Myths & Facts of Capital Gains Tax Cuts

Myth: Lowering capital gains
tax rates will not help the economy.

Fact: Cutting capital gains tax rates is the single
best tax policy to improve economic growth.

  • Capital gains play a unique role in fostering economic activity,
    especially by entrepreneurs in high-technology areas.
  • In fact, many economists believe that the optimal tax rate on
    capital gains is 0 percent.
  • Because government first takes money through corporate income
    taxes, taxation of capital gains (and dividends) represent
    double-taxation of investment returns and should be eliminated.

Myth: If there is a capital gains tax cut, it should
be temporary and it should not be available to all investors.

Fact: Only a permanent capital gains cut available to
all investors – include those who invested long ago — will stimulate
new investment and revive economic growth.

  • A temporary cut will induce people to sell assets, but it will
    not stimulate new investors who will face today’s high rates again
    in the future after the temporary reduction has expired.
  • A temporary cut will “lock-out” new investment and will
    hurt economic growth.
  • The induced selling without incentives for new investment will
    further depress stock and other asset prices and will not stimulate
    new investment. By unlocking held assets and inducing people to sell
    investments, a temporary cut may increase tax revenue – it may not,
    though, because asset prices will be lower – but it will not help
    stimulate economic growth.
  • A permanent cut will provide the incentives for people now to
    sell long-held unproductive assets and for people now and in the
    future to make new productive investments.

Myth: Cutting capital gains tax rates will cause
stock markets to fall.

Fact: Cutting capital gains tax rates will, as it has
in the past, cause asset values, including stock markets, to rise.

  • Some people claim that lowering capital gains tax rates will
    cause the stock market to fall, because people would sell their
    investments. By this silly logic, if people want to increase stock
    market values, then there should be an increase in capital gains tax
    rates, because, then investors would be less willing to sell
  • In fact, lowering capital gains tax rates increases the prices of
    stocks and other assets. Stock markets reflect the collective
    actions of people looking forward.
  • Lowering the cost of capital by decreasing tax rates on
    investment returns will increase asset values.
  • For example, the 1997 cut in the top capital gains tax rate from
    28 percent to 20 percent increased stock prices by approximately 8

Myth: Capital gains tax cuts benefit the “wealthy.”

Fact: Capital gains tax cuts improve the entire

  • Capital gains tax reductions stimulate economic growth, which
    benefits the entire country.
  • Capital gains taxes disproportionately hurt the elderly, low and
    middle-income investors who have less discretion over the timing of
    their capital gains.
  • Most people who report capital gains do not have high annual
  • People with high incomes are most sensitive to capital gains tax
    rates, because they possess the most flexibility and means to avoid
    high tax rates. When capital gains tax rates are high, people with
    high incomes do not sell their assets and realize their gains.
  • High-income people pay a greater percentage of capital gains
    taxes when capital gains tax rates are low than when capital gains
    tax rates are high.
  • High capital gains tax rates make capital scarce. When capital is
    scarce it goes to safe investments. Low capital gains tax rates make
    capital abundant. When capital is plentiful it goes to “riskier”
    investments – such as inner cities and disadvantaged areas.

Myth: Lowering capital gains tax rates will not lead
to more investment.

Fact: Taxpayers are very responsive to capital gains
tax rates. High capital gains tax rates punish and reduce investment.
Low capital gains tax rates induce more investment.

  • Taxpayers have a choice over when to realize capital gains and
    pay taxes. High capital gains tax rates lead people not to invest
    and current investors to hold assets, increasing the “lock-in”
  • Lowering capital gains tax rates increases new investment and
    unlocks long-held undesirable assets, thereby increasing capital
    gains realizations.
  • High-income taxpayers, who have great discretion over the timing
    of their investment decisions, are particularly responsive to
    changes in capital gains tax rates.

Myth: Government cannot “afford” large and
permanent cut in capital gains tax rates.

Fact: Improving economic growth is the proper focus
of the debate regarding capital gains tax rates, and greater economic
growth increases federal tax revenue from many sources.

  • The correct goal of tax policy should be to maximize economic
    growth, not tax revenue. Consequently, the optimal tax rate is the
    rate that is best for the economy, and this rate is lower than the
    rate that provides the government with the most tax revenue.
  • The government should not act like a business trying to maximize
    revenue. Rather, the goal of tax policy should be to enhance
    economic growth and raise only as much tax revenue as is needed, not
    as much as is possible. More investment and greater realizations
    caused by lower capital gains tax rates
  • lead to increased capital gains tax revenue and more revenue from
    other taxes such as corporate taxes, personal income taxes, and
    payroll taxes. When predicting the budgetary effects of capital
    gains tax rate changes, it is necessary to account for behavioral
    responses by using “dynamic” rather than “static”

Myth: Capital gains already receive preferential
treatment because they are taxed at lower rates than ordinary income.

Fact: Double-taxation of investment returns and
taxing inflation cause capital gains tax rates to exceed tax rates on
ordinary income.

  • The government taxes investment returns – dividends and capital
    gains – twice, first as corporate income taxes and then as personal
    income taxes.
  • This double taxation causes capital gains tax rates to exceed
    ordinary income tax rates.
  • For example when a corporation earns $100 profit, the government
    takes $35 in corporate taxes, leaving $65 distributed to investors
    taxed at 20%. The government takes another $13 (20% of $65) in
    capital gains taxes, leaving investors with $52 and government with
    $48 out of the original $100 profit. Thus, an effective tax rate on
    capital gains of 48%. (Note: Since dividend are also subject to
    double taxation, but are taxed at ordinary income tax rates, the
    effective tax rates on dividends can approach 60%!)
  • The most counterproductive and unfair characteristic of the tax
    on capital gains is that it taxes inflation, because capital gains
    are not adjusted for inflation. The example above does not even
    include the fact that capital gains taxes include taxes on
    inflation, and, therefore, actually tax investors at even higher
    real tax rates – at times more than 100%!
  • For example, if an investment of $1000 rises in value to $1100,
    while prices generally have risen 10%, there is no real (after
    inflation) increase in value. However, an investor who sold this
    asset for $1100 would still have to pay taxes on the inflationary
    gain of $100. At the current top statutory rate of 20%, this
    investor would pay $20 in capital gains taxes on an investment that
    produced no real gain. The result, in this case, is a tax rate of
  • The policy of failing to adjust capital gains for inflation
    raises effective capital gains tax rates to levels substantially
    exceeding statutory rates and often surpassing 100 percent.
  • These high effective tax rates force investors to retain assets,
    increasing the “lock-in” effect. Moreover, the policy
    hurts economic growth by inhibiting new investments, because under
    current law inflation is a risk investors must bear.
  • The tax on inflation most severely punishes the elderly,
    low-income, middle-income, and less successful investors, because
    these people are less able to adjust the timing of their investment
    decisions than investors with higher incomes.
  • Indexing (adjusting) capital gains for inflation – as other
    countries have done – would eliminate the unfair and harmful tax on


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