PF Feb 2018 - Abolish Capital Gains Tax - Pro Position

Resolved: The United States should abolish the capital gains tax.

Pro Position

It bears repeating in my opinion, the topic of U.S. taxation is complex. For this reason, lawyers and financial experts are employed to assist in wading through the nuances and dark alleys of current tax law. In my opinion, neither side of this debate should attempt to deep-dive into the topic without being fully educated themselves and having a pretty good idea of what the so-called "citizen" judge sitting at the back of the room can comprehend. For many of those judges, filling out a 1040 form is about as complex as they want to go and believe me, even the language of the 1040 often requires research by the average tax payer who is working without benefit of a tax professional or a highly-rated software program to slog through it. I do think this resolution is nevertheless debatable for high-school students and typical Public Forum judges. The Pro side of this debate focuses on a particular source of taxable revenue, the tax on capital gains which are paid when an investor realizes (sells to recover the cash value of) the gains on a capital investment such as real-estate, stocks, mutual funds, art, etc. For everyday people, the tax can be avoided under some circumstances. For businesses, the tax can be offset by corresponding losses on other investments and so an entire cottage industry of financial advisers exists which guides large-scale investors such as corporations, into offsetting investments so as to reduce the impact of the capital gains taxes (CGT).

Pro will argue that CGT are harmful to the economy. They encourage investors to hold on to capital rather than liquidate it or move it to other investments and this fact alone, has repercussions on economic growth, employment levels and wages for the judge in the back of the room who struggles to fill out that 1040 form every year. This very much suggests a framework of preference for the side which most benefits the average American, most of whom are middle or lower class, and financially treading water, concerned about paying for the higher education of their children, some of whom may be debating this topic.

The Pro can take two approaches to the topic. It can present the disadvantages which arise from CGT and their negative impacts on individuals and the economy and they can present the advantages of abolishing CGT.

Double Taxation

CGT is double taxation. To illustrate this consider the average parent investor who puts money into a mutual fund with hope of making some money for a student's college fund. The parent pays an income tax on the money that is earned and eventually used to purchase the shares of the mutual fund. Later, when the fund is realized (sold) the government levies CGT.

Pomerleau 2015:

Capital gains taxes represent an additional tax on a dollar of income that has already been taxed multiple times. For example, take an individual who earns a wage and decides to save by purchasing stock. First, when he earns his wage, it is subject to income taxes at the state and federal levels. He then purchases stock and lets his investment grow. However, that growth is smaller than it otherwise would have been due to the corporate income tax on the profits of the corporation in which he invested. After ten years, he decides to sell the stock and realize his capital gains. At this point, the gains (the difference between the value of the stock at purchase and the value at sale) are taxed once more by the capital gains tax. The effective capital gains tax rate could be even higher after accounting for inflation; a significant difference in the value of the stock may be from inflation, not real gains.

One major problem with this additional tax (CGT) is it fails to adjust for inflation. It is possible an investment in a commodity may increase in real terms very little or zero, yet due to inflation which drives up prices of most things over time, the commodity can be sold at a higher cost. This increase is not due to an increase in real value and yet the government will tax it as if it were.

The double (or multiple) taxation problem does not only affect average middle or lower class investors. It also has significant impact on wealthier investors, many of whom are the small business job creators in the U.S.  In 2012 when Mitt Romney was running for President and it was revealed he paid approximately 14% in taxes his political opponents were quick to paint him as an example of a wealthy elite, with a privileged tax status. The truth is perhaps more complex. Since he draws most of his wealth from capital investments, he does realize a lower CGT rate than a person paying normal income tax, but when the double taxation effect is exposed, Romney and others like him pay much more in taxes.

Whalen 2012:

The reality is that Romney, and others like him who derive significant capital gains or dividends, has already been taxed by the time they receive this income, which is taxed around 15 percent. But this income gets taxed twice, once at the corporate level and then again at the individual level. Added together, the total tax rate may, in some cases, reach 44.75 percent. The bulk of the tax payments were lopped off before the investor received a penny. The seemingly lower tax rate is simply an artifact of how taxes are calculated rather than a reflection of the actual taxes paid.

Getting more to the point, the double-taxation of CGT impacts the decision calculus of large investors, such as corporations which drive the economic machinery of the U.S. which potentially weakens the overall economy as a result.

Carroll & Prante 2012:

The double tax on corporate profits is of significant concern because it distorts a number of economic decisions. First, it discourages capital investment, particularly in the corporate sector. This both reduces capital formation generally and leads to the misallocation of investment within the economy. Second, the double tax favors debt over equity financing. Greater reliance on debt financing may leave certain sectors and companies more at risk during periods of economic weakness. Finally, a tax policy that discourages the payment of dividends can affect corporate governance by disrupting important signals dividend payments provide to investors about the financial health of companies.

Lock-in Effect

Without doubt, one of the most important side-effects of CGT is the so-called lock-in effect. This occurs when investors tend to hold on to their capital for longer periods of time rather than realize the investment and pay the CGT. The capital is, in effect, locked into the investment. According to the advocates for lower or zero CGT, economic growth flourishes when capital is realized and redistributed to new businesses which are trying to increase their net worth.

Bloomfield 2017:

High capital gains taxes have implications beyond individual investors’ tax returns. The Congressional Budget Office has documented that the Obama-era tax hikes created a lock-in-effect. Realizations of capital gains are well below earlier years, even as stock indexes have reached new highs. The lock-in of capital gains reduces the mobility of private capital—and, more important, its flow to the new, small and rapidly growing companies that create the most jobs.

The impacts of the lock-in effect are documented in many sources. We can look to other nations which have dropped or eliminated CGT to understand the potential positive impacts of affirming this resolution.

Mitchell 2014:

It turns out that there are many reasons why the capital gains tax harms economic performance. Clemens, Lammam and Lo explain the "lock-in effect."
"Capital gains are taxed on a realization basis. This means that the tax is only imposed when an investor opts to withdraw his or her investment from the market and realize the capital gain. One of the most significant economic effects is the incentive this creates for owners of capital to retain their current investments even if more profitable and productive opportunities are available. Economists refer to this result as the "lock-in" effect. Capital that is locked into suboptimal investments and not reallocated to more profitable opportunities hinders economic output. ...Peter Kugler and Carlos Lenz (2001)...examined the experience of regional governments ("cantons") in Switzerland that eliminated their capital gains taxes. The authors’ statistical analysis showed that the elimination of capital gains taxes had a positive and economically significant effect on the long-term level of real income in seven of the eight cantons studied. Specifically, the increase in the long-term level of real income ranged between 1.1 percent and 3.0 percent, meaning that the size of the economy was 1 percent to 3 percent larger due to the elimination of capital gains taxes."

Increases Wages

Pro can take the impacts of double taxation and lock-in even deeper. These effects have real-world impacts on the wages of working Americans, The same kind of individuals that are judging your round.

Carroll & Prante 2012:

The double tax affects a number of economic decisions. One effect is to lower the after-tax return to equity-financed corporate investment, which discourages capital investment and results in less capital formation. With less capital available for each worker to work with, labor productivity is lowered, which reduces the wages of workers, and ultimately, Americans’ standard of living. In addition to discouraging capital formation generally, the double tax also distorts a number of other economic decisions.

Globalization also weighs heavily into business decisions when, as we have seen in Mitchell '14, some countries such as Switzerland have seen positive impacts from eliminating CGT. Capital is not necessarily sitting on a foundation in the U.S. The effect of higher CGT may discourage investment in U.S. assets which increases the tax pressure on individual Americans.

Dolan 2017:

Capital can move across national borders much more easily than labor. Thus, if one country imposes a higher corporate tax rate than others, investors will be inclined to decamp but workers will largely stay put. That means less investment per worker in the higher tax country and therefore lower labor productivity and wages. This downward pressure on wages effectively shifts part of the burden of the tax to workers. And, of course, this effect is especially relevant to the United States, which has the highest statutory corporate tax rate of any major economy.

Proponents point out as capital worth grows and spreads, the value of the U.S. labor force increases as well. This increases the competition for jobs which drives up wages.

Moore & Silvia 1995:

Opponents of a capital gains tax cut often maintain that the returns on capital accrue primarily to the owners of the capital and that those owners tend to be wealthier than the average American worker or family. It is therefore argued that a capital gains tax cut would mostly benefit affluent Americans. But that ignores the critical link between the wage rate paid to working Americans and the amount of capital they have to work with. This is what Nobel laureate Paul Samuelson, a member of John F. Kennedy's Council of Economic Advisers, and William D. Nordhaus had to say about the importance of capital formation to worker well-being:
What happens to the wage rate when each person works with more capital goods? Because each worker has more capital to work with, his or her marginal product [or productivity] rises. Therefore, the competitive real wage rises as workers become worth more to capitalists and meet with spirited bidding up of their market wage rates.[6] The facts support the economic axiom that capital formation benefits American workers. Roughly 95 percent of the fluctuation in wages over the past 40 years is explained by the capital-to-labor ratio (see Figure 1).[7] When the ratio rises, wages rise; when the ratio flattens, wages stagnate.

Creates Jobs And Helps the Economy

Not only does abolishing CGT help those in America who are working, it helps to stimulate new job creation. In 2012 when the U.S. was still in the depths of of the 2008 economic depression, Proponents were clamoring to get out the word it was time to cut the CGT to stimulate the growth.

Whalen 2012:

As an entrepreneur and job creator, I believe that we ought to have a free enterprise system that incentivizes investment. As we look toward this fall's elections and the impact that the results could have on the overall policy debate and efforts for comprehensive tax reform, it's imperative to focus our elected leaders on progrowth policies that will encourage economic growth. In the midst of a fragile recovery is not the time to be raising taxes on anyone—much less on the kind of economic activity that will power entrepreneurship: investment. A return to a 28 percent capital gains rate would result in the loss of more than 600,000 jobs annually. By contrast, eliminating taxes on investments would create 1.3 million jobs per year.

The negative effect of CGT on the economy are seen when one looks at the marginal cost (look it up. Lower marginal cost can mean higher profits) to produce products. Again we can look outside of the U.S. for an example of the effects of lowering on CGT on the economy.

Mitchell 2014:

Dale Jorgensen and Kun-Young Yun (1991)...estimate the marginal efficiency costs of select US taxes and find that capital-based taxes (such as capital gains taxes) impose a marginal cost of $0.92 for one additional dollar of revenue compared to $0.26 for consumption taxes. ...Baylor and Beausejour find that a $1 decrease in personal income taxes on capital (such as capital gains, dividends, and interest income) increases society’s well-being by $1.30; by comparison, a similar decrease in consumption taxes only produces a $0.10 benefit. ...the Quebec government’s Ministry of Finance...found that a reduction in capital gains taxes yields more economic benefits than a reduction in other types of taxes such as sales taxes. Reducing the capital gains tax by $1 would yield a $1.21 increase in the GDP.

Harms the Middle Class

It's time to reconsider our framework. What effect do CGT have on the average working American? Con will argue that abolition of CGT is a massive give-away to the wealthiest x%. But we have shown that higher CGT has negative effects on the economy with holds down wages, and discourages business growth. Consider the average working person, the heads of families who save and invest to meet their future financial needs.

Kalimtgas & Goldman 1995:

An investor pays the capital gains tax only when he liquidates his investment. In practice, investors liquidate taxable securities and incur the capital gains tax only if they must do so in order to meet large, non-recurring expenses. Wealthy investors often hold onto assets that have appreciated in value until they die, passing them to their heirs and avoiding the capital gains tax (though not the estate tax) altogether.
In contrast, middle-class families who have either invested in securities or built small businesses typically must sell a large portion of their investment at the peak of their savings, in order to pay for a large expense like retirement, a child’s education, or the purchase of a home. At that time, these investors have no choice but to pay tax on their capital gains.

Pro can concede, the wealthy do have advantages under the current tax law. They can afford the benefits of expert advice and set aside the investments that are used to offset their CGT. A benefit the normal tax-payer never accesses.

Kalimtgas & Goldman 1995:

The capital gains tax is applied to the net profit on investments sold in a given year. Therefore, an investor who sells profitable securities may offset his gains by also selling securities that have lost money. The owner of a small business or the small investor in a conservative mutual fund will not have such offsetting losses. But a wealthy investor is more likely to have access to sophisticated advice on how to manage his portfolio to avoid taxes.

Eliminating the CGT eliminates the advantages enjoyed by the wealthiest Americans. There would be no more need for tax shelters to shield investors from a CGT which is a already described as a double-tax which discourages economic growth. Voting Pro benefits all Americans.

For all these reasons and more, we urge a Pro ballot.

For more on this topic or other PF topics, click the Public Forum page tab.

Sources:


Bloomfield, MA (2017), Will Republicans Raise Capital Gains Taxes?, American Council for Capital Formation, Nov 16, 2017. http://accf.org/2017/11/16/will-republicans-raise-capital-gains-taxes/


Carroll, R, Prante, G (2012), Corporate Dividend and Capital Gains Taxation: A comparison of the United States to other developed nations, Ernst & Young, Prepared for the Alliance for Savings and Investment, Feb 2012. https://www.realclearmarkets.com/blog/EY_ASI_Dividend_and_Capital_Gains_International_Comparison_Report_2012-02-03[1].pdf


Dolan, EG (2017), The Progressive Case for Abolishing the Corporate Income Tax, The Milken Institute Review, Jan 12, 2017. http://www.milkenreview.org/articles/the-progressive-case-for-abolishing-the-corporate-income-tax-2


Kalimtgis, E, Goldman, D (1995), Capital Gains: A Tax on the Middle Class, Manhattan Institute, Issue Brief, Jun 1, 1995. https://www.manhattan-institute.org/html/capital-gains-tax-middle-class-5605.html


Mitchell, DJ (2014), The Overwhelming Case Against Capital Gains Taxation, Forbes, Bov 7, 2014. https://www.forbes.com/sites/danielmitchell/2014/11/07/the-overwhelming-case-against-capital-gains-taxation/


Moore, S, Silvia, J (1995), The ABCs of the Capital Gains Tax, Cato Institute Policy Analysis No. 242, October 4, 1995. https://www.cato.org/publications/policy-analysis/abcs-capital-gains-tax


Pomerleau, K (2015), The High Burden of State and Federal Capital Gains Tax Rates in the United States, Tax Foundation, mar 24, 2015. https://taxfoundation.org/high-burden-state-and-federal-capital-gains-tax-rates-united-states/


Whalen, M (2012), Eliminate the Capital Gains Tax, U.S. News and World Report, Sep 28,2012. https://www.usnews.com/opinion/blogs/economic-intelligence/2012/09/28/eliminate-taxes-on-capital-gains