Thursday, August 7, 2008

Furman vs. Holtz-Eakin

The Wall Street Journal has a nice back-and-forth between the campaign's economic advisers here. The best parts are the discussion on energy policy and taxes, particularly Jason's spirited argument that the capital gains and dividend tax rates Obama is proposing would not be a drag on growth:

Barack Obama has proposed establishing a new tax bracket for capital gains and dividends for families making over $250,000. This bracket would be somewhere between 20 and 28 percent, although Obama has said that he believes that he will be able to propose something at or close to 20 percent. Not only would 98 percent of the population see their tax rates unchanged by this proposals, but Obama is also proposing to entirely eliminate capital gains taxes for small businesses and start-ups. And to put the impact of the proposal on the top 2 percent of households in perspective, at a 20 percent rate for capital gains and dividends:

–The dividend rate would be 39 percent below what President Bush proposed in his 2001 tax cut and lower than all but 5 of the last 92 years;

–The capital gains rate would be the same as what President Bush proposed in his 2001 tax cut, 29 percent below what Ronald Reagan raised it too, and 22 percent below the post-war average

–Taken together with Obama’s other proposals, 100 percent of households would pay lower taxes than they did in the 1990s.

These rates are perfectly compatible with strong economic growth and strong asset market growth. The stock market rose 270 percent in the decade following Ronald Reagan’s increase of the rate to 28 percent (which exceeds the rate that Obama would likely propose). The economy created 23 million jobs in the 1990s, a period when capital gains and dividend taxes were well above the levels that Senator Obama proposes.

2 comments:

Anonymous said...

"These rates are perfectly compatible with strong economic growth and strong asset market growth."

Of course they are. The question, though, is not whether an economy can still grow during a period such as the tech boom despite a high capital gains tax. The question is whether these rates adversely affect an economy that is not experiencing an economic explosion and may not experience one in the foreseeable future.

In this case, we need to eek as much out of the system as we possible can. This means that we should not have taxes that decrease the ability of capital to move to more profitable sectors of the economy.

Again, if we have a booming economy, a reasonable capital gains tax will be a minor hindrance to capital growth. But in a weak economy, where there exists more timidity, an excessive capital gains tax can hinder the movement of capital and thus slow growth.

donpedro said...

Anonymous,
There's no evidence for what you're claiming. Here's Len Burman's explanation:

If the capital gains tax cuts really were the elixir for the economy, you'd expect to see evidence in the data.

But historically, there is no relationship between the taxation of capital gains and economic growth.

Yes, businesses have more money they can put into productive activity.

But at the same time, it also creates lots of incentives for unproductive tax shelters that hurt the economy.

Right now, the top tax rate on capital gains and dividends stands at 15 percent.

Meanwhile, the top tax rate on ordinary income is a much higher 35 percent.

When tax rates on investment gains are much lower than rates on ordinary business income, tax lawyers find ways to dress that ordinary income to look like those capital gains.

The IRS knows this trick and has shut the door on the most obvious abuses. But that just makes the challenge more fun and lucrative for the legal and financial wizards in the tax shelter industry.

Here's how it works. You make an investment that produces tax deductions--say lease payments for something you may or may not need.

Right away, your current taxable income drops. Down the road, you get your money back in the form of a capital gain, which is taxed at less than half the rate of your other income.

You can save up to $200,000 in taxes on every million you launder this way.

Thanks to these tax shelters, some very rich people can wiggle out of most of their tax bills.

Besides that, shelter investments are invariably lousy, unproductive ventures that would never exist but for tax benefits. And money poured down these sinkholes isn't available for more productive activities.

What's more, the creative energy devoted to cooking up tax shelters could otherwise be channeled into something productive. Wouldn't it be a shame if the next Bill Gates wasted her talents inventing tax shelters instead of inventing a new industry?

Bottom line: low tax rates on capital gains are as likely to depress the economy as to stimulate it.