Does the Low Capital Gains Tax Harm the Poor?

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An article in the Washington Post makes this assertion, but provides little to no evidence to back up its claim

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Should the rich pay more in taxes? Most Americans think so, and they do face higher income tax brackets. But they also benefit from a relatively low capital gains tax, which can result in some wealthy individuals having a relatively lower effective tax rate than poorer people.

This situation inspired Billionaire investor Warren Buffett to pen an op-ed piece about a month ago, calling on regulators to take a hard look at the capital gains tax. Today, the Washington Post has a sprawling front-page story about how the capital gains tax hurts the poor by feeding the inequality gap. Unfortunately, its authors provide no credible evidence that this is the case.

Why Capital Gains Taxes Are So Low

For starters, simple math can show that if rich people invest their money and face a relatively low tax rate on their profits then wealth inequality will grow. Indeed, unless you make investing illegal, the gap between rich and poor would widen no matter how high the tax rate: those who are have more money to invest would boost their incomes more than those who don't. Lower tax rates just cause the gap to grow faster. 

But why have a relatively low capital gains tax rate? Doing so encourages investment. Obviously, the poor, along with everybody else, would benefit from investment and the growth that follows. If capital gains taxes are very high, then wealthy people would prefer to spend more of their money instead of investing it. Taxing worker income doesn't run into this problem: people have no choice but to work, unless they intend to rely on the welfare system. But those with extra capital always have a choice about how to use it: enjoy the money now through consumption or invest it to have more money to spend in the future. For this reason, the decision to generate income through investment should be more sensitive to tax rates than the decision to generate income from work.

Will More Tax Revenue Necessarily Benefit the Less Affluent?

Now let's look at the WaPo article. Its authors Steven Mufson and Jia Lynn Yang argue that the capital gains tax should be raised because doing so will help to close the income gap. This could only help if it makes the poor better off. But this assertion relies on the assumption that the poor aren't actually better off with additional opportunities for better employment provided by more investment. Here's the first argument they provide to support that assumption.

Many tax experts contest the benefits of a low capital gains rate.

Jane Gravelle, a tax expert at the Congressional Research Service, says a [capital gains] rate cut could generate more government revenue for a year or two as investors take advantage of lower rates or a rising stock market, but she says that initial bump in tax revenue would fade. And the government, over time, would collect more overall if it kept the rate higher.

If we assume that Gravelle is right, then this means that a low capital gains tax doesn't provide additional capital gains tax revenue in the long run. So what? Lower wage earners are only necessarily better off when more tax income is generated if you assume that transfer payments are the only way to create a thriving lower- and middle-class. Instead, less affluent workers could still ultimately benefit from a lower capital gains tax if the additional investment it provides creates better job opportunities. And higher paying jobs could, in turn, provide more overall tax revenue for the government.

Do Low Capital Gains Taxes Create Jobs?

But do lower capital gains taxes really create jobs? The article takes a shot at that possibility too:

"Lower capital gains [taxes] are a mixed bag even if you're just looking at efficiency," said Leonard Burman, a professor at Syracuse University and former head of tax analysis at the Treasury Department. "It might encourage more risk-taking, but it also creates huge opportunities for tax shelters aimed at converting ordinary income to capital gains. People would make investments only because of the tax benefits."

Moreover, he notes, given the recent financial crisis, it's not clear that an absence of risk-taking is what's ailing the economy.

This comment is bizarre for a couple of reasons. For starters, stating that increased "risk-taking" is the purpose of a low capital gains tax is a loaded way to express its objective. If you want to define startups and business expansion as "risk-taking," then you'll find this explanation sensible. But risk is really just an inescapable feature of investing. More accurately stated, a low capital gains tax should produce more investment generally, since it would discourage consumption and encourage saving (via investment). Such investment will create jobs.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
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