NCPA - National Center for Policy Analysis

Why Tax Capital Gains?

September 9, 2002

Pragmatic arguments for cutting the capital gains tax may have worked once, but now we need a principled case why capital gains should not be taxed at all. The metaphor of the fruit (income) and the growth of the tree from which it comes (capital) is useful.

  • Not taxing capital gains--not chopping limbs--would allow the tree to grow, which will produce more fruit in the future and increase government's when it's taxed.
  • Therefore, in principle, capital gains should not be taxed at all, since they are not income, except in the minds of those incapable of complex thought.
  • The present 20 percent maximum tax rate on capital gains, while the top rate on wages is more than twice that, is not a preference or giveaway, but the mitigation of something that is wrong in the first place.
  • Viewed in this light--a position once held by the U.S. Supreme Court in the case of Gray v. Darlington (1872)--cutting the capital gains tax is simply the redress of an illegitimate form of taxation.

And of course, cutting the capital gains tax will also have beneficial economic gains.

  • The experience of the 1969 and 1986 increases in the capital gains tax, and the 1978, 1981 and 1997 reductions, strongly suggests that capital gains realizations will expand by more than enough to actually raise federal revenue. (see chart)
  • According to the Treasury Department, there is almost an exact inverse relationship between the long-term capital gains tax rate and realizations as a share of the gross domestic product.
  • When the rate goes up, realizations go down, and vice versa.

President Bush should not be shy about making both the practical and the moral argument for eliminating the capital gains tax.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, September 9, 2002.

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