[Capital Gains] rate reductions in 1978, 1981, 1997 unleashed historic levels of venture-capital funding for business start-ups.
—Editorial Board, “A Capital Gains Primer, ” Wall Street Journal,
Sept. 21, 2012.
Speaker Nancy Pelosi’s House bill promises another $3 trillion for her various constituencies. The goal is income redistribution, not economic growth.
If Mr. Trump really wants to upset the swamp, he’d propose that every private investment made for the rest of this year be exempt from any capital gains tax. The post-shutdown economy will need new investment and the risk-taking known as animal spirits. A zero rate on gains would counter the uncertainty of pandemic risk.
Sooner or later the pandemic will end. The question is what kind of economy will be left. A second CARES Act would leave a legacy of vastly larger government that would mean slower growth and take years to overcome.
—Editorial Board, “After We Defeat the Virus, ” Wall Street Journal,
May 26, 2020.
I used to jokingly tell my students that neoliberal economists have one surefire cure for every economic problem: Cut capital gains taxes. If your economy is feeling depressed, or even just recessed, simply lower taxes on the gains of investors. Mind you, I was mimicking the advertisement for Geritol, the much-investigated 1950s and 1960s energy tonic that promised “to carry strength and energy to every part of your body within seven days or your money back. ”
Little did I know that the Wall Street Journal editors, along with Kevin Hassett, President Trump’s senior economic advisor, would go so far as to claim that eliminating capital gains taxes for the rest of the year would restore the health of the post-virus economy. It shouldn’t have been a surprise since the editors published a primer in 2007 and again in 2012 making the case for cutting capital gains taxes.
Unlike Geritol, their capital gains tax holiday doesn’t come with a money-back guarantee if it fails to revitalize our economy. The superrich, however, would get to keep their tax giveaway, whatever our economic future holds. And there is little reason to believe that cutting capital gains taxes will do any more to revitalize our economy than Geritol did to revitalize anyone’s health.
But that’s no nevermind to the Wall Street Journal editors, who could give the Geritol ad writers a run for their money when it comes to deceptive claims.
Redistribution for Whom?
The editors sure seem to have a problem with the House of Representatives’ vote to approve the $3 trillion Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act (which as of this writing hasn’t become law). But surely it can’t be that the House legislation redistributes income. The editors’ proposal to suspend taxes on capital gains is far more redistributive than the HEROES Act. The real difference is that the HEROES Act, if enacted, wouldn’t make today’s jaw-dropping inequality even worse, whereas the editors’ capital gains tax cut, if it accomplished nothing else, would bring about an impressive amount of inequality-worsening redistribution.
The benefits of suspending the income taxes investors pay on their gains from selling assets for more than their purchase price—whether the assets are stocks, bonds, homes, or something else—go overwhelmingly to the superrich and nearly exclusively to the well-to-do. The Tax Policy Center estimates that in 2019 three-quarters of long-term capital gains (from selling assets held over a year) went to the richest 1% of taxpayers. And just 6% of households in the bottom 80% report any capital gains income at all. Moreover, long-term capital gains already get preferential treatment when it comes to the rate at which they are taxed. Income tax rates on long-term capital gains income are capped at a 20% rate for capital gains income above $434,551 (for a single taxpayer in 2019). That rate is lower than the 22% income rate levied against wage income above $39,476 and well below the 37% maximum income tax on wage income.
The HEROES Act, unlike the editors’ highly regressive proposal, would make the distributional effects of the economic stimulus packages to date more progressive. The bill includes four major cash payment and tax provision programs. Nearly one-half (49%) of the combined benefits from these programs would go to the bottom 60% of the population, almost twice their share of the national income, according to estimates from the Institute on Taxation and Economic Policy. Three of these programs provide much needed support to a wide swath of the population (specifically families with incomes of up to $150,000) without any of their benefits going to the top 1%. These programs include a new one-time payment of $1,200 that would go to adults and an additional $1,200 each for up to three dependents. The HEROES Act would also expand the family benefits from the previous $2.1 trillion House stimulus legislation (the CARES Act) to cover all dependents—not just those under 17—as well as immigrant families. (Undocumented immigrants, along with their U.S. citizen or documented non-citizen spouses, were excluded from the $1,200 relief payments that happened through the CARES Act.) In addition, the bill would triple the maximum Earned Income Tax Credit available to workers without children and temporarily increase the Child Tax Credit from $2,000 to $3,000 per child.
Two other tax provisions of the HEROES Act directly affect the amount of taxes paid by the richest 1%. One reduces their tax burden and the other increases it. The HEROES Act would suspend the $10,000 cap on deductions for state and local taxes from federal individual income taxes. This benefit would go exclusively to the top fifth of the population, with three-fifths of those benefits going to the richest 1%. The cap, put in place with the Trump 2017 tax cut, hit well-to-do taxpayers living in higher-tax states, which were often “blue states, ” the hardest. At the same time, however, the HEROES Act would close a $135 billion tax loophole introduced by the previous stimulus package that benefits the superrich. (The CARES Act removed the cap on the amount of business losses from certain years that non-corporate business owners could use to offset their non-business income subject to the individual income tax in other years and avoid paying taxes or even get a refund.) According to the Congressional Joint Economic Committee, 82% of the benefits from the tax loophole went to 43,000 taxpayers who earned over $1 million, with hedge fund investors and real estate businesses being the chief beneficiaries. The tax loophole cost more than one-and-a-half times the cost of the support that the stimulus act provided for hospitals and public health providers.
So, when it comes to redistribution, even the most regressive program of the HEROES Act falls short of the editors’ proposed tax giveaway to the richest 1%, whose incomes already average over $2 million.
Economic Growth Couldn’t Possibly Be Their Goal
Here’s how cutting capital gains taxes is supposed to work: Lower or zero capital gains taxes would encourage investors to cash in their investments to take advantage of the windfall profits from paying fewer taxes. In turn, those freed-up funds would go to finance new investments that would spark economic growth in the post-virus economy.
Sounds good. But in practice would cutting capital gains taxes boost investment and promote economic growth? The right answer is perhaps, but not by much. And by nothing at all is the better bet in today’s economy.
A capital gains tax cut is an ill-targeted, blunt instrument for attempting to tease more investment out of the economy. Much of the tax cut would go to windfall profits on past investments instead of encouraging new investments. The Wall Street Journal editors’ proposal avoids that problem because it would eliminate capital gains taxes on investment “made for the rest of the year, ” not made in the past. Nonetheless, much of its windfall gains would go to increase the rate of return on investments that would have been made anyway without the tax cut, instead of going to prompt additional investments.
On top of that, today many investors are no longer even subject to capital gains taxes. Even the stock market, Trump’s obsession, would be unlikely to get much of a boost from cutting capital gains taxes. Today, monies from pension funds, nonprofit institutions, and foreigners who do not pay capital gains taxes finance most stock investments. Economists Steven Rosenthal and Lydia Austin found that as stock purchases from institutional and foreign investors grew in importance, the share of U.S. corporate stocks subject to the capital gains tax fell from 84% in 1965 to just 24.2% in 2015.
Capital gains taxes, on the other hand, do affect capital gains realization. Investors pay taxes on capital gains only when they sell their assets or realize their gains. Investors can wait for an advantageous time to realize those gains. For instance, realizations spiked before the 1986 tax increase went into effect, which for a while eliminated the preferential tax treatment of long-term capital gains. But after their 1986 spike, capital gains realizations returned to their previous level in 1987. Realizations also picked up following the 1997 and 2003 reductions in capital gains tax rates. In both cases, lower capital gains taxes “had a stock market unlocking effect, ” just as the editors promised it would in their primer. But the unlocking of past gains in the 1990s helped to fuel the speculative frenzy that ended in the high-tech stock market crash in 2000, which was followed by a year-long recession. After the 2000s, the unlocking of past gains made it possible for the economy to continue to grow slowly as it helped to inflate the real estate market bubble that then crashed, bringing on the Great Recession. That’s hardly convincing evidence that cutting capital gain taxes will restore sustainable economic growth in the post-virus economy.
Also, contrary to the editors’ assertion that a lower tax rate for capital gains would result in increased risk-taking, “there is no good evidence to date on whether capital gains taxes raise or lower risk-taking, ” according to tax economist Jonathan Gruber. What we do know is that like stock investments, only a small sliver of venture capital investments—which could be, according to the editors, a key source of new investment and risk-taking—are affected by capital gains taxes; just 10% according to the estimate of Congressional Research Service economist Thomas Hungerford. Attracted by potential high rates of return and an opportunity to diversify their portfolios, pension funds, foundations, insurance companies, and other entities not subject to capital gains taxes typically fund these investments in start-up companies and small businesses.
Capital gains tax cuts may well add to the supply of funds available for investment by increasing realizations at least in the short term. But an increase in the supply of funds alone cannot lead to the surge in investment and entrepreneurial activity that the editors promise. Economists liken the problem to pushing on a string to move it forward. What’s needed is spending on the demand side that will pull the string along in the right direction.
That makes cutting capital gains taxes a particularly ineffective policy for boosting economic growth in the Covid-19 economy. Today’s economy, replete with record-low interest rates and awash in liquidity, does not suffer from a lack of funds but from a crippling collapse of spending that needs to be corrected by the public sector before output and employment improves in a sustainable way.
We Can Do Better
With such a shoddy record of boosting investment, cutting capital gains taxes would offer little bang for the buck when it comes to ending the spending drought. Instead, it would put more money in the hands of the rich, who spend less of their income than those who are less well-off. Many of the programs in the House HEROES Act, on the other hand, have a proven track record of promoting economic growth by reliably injecting much needed spending into the economy. That is surely the case for government supports to those who have lost their jobs, for cash-strapped state governments, and for hospitals that are struggling to provide care with far too little money in far too dangerous conditions.
But the current crisis has created an opportunity for enacting even bolder policies to reduce today’s staggering inequality. “The pandemic has brought us together in the same way that research shows greater equality does. Both make us feel we have more in common, ” writes British sociologists Richard Wilkinson and Kate Pickett, who are authors of The Spirit Level, an indispensable investigation of the debilitating effects of inequality. “Forced by the pandemic, the government has at last put human welfare before economic growth.”
The Wall Street Journal editors seem determined to make sure that doesn’t happen and that the economy fails to grow as well. Even the Geritol ad writers would have a hard time selling their policy proposal.
Steve Wamhoff and Meg Wiehe, “A Capital Gains Primer, ” Wall Street Journal, Oct. 17, 2007; Institute on Taxation and Economic Policy (ITEP), “Major Cash Payments and Tax Provisions in the HEROES Act, ” May 2020; Catherine Rampell, “Republicans’ latest proposed tax for the rich could permanently hobble future presidents, ” Washington Post, May 25, 2020; Thomas Hungerford, “The Economic Effects of Capital Gains Taxation, ” Congressional Research Service, June 18, 2010; Richard Wilkinson and Kate Pickett, “Why coronavirus might just create a more equal society in Britain, ” The Financial Times, May 4, 2020; Leonard Berman, “Capital Gains Cuts Won’t Cure the COVID-19 Economy, ” Tax Policy Center, May 11, 2020; Steven Rosenthal and Lydia Austin, “The Dwindling Tax Share of U.S. Corporate Stock, ” Tax Notes, May 16, 2016; Americans for Tax Fairness, “The Millionaires Giveaway: Explaining The Loophole and The Heroes Act Repeal, ” May 13, 2020; Joint Committee on Taxation, “Letter to Senators Sheldon Whitehouse and Representative Lloyd Doggett, ” April 9, 2020; Jonathan Gruber, Public Finance and Public Policy, sixth edition (Worth Publishers, 2019).
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