Raising Capital Gains Taxes Is the Fair Move


President Joe Biden wants to raise the capital gains tax, especially on top earners. This is a good idea, and long overdue. Arguments that a higher tax will lead to a dearth of business investment are misplaced and overblown.

Biden has been launching a blizzard of expensive spending plans. Many of those can be handled with deficits, but permanent ongoing spending items, like Biden’s child allowance, should be matched with new taxes. The key is to select types of new taxes that won’t derail the economy or put a substantial drag on growth going forward.

Capital gains taxes are a promising candidate. Unlike corporate taxes, you can make the levies progressive, charging people higher rates based on their overall income. And indeed, Biden intends to do exactly that, raising the top marginal rate to 39.6%. This would especially hit managers of hedge funds and private-equity funds, who derive much of their income from capital gains that are taxed at a lower rate.

Taxing the wealthy is better than taxing the middle class, not just because it probably seems fair after decades of spiraling inequality, but because rich people tend to spend much less of what they earn. Raising top-bracket taxes is thus unlikely to crimp demand and fling the country back into recession.

Nor are higher capital gains taxes likely to cause a dearth of business investment. Critics argue that people will have less of an incentive to put their money in the stock market, depriving businesses of the capital they need to invest and grow. That seems like a fairly trivial consideration at a time when the U.S. economy is as awash in cheap financial capital as it's ever been; when people are hurling money at a cryptocurrency whose only distinguishing feature is that it’s loosely associated with dogs, it’s probably not time to be worrying about willingness to participate in financial markets. But in any case, there are good reasons to believe capital gains taxes don’t curtail investment.

For one thing, if capital gains taxes are higher, it means there’s less incentive for investors to pull their money out of the stock market. Also, reducing the after-tax rate of return on stocks might make some investors want to invest in stocks even more than before. Stocks are generally the highest-returning asset class, so some investors might shift more of their money into stocks to make up for the returns lost because of the hike. These reasons might be why, as my colleagues Tim O’Brien and John Authers both note, previous capital gains tax hikes haven’t lead to long-term decreases in stock prices (there is usually a brief dip and a rapid rebound).

It’s also probably why dividend taxes — which are reasonably similar to capital gains taxes, since they both tax the distribution of corporate earnings to shareholders — don’t seem to affect business investment much at all. A 2015 paper by economist Danny Yagan found that President Bush’s substantial tax cuts on dividend income failed to boost capital purchases at the companies that were most affected by the cut. Incidentally, Yagan now works for the Biden administration.

In fact, higher capital gains taxes could even stabilize stock markets and thus make them more attractive destinations for investment. Short-term investors and traders have to pay the tax when they sell (in fact, the rate on rapid sales is even higher than for long-term holdings). Thus, raising the levy might discourage day trading, speculation and other activities that make finance more like a casino than a rational allocator of capital. Ultimately, we want a stock market that invests more for the long term.

But while this effect would be a nice bonus, it probably wouldn’t render the tax incapable of raising large amounts of revenue for the government. A recent paper by economists Natasha Sarin, Lawrence Summers, Owen Zidar and Eric Zwick estimates that increase the tax to the rate for ordinary income taxes would raise more than a trillion dollars over 10 years. That’s a substantial fraction of the $1.8 trillion mooted for Biden’s new family aid bill.

So the economics of capital gains taxes are sound. They hold out the promise of raising needed revenue without curbing either private investment or consumer demand. But in the end, the strongest justification for increasing the taxes might simply be fairness.

For decades, working Americans have watched wealthy investors pay far lower tax rates on the money they earned passively, simply from owning shares of companies, than those workers paid on their hard-earned paychecks. If capital gains taxes go up, it will probably be that glaring disparity, rather than rational data-driven arguments, that provides the political support for the move. But it’s good to know that the rational data-driven arguments are there regardless.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

©2021 Bloomberg L.P.

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