Tax Magic

Friday, October 24, 2008

HISTORY, John McCain said in New Hampshire this week, proves that cutting the capital gains tax actually yields more revenue: "Rates were cut in the Clinton years -- revenue went up. Rates were cut in the Bush years -- revenue went up. . . . But Senator Obama insists on a tax hike, as a matter of principle. And the principle seems to be the redistribution of wealth as an end in itself."

Mr. McCain would keep the capital gains rate, imposed on the sale of assets such as stock, businesses and land, at 15 percent. So would Mr. Obama -- except for individuals earning more than $200,000 a year and couples earning more than $250,000. These taxpayers would pay a 20 percent rate on capital gains and dividends. So would Mr. Obama's plan really produce less tax revenue, not more?

President Bush doesn't think so. His Treasury Department estimates that keeping the 15 percent rate in place, rather than allowing it to return to 28 percent as scheduled in 2011, would cost $104 billion over the next decade. The Congressional Budget Office doesn't think so. "The best estimates of taxpayers' response to changes in the capital gains tax rate do not suggest a large revenue increase from additional realizations of capital gains -- and certainly not an increase large enough to offset the losses from a lower rate," it said in May. Harvard economist N. Gregory Mankiw, former chairman of President Bush's Council of Economic Advisers, doesn't think so. Mr. Mankiw concluded that the economic benefit of a lower capital gains rate can help recover as much as 50 percent of the cost of the tax cut.

So what about the history that Mr. McCain cites? Sure, in the immediate aftermath of a tax cut, taxpayers have an incentive to sell their holdings to take advantage of the lower rate, but that's a timing shift, with the government getting tax revenue now rather than later. In addition, correlating capital gains rates with capital gains revenue ignores numerous other factors in the mix -- the stock market, for one. Mr. McCain can point out, for instance, that after capital gains rates were cut in 1997, capital gains tax revenue rose 40 percent that year and 25 percent the next. Sounds convincing, except that capital gains revenue rose 45 percent in 1996 -- before the cut -- and plummeted in 2001 and 2002, when capital gains rates remained the same. In other words, Mr. McCain and other true believers in the tax fairy notwithstanding, cutting the capital gains tax does not pay for itself.

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