The Dangers of Raising Taxes on Investment Income

March 13, 2012

In its fiscal year 2013 budget proposal, the Obama administration has proposed a series of tax law changes designed to raise more revenue from higher-income earners.  The administration has suggested increasing the tax rate on two major categories of investment income.  Long-term capital gains tax rates would rise from 15 to 20 percent, and the tax rate on income from corporate dividends would rise from 15 percent to a top rate comparable to that of the highest "ordinary" income bracket, or 43.4 percent.  These rates will serve the administration's purpose of raising tax rates on investment income in the name of its view of tax fairness or justice.  If, however, the administration is concerned that capital investment in U.S. firms continues at a time when economic recovery remains fragile, these proposals will harm the U.S. economy, says Diana Furchtgott-Roth, a senior fellow at the Manhattan Institute.

There is good reason to believe that higher rates on capital gains and dividend income would have negative effects on the U.S. economy by reducing the overall level of U.S. investment and by driving such investment to overseas markets.  Higher tax rates would reduce economic activity and, thus, economic growth, by reducing available financing for private companies, innovators and small firms just getting started.

Here are a series of reasons why this would be the case:

  • Taxes on U.S. investment would be higher compared to taxes abroad, so some investment capital is likely to move offshore.
  • Increased capital gains rates presume a steady appetite for risk on the part of investors, notwithstanding the prospect of decreased returns on investment capital. In other words, investments can just as easily lead to losses as gains -- and higher tax rates on capital gains will inevitably discourage some percentage of investors.
  • Investors cognizant of the risk of inflation will have, in higher tax rates, yet another reason to limit new investment.

More broadly, the administration's proposals fail to recognize the complexity of the question of how much Americans should -- and do -- pay in taxes.  This larger issue cannot be avoided in light of the additional administration proposal to raise tax rates for individual filers earning more than $200,000 and joint filers earning more than $250,000 from 33 to 36 percent, and 35 to 39.6 percent, respectively.  Simply put, the idea that high income earners are paying less than those at lower income levels is not supported by the facts.

Source: Diana Furchtgott-Roth, "The Dangers of Raising Taxes on Investment Income," Manhattan Institute, March 2012.

For text:

http://www.manhattan-institute.org/html/ir_5.htm

 

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