Obamanomics: Capital Gains Hikes and the Economy

President Obama just told the country during his State of the Union address that he is going to increase the capital gains rate again in order to raise revenue for new spending programs. Given that Obama already knows that raising the capital gains rate actually REDUCES revenue, we are left with a President who believes that we can pay for increased spending by reducing revenue. He acknowledged this in 2008 during a televised debate against Hillary Clinton, but went on to state that rates should be hiked – despite its effect of reducing revenue – because it was more “fair” taxation (ludicrous, but a subject for another day).

Extraordinarily and equally disappointing about this fundamental economic error is that no one in the major press outlets, on the day after the State of the Union speech, pointed out the President’s gaffe. Do we really have a President who pushes for paying for increased spending projects with policies that reduce revenue? Or do we have a President who puts forth an initiative that he knows has very little chance of realization, but chooses to do so anyway so he can characterize the Republicans as protecting the wealthy while he can claim to protect the middle class?

Capital gains are unusual in that the taxpayer has the ultimate decision as to whether and when to sell his asset (stock, his business, a work of art, etc.) The higher the tax rate, the LESS likely he is to sell, seeing as he will only be able to enjoy or reinvest what is left of the proceeds AFTER TAX. History has borne this out – capital gains tax collections go down in the periods after increases, and go up in the years after decreases.

The actual impact of raising the capital gains rate is also devastating to the economy. By discouraging the sale of assets, there is reduced capital available for new projects and opportunities, reducing job creation and wages, and resulting in lower revenue collection.

Furthermore, with higher capital gain rates, the expected after tax rate of return on new projects will go down, assuring that fewer of them will go forward.

Additionally, there are a number of localities, like the state of California and New York City, which have tax rates of 12% or more and also a large concentration of wealthy people and high performing businesses. Couple that with the proposed increase to the federal capital gains rate and you could see total capital gains rates of more than 44%, A capital gains rate this high would virtually bring elective capital to a standstill. This would amount to a rate more than twice the rate during the Bush Administration (15%) – when growth and the economy were very strong..

Raising the capital gains rate will put a stranglehold on risk taking and available capital. Why sell an asset to fund further investment and opportunity when the government takes a large share of the gain with the loss remaining all yours. It makes virtually no economic sense to do so, and the result means an already anemic economy will continue to struggle.