The Rationale Behind Low Capital Gains Taxes

University Of Chicago economist John Cochrane writes:

Intuitively, this is related to the theorem that you shouldn’t tax intermediate goods, or have tariffs for moving goods around the country.  Romney’s income was taxed once, when he made it. It’s not efficient to tax it again, because he chose to save it rather than spend it immediately on an orgy of houses, private jets, and a big vacation for his extended family.

If you made money in dollars, paid taxes, then went to Canada and got $1.20 Canadian, it would make no sense to say “you made 20 cents of income, we’ll tax it.” It makes no more sense to pay taxes again on money that is moved over time. We decry that Americans don’t save enough, the Chinese, the trade deficit and so on. Well, if you want people to save more, stop taxing it.

For this reason, the U.S. Tax code has been slowly reducing the taxation of rates of return. Capital gains and dividends are now taxed less than ordinary income. IRAs, 401(k), 526, and a welter of other devices allow people to save and invest without paying taxes on the rates of return. (It would be much simpler to just eliminate taxes on rates of return, but then the lawyers and accountants would have nothing to do.) Dividends are finally taxed at the same rate as capital gains. Estate taxes have been slowly and chaotically lowered. 

Full post can be found here.

4 Responses to “The Rationale Behind Low Capital Gains Taxes”


  • The rationale is your intuitions. Seems like it would be wrong. Seems like it would be inefficient.

    What matters to me is data. What has been the effect in the collapse of capital gains taxes? Capital gains rates are one part of a broader story that has lead to increases in inequality. Reduces union participation, which allows more wealthy owners to have a stronger bargaining position in wage negotiations. Reduced progressivity of income tax rates. Increases in regressive taxation rates, such as social security. And capital gains.

    So what has been the consequence? Reduced economic growth. All the effects of expanding inequality discussed here.

    http://bigwhiteogre.blogspot.com/2011/10/ted-talk-on-effects-of-inequality.html

    We’re setting records in poverty. We’ve emerged from what was called the golden age of capitalism to stagnation. All in all it’s been pretty bleak, except for the top .01%.

    I think this is what happens when you focus on intuitions instead of real world consequences.

  • Not true Jon. In fact, if you care about maximizing government revenue, the capital gains tax should be lower, see here.

  • Why would I care about maximizing government revenue? You shift the tax burden from the rich to the poor, and you really crush the poor by shifting it dramatically, you might get more government revenue. But you’ll harm the poor and the majority of people.

    Sure, taxes on the rich have fallen. Check the chart of sources of revenue at this link.

    http://motherjones.com/politics/2011/04/taxes-richest-americans-charts-graph

    The regressive taxes are an ever larger share of federal revenue. Corporate taxes an ever declining share.

    And though income taxes have stayed a constant share of revenue, even the burden of those has shifted more to the poor. If you are worth a quarter of a billion you pay 13.9% total, like Mitt Romney.

    http://www.huffingtonpost.com/2012/01/24/mitt-romney-tax-returns-released_n_1225247.html?1327382664

    Nice low capital gains rate. Cayman Islands and Swiss accounts. Rich people get their loopholes and make the middle and upper middle class take on the major brunt of the tax burden. Take a look at the effective rates for the various income groups.

    http://bigwhiteogre.blogspot.com/2011/07/tax-facts.html

    The implemented policies have all been in service to the rich. And by rich I mean the really rich. Not necessarily the 1%. A lot of them pay through the nose. It’s the top .01%. Hedge fund managers, CEO’s, etc.

    And yet the University of Chicago says it’s time to double down. We’ve given the rich everything they’ve wanted over the last 30 years and sent our economy into a tail spin. The solution? More of the same. And on top of that as Bryan Caplan says, we should sing songs to the rich. Tell them how great they are. Give them more money. And when that fails I’ll make a prediction about what they’ll want. More for themselves and less for everybody else.

  • Maximizing government revenue would make all other tax rates lower, everything else equal.

    In other words, we are arguing the same thing.

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