NCPA - National Center for Policy Analysis

A Tax Cut Close to a Free Lunch

May 13, 2003

There is a tax rate cut that doesn't lose revenue, but will increase jobs and economic growth, says Richard Rahn. It is included in House Ways and Means Chairman Bill Thomas' tax bill now before the Congress. Thomas' bill contains a provision to reduce the maximum rate on long-term capital gains to 15 percent from the current 20 percent.

Capital gains taxes, unlike most taxes, are largely discretionary. Individuals or companies only realize capital gains if they sell an appreciated asset. If the tax rate is too high, people will often choose not to sell and the government gets zero revenue.

Since 1978, the maximum capital-gains tax has been decreased three times (1978, 1981, 1997) and increased twice (1986 and slightly in 1990). When rates were lowered, investors sold more assets and federal revenues went up. When rates were hiked, fewer gains were realized and federal revenues went down:

  • In 1977, when the maximum tax rate was 40 percent, about $44 billion of long-term capital gains were realized and taxed, generating nearly $8 billion in federal revenue.
  • After the rate was slashed to 28 percent (1978), roughly $70 billion in gains were realized in each of the two following years, and revenue shot up to more than $10 billion annually.
  • In 1981 the rate was cut to 20 percent, and revenue kept rising -- reaching $51 billion in 1986.

The 1986 tax bill raised the rate back up to 28 percent, and federal revenue fell -- from less than $32 billion in 1987 to $26 billion in 1990. The 1990 tax bill raised the tax rate slightly to 29 percent, and revenue fell to less than $22 billion in 1991.

Revenues gradually recovered during the 1990s, reaching nearly $59 billion in 1995.

However, when in 1997 Congress cut the rate to 21 percent, realizations rose to $425 billion, and federal revenue reached $81 billion in 1998.

Source: Richard W. Rahn (Discovery Institute), "Want a free lunch?" Washington Times, May 8, 2003.


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