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InsiderOnline Blog: January 2013

Capital Gains Taxes Move the Wrong Way

In the fiscal cliff deal, capital gains taxes increased from 15 percent to 23.8 percent. That’s the wrong direction. As Chris Edwards explains, any capital gains tax rate above zero unfairly penalizes the very behavior on which economic growth depends:

[Capital gains taxes] penalizes frugal people and rewards the spendthrift. That’s because earnings are taxed a second time when saved, while immediate consumption does not face a further tax. That makes no sense because it is frugal people—savers—who are the benefactors of the economy since their funds get invested in the new businesses and new capital equipment that generates growth. […]

Another problem is “lock-in,” which occurs when taxpayers delay selling investments that have large unrealized gains in order to avoid the immediate tax hit. […] Economic growth is synonymous with economic change, and thus growth is dependent on capital being moved from older to newer uses. Capital gains taxes create a barrier to that beneficial movement. […]

A key reason for reducing tax rates on both capital gains and dividends is that the underlying income is already taxed at the corporate level. Corporate profits in the United States bear a heavy burden from an average federal-state tax rate of 40 percent. When individuals receive corporate profits in the form of dividends and capital gains, the income is taxed again. By contrast, wage and interest income are only taxed at the individual level because they are deductible to corporations. […]

Double taxation of capital gains and dividends disadvantages corporate equity compared to debt. The result is that firms tend to overleverage, which makes them more unstable and vulnerable during downturns. [“Advantages of Low Capital Gains Tax Rates,” Cato Institute, December 2012]

Posted on 01/03/13 08:34 PM by Alex Adrianson

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