Policy Documents

Research & Commentary: Capital Gains Taxes Update

June 13, 2012

Absent Congressional action, several tax increases will go into effect at the end of the year. Allowing the 2001–03 tax cuts to expire, combined with tax increases under the Obama health care plan, what some critics are calling “Taxmageddon” would be a historic hike in tax rates across the board.

One of the most significant increases would be a dramatic hike in the rate of the capital gains tax, which is paid by individuals and corporations on the profits realized when a capital asset is sold for a gain. Currently the top tax rate for capital gains is an internationally competitive 15 percent. Under the new tax rates, the long-term capital gains tax rate will rise to 20 percent.

The current rate is lower than rates in only nine of the 25 major economies in the world, according to a report by Ernst & Young. After the scheduled increase the United States will have a lower tax than only six of those countries. This 33 percent tax hike will further hurt the competitiveness of the U.S. economy and discourage domestic investment.

According to a study by the Institute for Research on the Economics of Taxation, “Higher taxes on capital retard capital formation and reduce wages across the board. The particular tax increases that the Congress and the Administration are most likely to adopt would damage the economy and reduce the tax base. In fact, they are likely to result in lower federal revenues, and larger budget deficits.”

An increase in the capital gains tax rate, combined with a hike in dividend taxes and high inflation dramatically increases the effective tax rates paid by taxpayers. With the U.S. economy still struggling to crawl out of the economic downturn, it’s important to avoid policies that hinder capital formation and investment in U.S. markets, as raising capital gains tax rates would do. Instead, Congress should focus on making the tax code less distorting and cumbersome, to help foster economic growth, not kill it.

The following articles offer additional information on capital gains taxes.

State and Federal Individual Capital Gains Tax Rates: How High Could They Go?
http://heartland.org/policy-documents/state-and-federal-individual-capital-gains-tax-rates-how-high-could-they-go
The American Council for Capital Formation’s Center for Policy Research highlights the effects of increased federal tax rates on long-term individual capital gains when the federal, state, and, in some cases, local taxes are combined. The study found a low capital gains tax rate is important in fostering economic growth.

The Effect of the Capital Gains Tax Rate on Economic Activity and Total Tax Revenue
http://heartland.org/policy-documents/effect-capital-gains-tax-rate-economic-activity-and-total-tax-revenue
This study by the Institute for Research on the Economics of Taxation identifies how taxpayers and investors react to capital gains tax rates: “The tax treatment of capital gains and dividends greatly affects the quantity of capital created and employed. The quantity of capital affects the productivity, wages, and employment of labor. Output and incomes are lower at higher levels of taxation of capital. Raising the tax rate on capital by increasing the tax rate on dividends and capital gains from current levels would shrink national income across the board.”

The Dangers of Raising Taxes on Investment Income
http://www.manhattan-institute.org/html/ir_5.htm
Manhattan Institute Senior Fellow Diana Furchtgott-Roth contends higher rates on capital gains and dividend income will likely harm the economy by reducing the overall level of U.S. investment and driving investment overseas. Furchtgott-Roth concludes higher tax rates would reduce economic activity, and thus economic growth, by reducing available financing for private companies, innovators, and small firms just getting started.

Can Tax Reform Save the U.S. Economy?
http://heartland.org/policy-documents/can-tax-reform-save-us-economy
Several economic experts comment on whether tax reform can save the U.S. economy, in this article from The International Economy magazine. The experts comment on several proposed reforms and tax changes, including those on capital gains tax rates.

Ten Reasons to Extend Tax Relief and Stop Tax Hikes
http://www.ntu.org/news-and-issues/taxes/extend-tax-relief.html
Pete Sepp, executive vice president of the National Taxpayers Union, gives ten reasons why Congress and the Obama administration should extend tax relief beyond this year and stop the tax hikes that would result from the expiration of the 2001–03 tax cuts.

Taxmageddon: Massive Tax Increase Coming in 2013
http://heartland.org/policy-documents/taxmageddon-massive-tax-increase-coming-2013
Curtis Dubay of The Heritage Foundation discusses Taxmageddon, an enormous, unprecedented tax increase that will fall on American taxpayers starting on January 1, 2013. Dubay examines the many sources of the tax increases and calls on Congress and the White House to start working together now to prevent the tax hikes. Doing so, Dubay argues, would assure families, businesses, and investors their taxes will not rise sharply and prolong the economic stagnation.

U.S. Individual Capital Gains Tax Rates High
http://heartland.org/policy-documents/us-individual-capital-gains-tax-rates-high
This special report commissioned by the American Council for Capital Formation compares the capital gains taxes of the top 25 national economies. The report notes, “The 2003 capital gains tax cuts have also been a boon to the U.S. economy. Extension of the 15% rate is crucial to maintaining the U.S. competitive edge against its major trading partners.”

Economic Effects of Increasing the Tax Rates on Capital Gains and Dividends
http://heartland.org/policy-documents/economic-effects-increasing-tax-rates-capital-gains-and-dividends
The Heritage Foundation finds rolling back the 2003 tax cuts on capital gains and dividends would slow economic growth: “The slower economy causes employment to shrink by 270,000 jobs in 2011 and 413,000 in 2018. Similar job losses continue for the next seven years of our model’s forecast horizon of 2008 through 2018.”

The Economic Costs of Capital Gains Taxes
http://heartland.org/policy-documents/economic-costs-capital-gains-taxes
This study from the Fraser Institute outlines the effects of capital gains taxes: “Unfortunately, the cost of capital gains taxes is not limited to the amount of tax collected. Capital gains taxes impose additional costs on the economy because they reduce returns on investment and, thereby, cause individuals and businesses to alter their behaviour.”

Tax Cut Permanency Report #1: The Capital Gains Tax
http://heartland.org/policy-documents/tax-cut-permanency-report-1-capital-gains-tax
Raymond J. Keating, chief economist for the Small Business & Economic Council, explains why Congress and the president should make the cuts in the capital gains tax permanent, noting the rate hikes would not increase government tax revenue: “Since a capital gains tax reduction boosts investment, entrepreneurship and the economy, the government does not suffer the revenues losses that static analysis would predict.”

Research & Commentary: Extending the Bush Tax Cuts
http://heartland.org/policy-documents/research-commentary-extending-bush-tax-cuts
Heartland Institute Government Relations Director John Nothdurft discusses the likely economic effects of the expiration of the 2001–03 tax cuts. “Without serious spending reforms the nation’s deficits will remain inevitable and incurable regardless of how many taxes are raised or how much. The best way to rein in the deficit is to control spending and create an economic environment that fosters growth and thus provides more revenues,” Nothdurft writes.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the FIRE Policy News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.