On Raising Capital Gain Taxes
The case for switching from “either-or” to “let’s have both”.
The discussion about raising the capital gains taxes rates (CGTR) has been going for quite a few years now.
The proponents of raising CGTR point out that reach people receive a bigger share of their income via capital gains than less well off. Which effectively means they pay lower taxes as a result. And that is not how the system is supposed to work.
The opponents argue that raising CGTR will lead to declines in capital mobility. Instead of reinvesting capital from Opportunity A that expected to produce 10% annually to Opportunity B with an expected yield of 20% the savvy investor will continue to hold A. This position is very well articulated here.
It goes like this: if the investor sells A, they will be hit by a high tax (say 35%+) that will reduce their reinvestment amount significantly and remove any attractiveness of reinvesting the much smaller after-tax amount of proceeds into B despite B yielding more. Because of that, high CGTR will disincentivize the movement of capital into more productive opportunities, which means lower economic growth, fewer new jobs, less prosperity for the society.
Because both positions have merits, the struggle goes on. It’s better to have a more fair distribution of tax burden. But it is a terrible idea to do it by sacrificing economic growth.
But maybe there is a way to have both.
The approach to having both is to tax long-term capital gains and qualified dividends (CG) based on how that income is spent. If spent on consumption — apply regular income tax rates. If reinvested — apply CGTR.
A few considerations:
- This split approach will lead to an increase in tax revenues from the same base of CG because the “consumption” portion of CG will be taxed at higher rates. It makes it possible to keep tax revenues flat and reduce CGTRs at the same time — thus increasing capital mobility and economic growth.
- The approach will incentivize the savvy investors to reinvest a bigger portion of CG than they would have otherwise and increase overall rates of investment in the economy.
The question of what the actual CGTR should be is a separate one and while it is important, it is much more important to focus on getting the structure right first.
Another consideration is potential fraud, like people trying to game the system by re-investing in entities that will park the money for a year or two and then liquidate. These cases should be possible to catch and should not become an obstacle on a way to creating a better system.