Guess what? Tax cuts DO increase tax revenue

[Stevicat]

TASTES GREAT, MORE FILLING

Daily Policy Digest

TAXES


Friday, February 03, 2006


--------------------------------------------------------------------------------

The latest statistics on capital gains tax collections from the Congressional Budget Office show receipts are not down but way up. By 45 percent to be exact. As part of President Bush's 2003 investment tax cut package, the capital gains tax rate was reduced to 15 percent from 20 percent. Opponents predicted, as ever, that this would reduce tax revenue, says the Wall Street Journal.

Not even close. Here's what actually happened, says the Journal:

This 25 percent reduction in the tax penalty on stock and other asset sales triggered a doubling of capital gains realizations, to $539 billion in 2005 from $269 billion in 2002.
One influence was the increase in stock values over that time, thanks in part to the higher after-tax return on capital induced by the tax cuts.
But another cause for the windfall was almost certainly the "unlocking" effect from investors selling their existing asset holdings in order to realize some of their profits and pay taxes at the lower rate, explains the Journal. They could then turn around and buy new assets, hoping for higher rates of return. This "unlocking" promotes the efficiency of capital markets by redirecting investment into new and higher value-added companies.

It also yields a windfall for the Treasury, says the Journal:

In 2002, the year before the tax cut, capital gains tax liabilities were $49 billion at the 20 percent rate.
They rose slightly to $51 billion in 2003, then surged to $71 billion in 2004, and were estimated by CBO to have reached $80 billion last year -- all paid at the lower 15 percent rate. In short, the lower rate yielded more revenue.
Source: Editorial, "Tastes Great, More Filling," Wall Street Journal, February 3, 2006.

For text (subscription required):

[SonomaCat]

So capital gains have increased since 2002. Is that due to tax cuts, or is that due to the fact that 2002 was a HUGE negative correction period for the stock market?

So if one can prove that reducing taxes directly improved the stock market, then the assertion stands without question. However, I don't think anybody can reasonably make that case. Tax cuts may have helped to drive some additional capital gains (and it made it more profitble for people to invest in stocks), but it is impossible to quantify whether that marginal increase in capital gains exceeded the tax revenue that was lost from lowering of the tax rate.

So it is an interesting set of data points, but it does little to prove a cause-effect relationship.

[Bleedinbluengold]

You completely lost me, BAC?

[SonomaCat]

You completely lost me, BAC?

I do that to myself sometimes.

Despite the fact that capital gains went up, it is difficult to prove that the tex cuts resulted in a net increase in tax revenues. Other factors may well have contributed to most of the increase in capital gains (2005 not being at the tail-end of a stock market implosion like 2002, for one).

I hope that makes more sense. Words get the best of me sometimes....

EDIT: Philosophically, I actually think that the corporate tax rate should be zero and that capital gains should not be taxed at all, but those kinds of changes, if applied literally, would probably really mess up our budget in a huge way, so they aren't practical.

[Bleedinbluengold]

So, are you saying that part of the increase was, perhaps, because people bought stocks at lower levels in 2002, and sold them in 2003, 2004 and 2005 because the stock price did, in fact, go up?

If that is the case, then at worst, there is symbiotic relationship between the cap gains rate now and the frequency with which investors sell stocks. If the cap gains rate was not the flat 15% that you get if you hold for year, I would argue that people would not sell those stocks, because it is generally believed that your personal tax rate goes down after retirement. Since the cap gains rate is now 15%, then it makes more sense to sell stocks sooner rather than later, because (a), the rule could be repealled, and (b), the liklihood that the cap gains rate will ever be less than 15% is very low.

So - in my opinion - the tax cuts did indeed result in more tax revenue, whether directly or indirectly.

[SonomaCat]

So, are you saying that part of the increase was, perhaps, because people bought stocks at lower levels in 2002, and sold them in 2003, 2004 and 2005 because the stock price did, in fact, go up?

If that is the case, then at worst, there is symbiotic relationship between the cap gains rate now and the frequency with which investors sell stocks. If the cap gains rate was not the flat 15% that you get if you hold for year, I would argue that people would not sell those stocks, because it is generally believed that your personal tax rate goes down after retirement. Since the cap gains rate is now 15%, then it makes more sense to sell stocks sooner rather than later, because (a), the rule could be repealled, and (b), the liklihood that the cap gains rate will ever be less than 15% is very low.

So - in my opinion - the tax cuts did indeed result in more tax revenue, whether directly or indirectly.

I would say (similarly, just my opinion) that the additional tax revenue was more directly tied to economic and market factors that had little to do with tax policy, so there is no strong cause-effect relationship to be drawn from the decrease in tax rates and the increase in tax revenue.

We could compare the tax rates at 1999 to the tax rates at 2005, and the comparable tax revenues for the two periods, and we would assert (if applying the same theory as the premise of this thread) that the higher taxes in 1999 were responsible for the much, much higher capital gains we saw during that period. As we know, that's not a true statement, either.

If we wanted to do a meaningful analysis of the impact of capital gains rates on the net impact on the capital gains and net tax revenues, we need to incorporate a lot more data points than two tax years ... especially when one of the tax years (2002) was at the tail-end of one of the worst market meltodowns in our history.

I do like your ideas about the market psychology of the tax cuts and what impact they may have had in pushing people's decision-making process. There may well be a lot of that thinking going on as well. But in general, going back to the implosion of the market, I think a lot of people are also much quicker to cash out these days when they have a nice gain as opposed to "waiting until the stock hits 100" like we used to. Losing lots of paper gains has made for a lot of gun-shy investors -- me among them.