May 5, 2008 9:22

The official word on whether capital gains tax cuts increase revenue (it's no)

The Congressional Budget Office issued a report Friday on Sources of the Growth and Decline in Individual Income Tax Revenues Since 1994. The gist of it was that the big gains in federal tax revenue from 1994-2000 had very little to do with changes in the tax code, while about half of the decline in tax revenue (as a share of GDP) between 2000 to 2004 was the result of the Bush-administration tax cuts.

The report also includes this conclusion about the impact of capital gains tax rates on revenue:

Because taxpayers can choose when to realize capital gains (and losses), more gains are realized when tax rates are lower. However, over time, the increase in realizations induced by lower tax rates is not sufficient to offset the direct impact on revenues from the tax reduction itself, for two reasons. First, revenues will always increase by less than realizations following a tax cut because gains are taxed at the lower rate... Second, increases in realizations are generally much larger in the short term than in the long term because some of the additional revenues in the short term come from gains that would have been realized in later years. ...

Separating the effects of changes in the tax rate from other factors affecting capital gains realizations is difficult. The best estimates of taxpayers' response to changes in the capital gains tax rate do not suggest a large revenue increase from additional realizations of capital gains--and certainly not an increase large enough to offset the losses from a lower rate.

The report then cites a bunch of studies on the subject, the most recent of which is Leonard Burman's 1999 book, The Labyrinth of Capital Gains Tax Policy. Which is kind of disappointing; one would hope lots of people would be studying the the capital gains rate cuts of 1997 and 2003 to figure out what they actually accomplished. And maybe they are; but if so they're so far keeping their work under wraps.

So on the one side we get lots of confident claims from supply-side zealots that the cuts more than paid for themselves--claims that rely both on the latest data on tax receipts and the (almost certainly erroneous) belief that the movements of stock market and other financial markets are driven entirely by capital gains tax rates. And on the other we get the serious economists telling us that capital gains rate cuts don't increase revenue, but not offering anything in the way of up-to-date evidence for this. Which helps explain why the zealots continue to be taken more seriously by the media than they deserve.