Why The Low Capital Gains Tax? (Redux)

Portfolio’s editors, in the April issue of the magazine, tackle the issue of which Bush tax cuts should be left to expire in 2010, and which should be extended. I like the idea of a flat 15% inheritance tax rate on all estates over $1 million. But that’s not the only 15% tax we’re being urged to keep:

The reduction of most capital-gains and dividend taxes to 15 percent, on the other hand, stimulates investment and saving by improving investors’ returns and should remain in place. While we reject the absolutist argument that all levies on investment returns amount to the evil of double taxation, we do believe it makes sense, as plenty of left-leaning European nations have recognized, to tax capital at a lower rate.

I’m glad that the editors are rejecting the double-taxation argument. Tax burdens matter in aggregate: I’d much rather be taxed 10% on my income twice than be taxed 35% on my income once. So just shouting "double taxation" and ending the argument there makes no sense.

But if you’re rejecting the argument from double taxation, what exactly is the reason for keeping such a low capital-gains tax? Is there really any empirical evidence that it "stimulates investment and saving"? Alan Blinder doesn’t think so. I asked this question back in August, and got no good answer: why should capital gains be taxed at a lower rate than income? With a bit of sophistication, it’s often quite easy to convert income into capital gains, by diverting it into a corporate shell, so one would think it makes sense to tax the two equally.

As for the Europeans, they tend to have much higher marginal tax rates for top earners; lower capital-gains rates are a kind of stealth tax cut for the rich. And make no mistake: it’s the rich who pay capital gains taxes, not the poor. So if you want to keep capital gains taxes at half the rate of income taxes, you’re essentially undertaxing the rich.

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