Ben White, Politico’s Morning Money columnist offers up this “fiscal cliff” tidbit:
Lot of chatter about what an increase in the capital gains and dividend tax rates would do to markets and the economy. M.M. brought this up with the president of a large Wall Street firm last week. This person’s answer: “Absolutely nothing.”
Nothing — other than exacerbate the current tax code bias against savings and investment, not to mention other distortions. This is simple economics. As AEI’s Alex Brill and Alan Viard explain, “The preference reduces three important distortions: the lock-in effect, the tax bias against equity-financed investment by C corporations, and the tax penalty on savings. In each case, the preference plays a beneficial role, even though it is not ideally suited to achieving the purpose in question. It therefore would be highly undesirable to remove the capital gains preference while leaving the rest of the tax system unchanged, even though an ideal tax system would replace the preference with other policy instruments.”
Really, it’s best to look at capital gains and dividend rates in combination with the corporate income tax since both are essentially the same tax, just collected at different points, one at the business level and one at the household level. Consultancy Ernst & Young:
– Most developed countries provide relief from the double tax on corporate profits because it distorts important economic decisions that waste economic resources and adversely affect economic performance.
– It discourages capital investment, particularly in the corporate sector, reducing capital
formation and, ultimately, living standards.
– It favors debt over equity financing, which may result in greater reliance on debt financing and leave certain sectors and companies more at risk during periods o economic weakness.– A tax policy that discourages the payment of dividends can impact corporate governance as investors’ decisions about how to allocate capital are disrupted by the absence of signals dividend payments would normally provide.
And these two charts show just how high the U.S. integrated tax rate on capital income current is and how high it is headed under the Obama plan:
Although much of the fiscal cliff focus has been on the top marginal tax rates on labor income, the proposed rate hikes on capital income are probably far more injurious and take the tax code in completely the wrong direction. We should want to move the tax code int the direction of a consumption tax that does not penalize investment in favor of current consumption.