The Bush Capital Gains Tax Cut after Four Years: More Growth, More Investment, More Revenues

Studies | Taxes

No. 307
Thursday, January 10, 2008
by Stephen Moore and Tyler Grimm


Conclusion

“Lower capital gains tax rates increase asset values and encourage investment.”

By every objective measure, the 2003 capital gains tax cut has had positive economic and fiscal effects.  Even the argument that the capital gains tax change would only benefit rich people has been proven to be inaccurate given that more than half the tax returns with capital gains income are from filers with adjusted gross incomes of $50,000 or less.  Whether the tax cut will pay for itself in the long term is an open question, but what is irrefutable is that the capital gains cut, so far, has increased collections from this tax after four years.  The stock market and real estate market booms have been the major factors in the doubling of capital gains revenues, but the higher asset valuations have been partly due to investors seizing on the lower taxes on capital assets.

The Treasury Department recently provided a concise summary of the 2003 capital gains cut experience:

The lower tax rates on dividends and capital gains lower the cost of equity capital and reduce the tax biases against dividend payment, equity finance and investment in the corporate sector.  All of these policies increase incentives to work, save and invest by reducing the distorting effects of taxes.  Capital investment and labor productivity will thus be higher, which means higher output and living standards in the long run.31

The Treasury’s analysis is by no means a modern revelation.  In 1963 President John F. Kennedy clearly understood the fundamental importance of capital investment’s role in the economy:

The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital . . . the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy.32

“Congress should permanently reduce taxes on capital gains.”

Finally, circumstantial evidence suggests that the political uncertainty of the direction the capital gains tax is headed may now be hurting the stock market and reducing the value of U.S. assets, which may be exacerbating the dollar’s fall relative to the euro and other currencies.  After 2010, the capital gains tax is scheduled to rise back to 20 percent.  This reduces the value of stocks today, because the after-tax rate of future returns on stocks is lower with the possibility of this coming tax hike.  Moreover, the Wall Street Journal reports that investors are already beginning to sell stocks and other assets in anticipation of the higher tax rate in 2011.

In our opinion, it is not only critical that Congress extend the life of the tax cuts by making them permanent, but also vital to do so sooner rather than later.  This would help boost the economy now and reduce the bearish nature of economic and fiscal policy uncertainty.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.


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