Why the Capital Gains Tax Rate Should Be Zero

Studies | Taxes

No. 245
Friday, August 31, 2001
by Bruce Bartlett


Introduction

Later this year, there is likely to be a renewed effort in Congress to cut the capital gains tax rate - something conspicuously absent from the recently-passed tax bill. Proponents of this change will cite economic studies showing increases in economic growth, realizations of gains and even higher revenue for the government.1 Opponents will dispute these points, but mainly argue that a capital gains tax cut is unfair because it only benefits the rich.2 If history is any guide, neither of these arguments will be decisive. In the end, whether the capital gains tax rate is cut or not will be solely a function of politics.

"It would be better for Congress to resolve once and for all the issue of whether capital gains are income."

Thus whether the capital gains tax is cut or not, it will remain a political football, as it has been almost continuously since 1921 when the first capital gains preference was enacted. It would be far better for Congress to resolve once and for all whether capital gains are income like any other form of income - such as wages, dividends, rent and interest - or are not income at all. If it accepts the former, it should move not only to tax capital gains as ordinary income, as was the case from 1914 to 1921 and from 1987 to 1990, but also to tax accrued capital gains on an ongoing basis, regardless of whether such gains are realized. If it accepts the latter, then capital gains should be completely removed from the tax base and not taxed at all. The alternative is to keep raising and lowering the capital gains tax rate depending simply on which way the political winds are blowing.


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