What Happens When You Raise Capital Gains Tax Rates?
Kurt Brouwer April 21st, 2008
This chart from the Wall Street Journal tells an interesting tale about the behavior of investors. It should be no surprise to readers of this blog, that when you change tax rates, investors change their behavior accordingly.
The chart below shows that as capital gains tax rates go up, investors slow down realization of gains. When capital gains tax rates go down, investors speed up realization of gains. Hmmm. Is there a correlation?
It’s important to remember that, as opposed to ordinary income from salaries and bonuses, investors have far more control of when and if they will realize a gain on a sale of stocks, mutual funds, real estate or a business.
And, this is not just an issue for the ‘rich.’ In recent years, most of the households reporting capital gains have been under $100,000 in annual income.
Source: Wall Street Journal
The correlation is not exact because the chart shows realization of capital gains went down in 2002. However, if you remember that 2002 was also a time of recession and a time of falling stock prices, it makes sense. Then, in 2003, the stock market perked up and the 2003 tax cuts kicked in and realizations of gains soared.
I believe that investors take a pragmatic approach to taxes. And, they change their behavior to take full advantage of changing circumstances.
When the tax rate for gains goes up, capital gains realizations go down. And, when investors realize fewer gains, they pay less in taxes. Conversely, when tax rates go down, realization of capital gains surges and tax revenues follow.
Now, in fairness, we have to point out that this effect does not work if you reduce capital gains rates to zero. Realization of gains would go up of course, but tax revenues would not because the rate would be zero. There is a point of diminishing returns from tax reduction and it may be around the current rate of 15%. I don’t know what the point is, but we are probably close.
However, that’s not the issue now. We are not hearing calls for lower capital gains tax rates. Instead, some politicians are calling for much higher capital gains tax rates. Despite decades of evidence to the contrary, they must still think that higher capital gains tax rates will result in higher tax revenues.
Based on what we hear on the campaign trail, the correlation noted in this post and the accompanying chart has not yet sunk in with all of our political leaders. We hope it does.
Via: Steve Janachowski
- Economy , Geopolitics , Money , Personal Finance
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