Advantages of Low Capital Gains Tax Rates

[Draggingtree]

Cato Institute:

 

No. 66 • December 2012

Advantages of Low Capital Gains Tax Rates

by Chris Edwards, Director of Tax Policy Studies, Cato Institute

 

The top federal capital gains tax rate is scheduled to increase from 15 percent to 23.8 percent next year. Some policymakers think that a reduced rate for capital gains is an unjustified tax preference. However, capital gains are different than ordinary income and have been subject to special low rates since 1922.1 Nearly every country has reduced tax rates on individual long-term capital gains, with some countries imposing no tax at all. This bulletin describes why policymakers should keep capital gains taxes low, and it presents data on capital gains tax rates for the 34 nations in the Organization for Economic Cooperation and Development (OECD). If the U.S. capital gains tax rate rises next year as scheduled, it will be much higher than the average OECD rate. Policymakers should reconsider capital gains tax policy. Capital gains taxes raise less than five percent of federal revenues, yet they do substantial damage. Higher rates will harm investment, entrepreneurship, and growth, and will raise little, if any, added federal revenue.

With regard to “fairness,” a Haig-Simons tax base penalizes frugal people and rewards the spendthrift. That’s because earnings are taxed a second time when saved, while immediate consumption does not face a further tax. That makes no sense because it is frugal people—savers—who are the benefactors of the economy since their funds get invested in the new businesses and new capital equipment that generates growth.