NCPA | Study #307, The Bush Capital Gains Tax Cut after Four Years: More Growth, More Investment, More Revenues

What Is a Capital Gain?

A capital gain is income derived from the sale of an investment. The capital gain is the difference between the money received from selling the asset and the price paid for it. A capital investment can be a home, a farm, a ranch, a family business or a work of art. In most years, slightly less than half of taxable capital gains are realized on the sale of corporate stock. The Joint Tax Committee defines a taxpayer’s net capital gain for the year as “the excess of the net long-term capital gain over the net short-term capital loss. Gain or loss is treated as long-term if the asset is held for more than one year.”

Some types of capital gains are exempt from capital gains taxes. For instance, most home sales are not subject to capital gains taxes when the seller purchases another home. Moreover, pension funds, which purchase stocks and other assets, are exempt from paying taxes on capital gains.

“A capital gain is the difference between the price paid for an asset and the money received when it is sold.”

For all the controversy surrounding the tax treatment of capital gains, it is not a major revenue source for the government — although paradoxically, as the tax rate on capital gains has been reduced, the revenues raised from the tax have increased. In the early 1990s, capital gains tax collections amounted to between $35 billion and $50 billion per year. Since the 1997 and 2003 reductions in the capital gains tax rate — to 20 percent and 15 percent, respectively — receipts have skyrocketed, and now stand at more than $100 billion. But even with this substantial increase, capital gains taxes account for less than 5 percent of total federal revenues, as Table I shows. Even if the capital gains tax were abolished entirely with no offsetting receipts, the federal government would still collect 95 percent of the total tax receipts each year it would otherwise.