ABC news anchor Charlie Gibson perpetuated a myth about taxes at the Democratic presidential debate on Wednesday night. Gibson said of the capital gains tax that "in each instance, when the rate dropped, revenues from the tax increased. The government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down." He asked Senator Obama, who has signaled that he would raise the capital gains tax from its current level of 15 percent to 28 percent, why he would bother doing this if it would actually reduce revenues.
There is just one problem. What Charlie Gibson said is not true. Revenues from capital gains do not rise when the tax is cut. They rise when the economy is booming and they collapse when the economy tanks. In fact, revenue from capital gains taxes is currently well below the peak it reached during the Clinton era ¢ÂÂ when taxes were higher.
A small group of ideologues associated with "supply-side economics" believes that tax cuts can actually increase revenues. While this notion is rejected by most mainstream economists and sounds ludicrous to the average person, members of the media and Congress seem unusually susceptible to being hoodwinked into believing it. Their general idea is that if we lower capital gains taxes, there will be more capital gains realizations (meaning more people sell their property that has gone up in value) because the tax on that profit has been cut, and this will lead to revenue increasing overall.
Even if there are more realizations as a result of a capital gains tax cut, the resulting revenue will be nowhere near enough to make the tax cut budget-neutral, much less revenue-enhancing.
The ups and downs in revenue collected by the capital gains tax seem to have more to do with what's happening in the broader economy than with tax policy. In the early and mid-1990s, when the top capital gains tax rate was 28 percent, the revenues collected by the tax shot through the roof. They continued to climb after the rate was lowered to 20 percent in 1997, but this looks more like the continuation of a preexisting trend linked to economic prosperity rather than a response to the change in the rate. Then in 2001 and 2002 the revenues collected by this tax fell precipitously. This was not following any change in tax policy at all, but clearly linked to the bursting of the dot.com bubble and its ramifications on the stock market.
Capital gains tax revenue did increase after 2003, when the rate was cut again to 15 percent, but we would expect the revenue to rise from the low point of the recession, regardless of what changes were made to the tax code. More importantly, the revenue obviously has not reached the high level of the Clinton years when the rate was higher. Measured as a percentage of GDP, the capital gains tax will probably collect only half as much revenue this year as it did in 2000, when the rate was higher.
Can support for the supply-siders' argument be found if one looks further back in time? No. Charlie Gibson seems to think that capital gains tax revenue fell when the rate was raised as part of the 1986 Tax Reform Act that was signed by President Reagan. The reality is that capital gains realizations surged in anticipation of the rate increase (which took effect in 1987). In other words, an increase in the rate actually increased revenues, albeit temporarily. After that, with fewer gains to realize, realizations predictably declined, and eventually returned to their normal level -- until the Clinton adminstration, when the stock market went up so much that realizations boomed.
When Gibson pressed Senator Obama a second time, insisting that cutting the capital gains tax rate would raise revenue, Obama replied, "Well, that might happen or it might not. It depends on what's happening on Wall Street and how business is going." Obama also brought up the issue of fairness in the tax code, and the fact that wealthy people with capital gains can pay less in taxes than middle-class Americans, which is an unacceptable feature of our system.
Senator Clinton, however, stated, "wouldn't raise [the capital gains tax rate] above the 20 percent if I raised it at all. I would not raise it above what it was during the Clinton administration." This is an unfortunate response. The rate was higher than 20 percent during most of the Clinton administration and the economy thrived and revenues poured in. And, since the revenue "baseline" used by Congress already assumes that the rate will revert to 20 percent when the Bush tax cuts expire at the end of 2010, no "new" revenue will be raised to pay for the candidates' health care proposals or other new initiatives by simply letting the rate revert to 20 percent.