Do low taxes on capital gains spur growth? Not necessarily.

at 11:56 AM ET, 01/19/2012

On Tuesday, Mitt Romney conceded that his taxes are low because he largely pays the 15 percent tax rate on investment income, rather than the higher 35 percent top rate on wage income. Those remarks renewed the debate over whether the tax on capital gains should be that low.

James Pethokoukis argued that lightly taxing capital gains helps spur investment, which the United States needs more of. Jared Bernstein, on the other hand, brings the graph to suggest that there’s never been a clear relationship between the capital gains tax rate and investment:


(Real investment is in natural logs to show proportional growth over this long time series.)

The top tax rate on investment income has bounced up and down over the past 80 years — from as high as 39.9 percent in 1977 to just 15 percent today — yet investment just appears to grow with the cycle, seemingly unaffected.

So is the capital gains tax rate really so insignificant? Perhaps. Back in August, the New York Times ran a piece on this very topic. Warren Buffett, for one, claimed that the tax rate on investment income doesn’t make much of a difference to actual investors: “I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off.”

Meanwhile, Troy Kravitz and Len Burman of the Urban Institute have shown that, over the past 50 years, there’s no correlation between the top capital gains tax rate and U.S. economic growth — even if you allow for a lag of up to five years. “Moreover,” they add, “any effect is likely small as capital gains realizations have averaged about 3 percent of GDP since 1960 and have never been more than 7.5 percent.”

In this old exchange, economist Tyler Cowen largely concurred, arguing that changes to the capital gains tax rate mainly affect investments already made rather than new investments — and the latter is what drives growth. Cowen cautioned that most studies look at the nominal tax rate rather than what investors actually pay in practice (which is presumably much, much lower, thanks to loss offsets and deductions for interest payments and so forth). Even so, he concluded: “I regarded this as one of the great myths of some schools of economics, namely the power of the capital gains tax rate.”

 
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