Tax Analysts Blog

Capital Gains Frustration for Tax Reformers

Posted on Dec 14, 2012

The Treasury tax expenditure budget tallies the cost of the 15-percent preferential rate on capital gains at $62 billion in 2013. That's a nice chunk of change that could be used for deficit reduction or lowering rates. And because the super rich get a lot of their income in the form of capital gains, the capital gains preference greatly reduces their tax rate. In fact, as shown in the chart below (using IRS data), the income tax rates for America's most wealthy are below those for you garden-variety millionaire with between $1 and $5 million of income.

So since we need revenue and there is now agreement that we should raise that revenue from the wealthy you might think raising the rate on capital gains would be an attractive target for our nation's lawmakers. But it ain't so.

The problem is that in the short term any increase in the capital gains rate will slow down sales of capital assets. In the first few years after enactment the negative revenue effect of this reduction in capital gains realizations can completely offset the positive revenue effect of a lower rate, so that it is possible for a rate hike on capital to lose revenue in the short term. Over time the slowdown in realizations fades away, but in the ten-year revenue window conventionally used by Congress the net revenue gain from a capital gains tax increase is only a small fraction of the revenue pickup suggested by the tax expenditure estimates.

The upshot of all this is that even liberals are going to be reluctant to take on raising the capital gains rate if they get so little revenue in return for what will surely be a nasty political fight from conservatives who consider low capital gains rates sacrosanct.

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