Why the Capital Gains Tax Rate Should Be Zero

Studies | Taxes

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


Notes

  1. See, for example, "Capital Gains Taxes and the Economy: A Retrospective Look," a study prepared by Standard & Poor's DRI for the American Council for Capital Formation (June 25, 1999), which shows that higher growth and asset prices offset 100 percent of the static revenue loss from the 1997 capital gains tax cut, which lowered the top rate from 28 percent to 20 percent.
  2. Indeed, within hours of the announcement of a proposal to cut the capital gains tax two years ago, Citizens for Tax Justice, a union-backed group, issued a study stating that 67.9 percent of the benefits would go to the top 1 percent of taxpayers and 84.5 percent to the top 5 percent. "Proposed GOP Capital Gains Tax Cut Means More Money for the Rich, Crumbs for the Rest," (July 7, 1999), available at http://www.ctj.org/html/cgcut99.htm.
  3. See Harry Edwin Smith, The United States Federal Internal Tax History from 1861 to 1871 (Boston: Houghton Mifflin, 1914).
  4. 82 U.S. (15 Wall.) 63, 65-66 (1872).
  5. 157 U.S. 429 (1895), 158 U.S. 601 (1895).
  6. The 16th Amendment states merely that income taxes may be imposed without being apportioned among the states. It did not in any other respect expand the Federal government's taxing power. See Evans v. Gore, 253 U.S. 245 (1920).
  7. 247 U.S. 189, 192 (1918). Emphasis in original.
  8. "Profits from Sale of Capital Assets as Income: Taxable under Sixteenth Amendment," Michigan Law Review, Vol. 19, No. 8, June 1921, pp. 857-58.
  9. Van Mayhall, "Capital Gains Taxation - The First One Hundred Years," Louisiana Law Review, Vol. 41, No. 1, Fall 1980, pp. 84-85.
  10. 247 U.S. 221, 231 (1918). One explanation for the seemingly contradictory rulings has to do with the fact that the first was decided under the corporate income tax statute, which had been found to be constitutional even before the 16th amendment because the Court ruled it to be an excise tax that was not, therefore, a direct tax that would be disallowed under the Pollock decision. The latter decision related to capital gains by an individual not regularly engaged in the trading of securities as a business.
  11. Marjorie Kornhauser, "The Origins of Capital Gains Taxation: What's Law Got to Do with It?" Southwestern Law Journal, Vol. 39, No. 4, November 1985, p. 900.
  12. 252 U.S. 189 214-215 (1919).
  13. 268 Fed. Rep. 207, 216 (1920).
  14. Editorial, "Taxation of Capital Gains," New York Times, February 15, 1921, p. 8.
  15. It should be noted that there was never any question that Congress could have passed a bill specifically taxing capital gains. The question was whether gains constituted "income" under the existing income tax law. Although the outcome may have been the same, had Congress passed the requisite legislation, it would have established the precedent that capital gains are by their nature different from other forms of taxable income. Furthermore, if capital gains were not taxable as income, any tax on them may have been considered a direct tax, and thus would have to be apportioned among the states. Although this constitutional provision has been considered a dead letter since the Pollock decision in 1895, some commentators still consider it to be a valid constitutional question. See Erik M. Jensen, "The Apportionment of 'Direct Taxes': Are Consumption Taxes Constitutional?" Columbia Law Review, Vol. 97, No. 8, December 1997; Calvin H. Johnson, "Apportionment of Direct Taxes: The Foul-Up in the Core of the Constitution," William & Mary Bill of Rights Journal, Vol. 7, No. 1, December 1998, pp. 1-103; Bruce Ackerman, "Taxation and the Constitution," Columbia Law Review, Vol. 99, No. 1, January 1999, pp. 1-58. 16 255 U.S. 509 (1921).
  16. 255 U.S. 509 (1921).
  17. "Constitutionality of Taxation of Realized Capital Increase under Federal Income Tax Acts," University of Pennsylvania Law Review, Vol. 69, No. 3, March 1921, p. 257.
  18. Fred Rogers Fairchild, "Federal Taxation of Income and Profits," American Economic Review, Vol. 11, No. 1, March 1921, p. 150.
  19. Mayhall, "Capital Gains Taxation - The First One Hundred Years," pp. 86-87.
  20. Kornhauser, "The Origins of Capital Gains Taxation," pp. 904-28.
  21. Lawrence H. Seltzer, The Nature and Tax Treatment of Capital Gains and Losses (New York: National Bureau of Economic Research, 1951), p. 367.
  22. See Charles C. Holt and John P. Shelton, "The Lock-In Effect of the Capital Gains Tax," National Tax Journal, Vol. 15, No. 4, December 1962, pp. 337-52.
  23. Annual Report of the Secretary of the Treasury, 1923 (Washington: Government Printing Office, 1924), p. 9. See also Annual Report of the Secretary of the Treasury, 1922 (Washington: Government Printing Office, 1923), p. 14. Some commentators agreed that eliminating capital gains from the tax base would probably not cost the Treasury any revenue, because although gains would not be taxed, losses would not be deductible. See "Profit on Investment as Taxable Income," Yale Law Journal, Vol. 30, No. 4, February 1921, p. 400.
  24. See Anita Wells, "Legislative History of Treatment of Capital Gains under the Federal Income Tax, 1913-1948," National Tax Journal, Vol. 2, No. 1, March 1949, pp. 12-32.
  25. See Walter J. Blum, "A Handy Summary of the Capital Gains Arguments," Taxes - The Tax Magazine, Vol. 35, No. 4, April 1957, p. 248; Noël B. Cunningham and Deborah H. Schenk, "The Case for a Capital Gains Preference," Tax Law Review, Vol. 48, No. 3, Spring 1993, pp. 325-26.
  26. Brian J. Arnold and Tim Edgar, "Selected Aspects of Capital Gains Taxation in Australia, New Zealand, the United Kingdom and the United States," Canadian Public Policy, Vol. 21, supplement, November 1995, pp. 58-61; Stephen R. Richardson and Kathryn E. Moore, "Canadian Experience with the Taxation of Capital Gains," Canadian Public Policy, Vol. 21, supplement, November 1995, pp. 77-99.
  27. B.E.V. Sabine, A History of Income Tax (London: George Allen & Unwin, 1966), pp. 60-61; F. Shehab, Progressive Taxation: A Study in the Development of the Progressive Principle in the British Income Tax (New York: Oxford University Press, 1953), pp. 97-98.
  28. Royal Commission on the Income Tax, Report (London: His Majesty's Stationery Office, 1920), p. 19.
  29. Robert M. Haig, "Capital Gains and How They Should Be Taxed," Proceedings of the Academy of Political Science, Vol. 11, No. 1, May 1924, pp. 131-142; idem, "Taxation of Capital Gains," Wall Street Journal (March 25 and 29, 1937).
  30. Royal Commission on the Taxation of Profits and Income, Final Report (London: Her Majesty's Stationery Office, 1955), pp. 25-37; G.D.N. Worswick, "Official Papers: The Royal Commission on the Taxation of Profits and Income," The Economic Journal, Vol. 66, June 1956, pp. 370-377.
  31. Interestingly, subsequent discussions of Britain's economic decline pinpointed the mid-1960s as a turning point. See, for example, Robert Bacon and Walter Eltis, Britain's Economic Problem: Too Few Producers, 2nd ed. (London: Macmillan, 1978); and Samuel Brittan, "How British Is the British Sickness?" Journal of Law and Economics, Vol. 21, No. 2, October 1978, pp. 245-68.
  32. Richardson and Moore, "Canadian Experience with the Taxation of Capital Gains."
  33. Carl Plehn, "The Concept of Income, as Recurrent, Consumable Receipts," American Economic Review, Vol. 14, No. 1, March 1924, p. 5.
  34. United States v. Oregon-Washington R. & Nav. Co., 251 Fed. Rep. 211, 213 (1918).
  35. See Robert M. Haig, "The Concept of Income - Economic and Legal Aspects," in Robert M. Haig, ed., The Federal Income Tax (New York: Columbia University Press, 1921), reprinted in Richard M. Musgrave and Carl S. Shoup, eds., Readings in the Economics of Taxation (New York: Richard D. Irwin, 1959), pp. 54-76; Henry C. Simons, Personal Income Taxation (Chicago: University of Chicago Press, 1938).
  36. Although no serious effort has ever been made to tax unrealized capital gains, proposals for doing so have periodically been put forward by tax theorists. See Joseph M. Dodge, "Restoring Preferential Capital Gains Treatment under a Flat Rate Income Tax: Panacea or Placebo?" Tax Notes, Vol. 44, No. 10, September 4, 1989, pp. 1133-43; David Shakow, "Taxation without Realization: A Proposal for Accrual Taxation," University of Pennsylvania Law Review, Vol. 134, June 1986, pp. 1111-1205; David Slawson, "Taxing as Ordinary Income the Appreciation of Publicly Held Stock," Yale Law Journal, Vol. 76, No. 4, March 1967, pp. 623-676.
  37. Richard Goode, "The Economic Definition of Income," in Joseph A. Pechman, ed., Comprehensive Income Taxation (Washington: Brookings Institution, 1977), pp. 1-30; Joseph A. Pechman, Federal Tax Policy, 5th ed. (Washington: Brookings Institution, 1987), p. 80. The latest Brookings publication on capital gains continues to maintain that Haig-Simons requires full taxation of unrealized capital gains. See Leonard Burman, The Labyrinth of Capital Gains Tax Policy (Washington: Brookings Institution, 1999). It should be noted that the Haig-Simons definition of income underlies the whole concept of "tax expenditures." For a critique of this concept, see Bruce Bartlett, "The End of Tax Expenditures As We Know Them?" IRET Policy Bulletin, No. 84, June 13, 2001.
  38. E.R.A. Seligman, "Are Stock Dividends Income?" American Economic Review, Vol. 9, No. 3, September 1919, p. 526.
  39. Richard W. Kopcke, "No Gain, No Pain: Some Consequences of Taxing Capital Gains," New England Economic Review, March/April 1989, p. 39. For a similar analysis, see Neil A. Stevens, "Taxation of Capital Gains: Principle versus Practice," Federal Reserve Bank of St. Louis Review, Vol. 60, No. 10, October 1978, pp. 2-8.
  40. Martin J. Bailey, "Comment," in Dan Usher, ed., The Measurement of Capital (Chicago: University of Chicago Press, 1980), p. 343.
  41. Simon Kuznets, National Income and Its Composition, 1919-1938 (New York: National Bureau of Economic Research, 1941), p. 12. See also M.A. Copeland, "Concept of National Income," Studies in Income and Wealth, Vol. 1 (New York: National Bureau of Economic Research, 1937), pp. 3-34; Roy Blough and W.W. Hewett, "Capital Gains in Income Theory and Taxation Policy," Studies in Income and Wealth, Vol. 2 (New York: National Bureau of Economic Research, 1938), pp. 191-239.
  42. Survey of Current Business, Vol. 80, No. 9, September 2000, p. 16.
  43. "Simplification of the Federal Income Tax - Discussion," American Economic Review, Vol. 18, No. 1, March 1928, p. 120.
  44. Simons, Personal Income Taxation, p. 157.
  45. Henry C. Simons, Federal Tax Reform (Chicago: University of Chicago Press, 1950), pp. 20-21; Richard A. Musgrave, "In Defense of an Income Concept," Harvard Law Review, Vol. 81, November 1967, p. 61; Charles E. McLure, Jr., "Integration of the Personal and Corporate Income Taxes: The Missing Element in Recent Tax Reform Proposals," Harvard Law Review, Vol. 88, January 1975, pp. 532-582.
  46. For practical problems with the Haig-Simons definition, see Victor Thuronyi, "The Concept of Income," Tax Law Review, Vol. 46, No. 1, Fall 1990, pp. 45-105.
  47. Haig, "The Concept of Income," p. 67.
  48. Simons, Personal Income Taxation, p. 155. See also Bruce Bartlett, "Inflation and Capital Gains," Tax Notes, Vol. 75, No. 9, June 2, 1997, pp. 1263-66.
  49. Martin Feldstein and Joel Slemrod, "Inflation and the Excess Taxation of Capital Gains on Corporate Stock," National Tax Journal, Vol. 31, No. 2, June 1978, pp. 107-118.
  50. U.S. Treasury Department, Report to Congress on the Capital Gains Tax Reductions of 1978 (Washington: U.S. Government Printing Office, 1985), p. 11.
  51. Congressional Budget Office, Indexing Capital Gains (Washington: U.S. Government Printing Office, 1990), p. 24.
  52. Leonard Burman and Eric Toder, "Indexing v. Exclusion of Capital Gains: Effects on Income Distribution and Economic Efficiency," 1992 Proceedings of the 85th Annual Conference on Taxation (Columbus, OH: National Tax Association, 1993), pp. 14-15.
  53. Congressional Budget Office, "Perspectives on the Ownership of Capital Assets and the Realization of Capital Gains," CBO Papers (May 1997), p. 29.
  54. Robert Eisner, "Capital Gains and Income: Real Changes in the Value of Capital in the United States, 1946-77," in Usher, Measurement of Capital, pp. 202-203.
  55. One who always did was Irving Fisher, who, although best known for his work on statistics and monetary theory, wrote extensively on why capital gains and saving in general should not be taxed in principle. Recent calls for a consumption-based tax system are really just echoes of Fisher's pioneering work. See Irving Fisher and Herbert W. Fisher, Constructive Income Taxation (New York: Harper & Brothers, 1942).

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