

Thanks for your thoughtful answers. But in the rush, you made a small typo in writing "They get a carried interest, typically 20% of the value of the investment they manage..." The carried interest is 20 percent of the profits, not the asset value. (There's also a typical 2 percent of asset fee, but I believe that is generally taxes as ordinary income.)

Lots of great questions.  I wish I had time to answer all of them.  If you are interested, the Senate Finance Committee is holding a hearing on capital gains and dividend taxes (as well as ordinary income tax rates on high-income people) on Wednesday at 10.  I'll be testifying as well as some people who see things differently.

my first time doing a live Q&A...are you getting good questions? how many? the process seems a bit slow from the reader's point of view

Thanks for joining this chat today.  If you have questions about or suggestions for our chats, I'd be glad to discuss them with you via email:

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Leonard Burman
Leonard Burman is the Daniel Patrick Moynihan Professor of Public Affairs at the Maxwell School of Syracuse University, an affiliated scholar at the Urban Institute, and research associate at the National Bureau of Economic Research and senior research associate at Syracuse University’s Center for Policy Research. Previously, he was the director and co-founder of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution. He has held high-level positions in both the executive and legislative branches, serving as Deputy Assistant Secretary for Tax Analysis at the Treasury from 1998 to 2000, and as Senior Analyst at the Congressional Budget Office. He is president of the National Tax Association. Burman is the author of The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed, and co-editor of Taxing Capital Income and Using Taxes to Reform Health Insurance, and author of numerous articles, studies, and reports. Recent research has examined US federal budget dynamics, the individual alternative minimum tax, the changing role of taxation in social policy, and tax incentives for savings, retirement, and health insurance. He holds a Ph.D. from the University of Minnesota and a B.A. from Wesleyan University.
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