POLICY DIGEST

Unlocking Capital

As part of their tax cut package, Republicans have pledged to reduce the tax on capital gains by 50 percent, from a maximum rate of 39.6 percent to 19.8 percent.

Historical evidence supports the contention that lowering the tax rate would increase federal revenues.

• In 1968, with a 25 percent capital gains tax rate, receipts were $33 billion (adjusted for inflation).

• In 1977, with a 35 percent rate after four increases in eight years, revenues had fallen to $24 billion (adjusted for inflation).

• In 1984, after the tax had been cut to 20 percent, revenues grew to an inflation-adjusted $32 billion, 25 percent above their 1978 level.

• After the capital gains tax rate was increased by 40 percent in 1986, capital gains tax revenues fell by $75 billion from 1987 to 1992.

In the 1990s, capital gains tax collections have been between $25 billion and $30 billion a year, just 3 percent of total federal revenues. The maximum capital gains tax rate for individuals is now higher than at any time in history except the slow-growth period of 1970-1981. The corporate capital gains tax rate of 35 percent is at its highest level ever.

Capital gains have usually been taxed at a lower rate than earned income (and in some high-growth countries aren't taxed at all) since assets are purchased with already-taxed dollars. Thus, taxing the revenue derived from capital gains is double taxation. In addition, the longer assets are held, the greater the share of increase that is due to inflation.

Source: Stephen Moore and John Silvia, "The ABCs of the Capital Gains Tax," Cato Policy Analysis No. 242, October 4, 1995, Cato Institute, 1000 Massachusetts Avenue, NW, Washington, DC, (202) 842-3490.

For full text, see http://www.cato.org/pubs/pas/pa-242es.html.