Presidential candidate Mitt Romney has selected a running mate, Paul Ryan, who has proposed eliminating the income tax on capital gains. The Vice President of the United States doesn’t have the authority to change the tax law, of course, so there’s no reason to think this idea or the rest of Ryan’s fiscal plan will become a reality, but pieces of it might eventually be discussed in Congress. Should Congress elimiate the capital gains income tax?
The first problem is having an understanding of how much revenue the government receives from the capital gains tax. Most studies group this tax with the rest of income tax, so there isn’t a lot of information about the capital gains tax alone. There are some studies, however, that do address the breakdown between the various forms of income tax. The following is from the Congressional Research Service, published in 2010, one of the most recent studies.
Overall, capital gains tax revenues have been a fairly small, but not trivial, source of government revenue. Since 1954, revenue from the capital gains tax as a share of total income tax revenue has averaged 5.2%. It reached a peak of 12.8% in 1986 and a low of 2.0% in 1957. Nonetheless, the 2007 capital gains tax revenue of $123 billion was equal to 75% of the FY2007 budget deficit.
In 2007, if tax on capital gains resulted in $123 billion in revenue and the amount of revenue from all personal income tax that year was $1.5 trillion (per usgovernmentrevenue.com), capital gains tax accounted for 8 percent of income tax. That’s certainly a significant amount of money that the government would not receive, making it more difficult to fund various programs without borrowing more. This isn’t a question of lowering the capital gains rate to find the level of tax that results in the most revenue; eliminating the capital gains tax without any adjustment anywhere else in the tax code is guaranteed to reduce revenue for the government.
Ignoring government revenue for a moment, proponents of the tax’s elimination also argue that a gift to investors will spur investments. Decreases in capital gains rates tend to spur selling (which in any market goes hand in hand with buying). Some theories suggest than investors might see the lack of capital gains tax as an incentive to move money from cash, where earned interest is considered regular income, to investments like the stock market, where realized increases in value are recognized as capital gains. Investors are generally moved by the perceived underlying value of their potential investment, however. You’re not going to invest in a company just because you have a chance of enjoying gains tax-free, you’re going to invest because you believe the company is going to thrive with your financial help.
Is the capital gains tax fair? For the most part, ask anyone who they believe pays too much tax and who they believe pays too little, the answers are “me” and “everybody else” respectively. The public is overwhelmingly in favor of a fair tax, but the definition of “fair” differs depending on who is writing the dictionary. The wealthiest Americans earn a good portion of their income every year from their investments. If that income comes in the form of realized capital gains and qualified dividends, Americans who can most afford higher taxes can, in some cases, owe a smaller percent of their income in income taxes than Americans who have traditional earned income. No one wants to live in a country where successful individuals are “penalized” for growing their personal wealth, but we live in a society that is more than a collection of individuals, and that type of society only functions well when everyone contributes to the welfare and infrastructure of the country.
Evaluating Mitt Romney’s tax return from 2010, Paul Ryan’s tax plan — which again has little meaning other than an indication of either what he believes is best for the country or what he believes is best for attracting fans and voters — would have Romney paying an effective tax rate of 0.82 percent. Although Romney argued against eliminating the capital gains tax when it was his opponent’s idea, it’s hard to turn down a proposal that effectively eliminates one’s entire tax bill.
Should Congress take cues from Paul Ryan and consider eliminating the capital gains income tax? Does your opinion reflect how you stand to gain from such a policy?
Updated August 21, 2012 and originally published August 15, 2012.