NCPA - National Center for Policy Analysis

What Kind Of Response To A Capital Gains Tax Cut?

December 7, 1995

Most economists realize that people change their financial behavior in response to a change in their economic environment. That's an important point to remember in the debate over cutting the top rate for taxpayers who achieve gains on their stocks, bonds and other assets.

Some computer models of the economy assume that people won't change their behavior if taxes are lowered. That's known as a static model. Dynamic computer models try to factor in what the human response is likely to be in a changed tax environment.

The Congressional Budget Office predicts that a capital gains tax cut will cost the government $36 billion in lost revenue over the next seven years. But private studies using sophisticated econometric models, based on dynamic responses among taxpayers, consistently show that a capital gains tax cut would -- at the very least -- pay for itself.

  • Given lower tax rates, investors are more likely to shift assets around, unlocking their gains and paying taxes.
  • One study predicts that lowering the rates would boost asset values by 5.5 percent, raising stock values more than $220 billion and increasing revenues by some $6.5 billion.
  • After 10 years, real growth could be 0.4 percent higher, adding $8 billion in federal revenue by 2005.
  • Another study which attempts to take all factors into account predicts a $50 billion increase in revenues over five years.
  • Still another study forecasts a revenue increase of $126 billion over the same period.

Congressional Republicans are boxed in by arcane rules that fail to take into account changes in human behavior under altered conditions. They are also disadvantaged in the tax and budget debate by the notion that a small decrease in the projected spending increase is somehow a "cut."In fact, federal spending increases every year under the GOP budget from now until 2002.

Source: John Merline, "Budget Rules Trap Republicans," Investor's Business Daily, December 7, 1995.


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