President Obama reopened a fiscal can of worms with his proposal to increase the capital gains tax to 28 percent, a plan Republicans said they would not adopt.
The administration has tried to paint it as a mainstream idea, noting that the rate was 28 percent under President Ronald Reagan, and saying it would close a “loophole” that benefits the richest 0.1 percent of Americans, who for more than two decades received about half of all capital gains.
But Reagan accepted the 28 percent rate as part of a tax reform that set a single top tax rate of 28 percent not only for capital gains but also for earned income and dividends. And Republicans have been trying to drive the rate down ever since, arguing that a lower rate encourages saving and investment.
“Proposing to raise the capital gains rate is not a serious attempt to find common ground with Republicans,” said N. Gregory Mankiw, a Harvard University economics professor and chairman of President George W. Bush’s Council of Economic Advisers. “It shows that the president is more interested in spending his last two years defining himself in opposition to the congressional majority than in trying to reach compromise and actually accomplish something.”
Most Democrats favor boosting the capital gains rate. They say the problem isn’t just the rate, but the unequal treatment of capital gains and wages. The income tax on wages has gone up while the capital gains tax dropped to 15 percent under Bush and rebounded only to 20 percent under Obama. Democrats say that is a key reason for growing inequality because the rewards of growth have flowed to investors, not workers.
Any individual making more than $37,450 a year in 2015 will pay a higher marginal tax rate on wages — 25 percent — than a billionaire will pay on profits from the sale of stock or bonds or real property.
“The tax code strongly favors income from capital gains — i.e., increases in the value of assets such as stocks — over income from wages and salaries,” wrote Robert Greenstein, head of the liberal-leaning Center on Budget and Policy Priorities. “This imbalance fuels inefficient tax avoidance and unproductive asset-hoarding. It’s also very regressive, since the top 1 percent of households hold about 42 percent of total wealth.”
He said that raising the capital gains tax rate while expanding tax credits would “reduce various inefficiencies,” while the revenue raised would be “reinvested” in ways that increase the productivity of the labor force.
The tripling of the child tax credit would make it possible for more people to enter the workforce, potentially expanding the economy, which is struggling, in part, because the population is aging, Greenstein said.
Republicans say that a low rate on capital gains spurs investment so much that everyone benefits..
“Taxes on capital income, such as the capital gains tax, are among the worst ways to raise revenue from the perspective of economic growth,” Mankiw said. “In particular, a tax that discourages capital accumulation reduces labor productivity and real wages. It thereby reduces the well-being even of those individuals who hold no capital.”
Many Republicans contend that the appropriate capital gains rate is zero because investors would not have any incentive to hang on to assets whose value might be better invested elsewhere.
The rate was 35 percent under Presidents Richard M. Nixon and Jimmy Carter, then dropped as low as 20 percent under Reagan before rebounding to 28 percent. It rose again, to 31 percent, under a very reluctant President George H.W. Bush as part of the controversial 1990 budget deal. Under Bill Clinton, the rate was cut to 28 and then 20 percent, before George W. Bush sliced it to 15 percent.
Obama has increased the rate to 20 percent again. (A Medicare surtax on wealthy Americans adds 2.3 percentage points more.) Under Obama’s proposal, a couple would have to make more than a half-million dollars a year for the higher rate, 28 percent, to be applied to them.
“It’s a religious issue for both sides of the political divide, with conservatives equating capital gains tax preferences with growth and liberals with unfairness,” tax expert Len Burman wrote on his blog. “The issues are more nuanced than the zealots on either side would admit.”