One of the worst aspects of the recent Obama tax hike was its treatment of investment income, raising capital gains and dividend tax rates by 60% (when you include the PPACA 3.8% surtax). The tax increase a) worsened further the tax code’s anti-growth bias against investment, and b) made the US even less globally competitive when it comes to taxing capital. Pro-growth tax reform should reverse those distortions, not exacerbate them. Studies suggest shifting to a consumption tax where households would be taxed only on their wages, not on any income from saving, such as interest, dividends or capital gains, would boost economic growth.
Keeping that in mind, read Rep. Paul Ryan’s answer to a question at a Wall Street Journal breakfast on Wednesday:
Joe Minarik, Committee for Economic Development: Number three, rates matter. OK, 1986 tax reform got you a 28 percent top rate by eliminating the preference for dividends and a much smaller preference at the time – (cross talk, inaudible) – yes, at eliminating the preference for capital gains. Are – if you don’t do dividends and capital gains, you are not going to get a top rate at that level. Are dividends and capital gains out of balance?
Rep. Paul Ryan: Yeah, I’ve never really – I mean, I think there is a good argument to have between ordinary income and capital income and how capital income is risk-based income and helps growth. But if your rates are getting low enough, then the difference between the two is not as severe with respect to growth effects. So I think that debate ought to be open with respect to tax reform.
Ryan’s answer sort of sounds like he’s open to the idea of eliminating the tax preference for capital gains and dividends, equalizing those rates with those on labor income. This has been a big tax reform goal of liberals. Now presumably Ryan would agree to this only if the top marginal rate on labor income were lowered substantially. But even if the top rate on labor income was lowered to 28%, it would still mean raising taxes on “risk-based income” even further.
About the only way to salvage this idea would be to do what innovation expert Clayton Christensen has recommended.Taxes on short-term investments would continue to be taxed at personal labor income rates. But that rate would come down the longer the investment is held, finally reaching zero after five years or so. As Christensen explains:
Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue. So the near-term impact on the budget will be minimal. But over the longer term, this policy change should have a positive impact on the federal deficit, from taxes paid by companies and their employees that make empowering innovations.