A “capital gain” refers to how much the value of an asset (such as a stock) has increased over time. Taxes on capital gains are triggered only when the asset is sold. So if you bought a few shares of Apple stock when it IPO’d in 1980, your shares would be worth a fortune today — but you don’t owe Uncle Sam a penny until you cash out.
And perhaps not even then.
Only a small sliver — about a quarter — of U.S. stock is taxable, because most equities are held in tax-exempt retirement accounts or by tax-exempt nonprofits or foreigners, according to the Tax Policy Center's Steven M. Rosenthal and Lydia Austin. Sales of assets that are taxable are taxed at preferential rates (that is, lower than what you pay on your wage or salary income) if the investments are held for more than a year.
The great majority of this taxable investment income accrues to the very richest Americans. Last year, for instance, the top 1 percent of households received three-quarters of all long-term capital gains. So that’s the population who’d primarily benefit when the White House suggests further capital gains tax cuts.
In fact, the government has already created other ways to help wealthy people avoid paying these taxes.
If you happen to die before selling those Apple shares, for example, your kids can inherit them without anyone ever paying income taxes on the gains accumulated during your lifetime.
Or, thanks to the GOP’s 2017 tax law, you can sell your shares, reinvest the profits into a designated “Opportunity Zone” project and have the taxes on your Apple profits postponed or partially forgiven.
Even before the pandemic, the White House was proposing additional capital gains tax off-ramps. Now Hassett suggests this new iteration: For some temporary, to-be-determined length of time, rich people could sell their assets, realize whatever gains they’ve accumulated over the decades, and never pay taxes on the income.
Why is the GOP so fixated on capital gains tax cuts?
One possible explanation is self-interest: Some important Republican constituents live off their wealth rather than the sweat of their brows. The GOP is hardly the only party pushing tax breaks that benefit high-income constituents: The Democratic House’s latest coronavirus-relief bill, while weighted overall toward lower-income Americans, nonetheless included a tax break that almost exclusively helps high-income, blue-state residents.
But Republicans insist that these tax breaks aren’t a cynical ploy to reward donors. They’re about boosting economic growth!
This was also the pitch for their 2017 corporate tax cuts. If only the feds take a smaller cut of investors’ returns, Hassett and others argued, investors would provide more capital to companies. Companies would then build more factories and buy more equipment, which would in turn make workers more productive and stimulate long-term economic growth.
Even if you believe this story (and the 2017 law’s track record provides reason for skepticism), a one-time, temporary capital gains holiday would only reward past investment decisions. It would not actually increase incentives to make new investments. Sure, the lucky guy who bought Apple stock in 1980 can now cash out tax-free. But the policy would do little to change future investment decisions and increase capital accumulation.
It’s also unlikely to produce much in the way of a Keynesian-style, demand-side stimulus, because the high-income households disproportionately reaping the benefits are more likely to save their windfalls rather than spend them.
It would, however, make budgeting more difficult for whoever’s in the White House when the holiday ends.
That’s because anyone with any unrealized gains today would use the holiday to sell and book those gains now, tax-free, thereby denying the government the ability to ever collect revenue on them. You can’t unring the bell. Absent some sort of (possibly unconstitutional) wealth tax, the holiday would deprive the treasury of taxes on the past 50 years or so of accumulated, unrealized capital gains.
This would permanently increase deficits, which in the long run would drag economic growth, according to University of Pennsylvania economist and Penn Wharton Budget Model director Kent Smetters.
But in the long run we’re all dead, right? Might as well make one last cash grab on the way out the door.