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Tax Policy Center Espouses Minority View on Capital Income Taxes

4 min readBy: William McBride

Chris Sanchirico, a law professor and visiting scholar at the TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Policy Center, continues to promote a view of capital income taxation that is contrary to what most economists think:

Long term capital gains are taxed only when the asset is sold and at roughly half the rate on wages and salaries. Dare to suggest that the rate on investment profits could be raised a bit—so that perhaps the rate on labor income could lowered—and you’re liable to be reprimanded for failing to understand something as plain as the nose on your face: To tax capital income is to tax the reward for saving and thus to discourage saving. Less saving means less investment and less investment means slower growth, fewer jobs, and lower wages.

Everyone knows that.

Everyone, that is, except the people who study the issue.

He references his Wharton policy brief in which he lays out a strange theory of saving behavior, and then for evidence points to this figure:

As he explains:

Figure 1 shows the sixty-year time pattern of the personal savings rate (the fraction of after-tax personal income not consumed) and the highest marginal effective tax rate on capital gains (accounting for deduction phase-outs, etc.). The graph reveals little discernible relationship between such tax rates and savings. Notice in particular that the personal savings rate appears to move with, not against, the capital gains rate until the mid 1980’s and from the mid-1990’s until the mid-2000’s.

But what Sanchirico has labeled as the maximum effective rate on capital gains is in fact the maximum statutory rate, as per Treasury data. Here is the corrected figure:

The corrected figure gives no indication that lower capital gains rates led to lower savings. In fact, there is an obvious decline in savings following the 1986 increase in the capital gains rate. Certainly, many other factors are in play, and a proper analysis should take these into account. Instead, Sanchirico gives us a hodgepodge of reasons to raise taxes on investors:

But even if one could support the claim that capital income taxes—considered in isolation—hinder growth, that would not be enough. Capital income taxes aren’t set in a vacuum. Lower capital income taxes mean higher labor income taxes or additional government borrowing. (Yes, capital income tax reductions could be offset with spending cuts. But that just begs the question of why such cuts aren’t instead being used to reduce labor income taxes or borrowing .) Thus, to make the case against capital income taxes, one has to argue not just that such taxes hinder growth, but that they hinder growth more than labor income taxes and government borrowing.

That’s not an easy task.

I wouldn’t say it is easy, but it does involve a balanced review of the academic literature, which I did here and here. The preponderance of evidence points to corporate taxes being the most harmful to economic growth, followed by personal income taxes, consumption taxes, and property taxes. Notice a pattern? The corporate tax is the largest tax on capital income in most countries, while the personal income tax is the largest tax on labor although it also taxes capital. Taxes on pure labor, like the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. , do not have as big an impact as taxes on capital. The studies typically are not able to measure the effects of shareholder taxes, which are also taxes on capital, precisely because these are minor or nonexistent taxes in most countries and the data is lacking. Further, the studies indicate that taxes on income and profit are worse for growth than deficits.

This and other evidence, as well as standard theory, points to capital income taxes being bad for growth, and this is why it is the consensus view among economists. For example, a recent survey by the Booth School at the University of Chicago asked 40 prominent economists for responses to this statement:

Despite relabeling concerns, taxing capital income at a permanently lower rate than labor income would result in higher average long-term prosperity, relative to an alternative that generated the same amount of tax revenue by permanently taxing capital and labor income at equal rates instead.

A fair amount of economists are uncertain (31 percent), because most economists are not tax experts. However, 36 percent agree or strongly agree, while only 13 percent disagree or strongly disagree. In fact, only one of the 40 economists strongly disagrees, and that is Emmanuel Saez, widely known for his research into income inequality and his calls for more redistribution of income through the tax code. Interestingly, the Booth School also asked for responses to this question:

Although they do not always agree about the precise likely effects of different tax policies, another reason why economists often give disparate advice on tax policy is because they hold differing views about choices between raising average prosperity and redistributing income.

Not a single economist surveyed disagrees with that statement.

Follow William McBride on Twitter @EconoWill