Time and time again, we hear that the tax breaks for income gained on capital gains are in place to spur economic growth. It’s repeated so frequently that it’s often treated as an economic fact. But has it ever passed the test of historical correlation? Does it even pass a simple “smell test”? With so much focus on our Federal budget deficit, we must look critically at the huge tax breaks we give to the wealthiest Americans and see if we’re really getting the intended benefits.
First, the history test. I’d love to see some hard numbers comparing the capital gains tax rate to key economic indicators like job creation, change in GDP and new business creation. From my own personal recollection, I don’t see any connection. I can remember the ‘90s as an unparalleled period of economic expansion, explosive creation of new companies and underemployment. In my field, we had a real tough time finding qualified personnel. After the Bush tax cuts slashed capital gains taxes in half, we still had strong economic activity (baring the jolt that the 9/11 attacks) but I don’t remember our economy doubling. On the flip side of the curve, we had the same low capital gains tax rates leading up to the 2007 financial meltdown and have maintained them throughout the sluggish recovery. Does anyone have a broader view of history that could find a one-to-one correlation? To draw any sort of strong causal relationship, we’d need to always find strong economic activity during low tax periods and never strong economic activity during high tax periods. Does it pass the test?
Then there’s the “smell test”. That’s what I’m calling a test that any of we can do yourselves based on our own common sense. Pretend you’re a middle to high-middle income earner and you have a couple thousand bucks sitting around. You could buy some consumer goods, or you could invest that money in the stock market. Where does that money do the most economic good? We know that if we buy something made in America, it sure as heck has economic benefit here. And even if it’s something made abroad, there’s plenty of American jobs that benefit from the widget’s transportation and retail and maybe even the American made software licensing used to make that widget in China. So we know that our money has benefit when we spend it. But what about if we buy some stock? Who do we buy it from? Well, unless it’s freshly minted shares, it’s just stock that somebody else was hanging onto and sold to me (hopefully for her) at a higher price than what she bought it for. Where’s the economic benefit in that?
Let’s keep going with the “smell test” and think more about that stock share. At one point, a company issued that share to raise money to do some cool economic stuff. That’s awesome and a great way to grow the economy. I can definitely see the case that an IPO will help a new company raise cash to create jobs. But 20 years later, after that share has been bought and sold a bazillion times, just how does that company use the fact that I bought it to generate economic activity? Sure, they can use those shares in a leveraged buyout or merger with another company. They might even be able to go deep in debt by borrowing against their shares. But how exactly does my buying of that share create more economic activity than me just buying some consumer stuff? If the goal is to encourage IPOs, isnt' there a more targeted way that we can do that without giving a blanket tax break to all capital gains activity accross the board, even if it had nothing to do with the birth of a new company?
Finally, let’s apply that “smell test” to the amount of economic activity that my income from the sale of stock capital gains generates. That’s what we’re really concerned with when it comes to the tax code. Our current tax code rewards people who get income from selling a capital asset while it penalizes normal income. I know that my day to day job generates huge amounts of economic activity. I help drive down medical costs for millions of people in the US. I’m proud of that. But when I get paid for that activity, I get penalized compared to when I simply sell off some shares that I’ve done nothing with for years and years. Let’s get even more concrete and think about real estate. If I buy a piece of property, sit on it for years and years, then sell it for a huge profit, I may end up paying capital gains no that huge amount of income. How has that generated jobs? Why is the sale of that piece of property treated special compared to my income I get when I drive down people’s medical costs? I can’t figure that out, so maybe someone can enlighten me here. Any takers?