The Dumbest Tax Increase – WSJ


If you need more evidence that ideology more than common sense is driving the Biden Presidency, look no further than its trial balloon to raise the top tax rate on capital gains to 43.4%. It’s the dumbest way to raise taxes for many reasons, not least because it will cost the government revenue.

The premise behind the tax increase is that a preferential tax rate for long-term capital gains is an unjustified loophole. (Gains on assets held for less than a year are taxed at the individual income rate.) Yet that preferential rate has persisted for decades, through Democratic and Republican administrations. The current top rate is 23.8%, which includes a 3.8% ObamaCare surcharge. Even in the economically irrational 1970s the top capital-gains rate never broke 40%, as the nearby chart shows.

***

There are good economic and fairness reasons for the preferential rate. First, under current tax rules, all gains from investments are fully taxed, but all losses are not fully deductible. Losses can offset gains in any given year, but losses that exceed gains can only be offset against personal income up to $3,000. The preferential rate compensates for this asymmetry.

Second, gains in asset values aren’t adjusted for inflation, so investors who hold assets for an extended period pay taxes on increases that are partly illusory. Other parts of the tax code, including the income-tax brackets, are indexed for inflation, but not capital gains that arguably need it the most since assets are often held for decades.

Third, a capital-gains tax is a second tax on corporate income. A neutral revenue code would tax all income only once. But the U.S. also taxes business profits when they are earned, and President Biden wants to raise that tax rate by a third (to 28% from 21%). When a business distributes after-tax income in dividends, or an investor sells the shares that have risen in value due to higher earnings, the income is taxed a second time.

No less a progressive than Democratic

Rep. Jerry Nadler

recently deplored the unfairness of “double taxation” regarding and state and local tax deduction, though he probably had no idea he was stating a principle that really applies to corporate income and capital gains.

The most important reason to tax capital investment at low rates is to encourage saving and investment. Consumption—buying a car or yacht—faces a sales tax but not a federal tax. But if someone saves income and invests in the family business or in stock, he is smacked with another round of tax. Tax something more and you get less of it. Tax capital income more, and you get less investment, which means less investment to improve worker productivity and thus smaller income gains over time.

As a former U.S. President once put it: “The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth of the economy.”

That wasn’t

Ronald Reagan.

It was

John F. Kennedy,

whose chief economic adviser was liberal Keynesian

Walter Heller.

A Democrat who said that today would be excommunicated, but it’s nonetheless true.

The last resort of progressives is that raising the capital-gains tax will raise revenue. They are wrong on that too. As former Federal Reserve Governor

Larry Lindsey

explains nearby, a 43.4% federal rate will cost the government money. The Congressional Budget Office says the revenue-maximizing rate for capital gains is about 28%. Other economists say it’s lower, and many think the ideal rate is zero. No one outside the fever swamps thinks it is more than 40%, much less the 55% or more that would apply in high-tax states if the Biden proposal becomes law.

The history of capital gains taxations bears this out. Selling an asset is usually a discretionary decision, so investors can decide when to realize a gain or loss. As rates rise, Americans tend to hold on to their assets longer, reducing realizations. CBO has found that for each 1% increase in the capital-gains rate, there is a 1.2% reduction in realizations. Raise the tax as much as Mr. Biden wants, and realizations will fall significantly. The higher rate will cost the government revenue.

***

So why raise a tax rate that would reduce investment, reduce wage growth and reduce revenue for the government? Temporary economic insanity is one possible explanation.

Mr. Lindsey suggests another: punishment for its own sake. Without a rational basis for the tax increase, this sounds right. This is what happens when you turn your economic policy over to

Bernie Sanders

and

Elizabeth Warren.

Envy is in the political saddle, and Joe Biden is going along for the ride.

Journal Editorial Report: The prospects of passage for police-reform bills. Image: Spencer Platt/Getty Images

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