The left keeps banging away at the preferential tax treatment of capital gains income. And that may be good politics. But is it good economics? Here is Tino Sanandaji, explaining the meaning of the above chart from his must-read, must-follow blog:
Again we see a remarkably strong association between the capital gains tax and Venture Capital Investments. Following tax cuts in the late 1970s Venture Capital fund-raising explodes. The tax increase a decade later is followed by a decline in committed fund. Investments again increased when Clinton cuts the capital gains tax in the late 1990s. The Bush-tax-cut – which the left claims had no effect – is also followed by an uptick in Venture Capital investments as a share of GDP. …
Paul Krugman declared that there is “no evidence” that capital taxes have hurtful effects on economic activity and that “the economic record certainly doesn’t support the notion” that low taxes are beneficial for prosperity. Either our eyes and systematic empirical research are misleading us, or Paul is not being his usual trustworthy self.
Tino notes that the analysis is crude, but it is also typical of the sort of analysis the left uses to attack the preferential treatment given investment income.
Tino also give a nice explanation on the fairness issue, pointing out that corporate taxes and capital gains/dividend taxes create a rather high integrated tax rate:
Regardless of the economics, isn’t it unfair to tax “unearned” capital gains at a lower rate than wages? First, capital gains of entrepreneurs are hardly “unearned”. Innovative entrepreneurs produce more economic value in relation to their income (even if the income is in billions of dollars) than other groups in the economy. This furthermore ignores double taxation. The capital gains tax is only part of the total tax burden, the company where capital gains are generated also has to pay taxes at the corporate level. The effective corporate tax rate is estimated at 27%. When Mitt Romney pays a visible capital gains tax of 15%, his total tax burden including the corporate tax is on around 38%. The impression that capital gains taxes are unfairly low is based on the government hiding much of the statutory capital tax burden through fiscal obfuscation.
Also check out Sita Slavov’s recent AEI post on the fairness of taxing capital income.