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The Wall Street Journal, August 10, 2007
Cap-Gains Logic
By Donald L. Luskin
Here's some advice to the Democrats on how to raise the revenues they'll
need to pay for all the spending they have in mind. Don't hike the capital
gains tax rate. Don't lower it, either. Eliminate the capital gains tax
entirely.
How can tax revenues be increased by eliminating a tax? It's simple, when
the tax in question is on capital gains. Capital itself exerts a multiplier
effect that benefits the entire economy. Investment in new plant, equipment,
business processes and whole companies creates new and higher paying jobs,
and higher levels of economic activity, all of which generate additional tax
revenues far in excess of what government would lose by foregoing cap-gains
taxes.
This idea has broad theoretical support. Former Clinton Treasury Secretary
Lawrence H. Summers has written, "the elimination of capital income taxation
would have very substantial economic effects" which "might raise
steady-state output by as much as 18%." Economist Jack L. Treynor has shown
that "the level of taxation on capital that is 'fairest' -- i.e., most
beneficial -- to labor is zero." And Nobel Prize-winning economist Robert E.
Lucas, Jr., has concluded, "neither capital gains nor any of the income from
capital should be taxed at all." These economists think in terms of very
complex models. But the real-world intuition here is quite straightforward.
The cap-gains tax is a barrier to the investment of capital. Without it,
capital will flow to investments that otherwise wouldn't have been made. The
cost of eliminating the barrier is foregone revenues from that particular
tax. But those revenues are small, usually deferred and non-recurring. In
their place, government receives large and recurring revenues from corporate
taxes, sales taxes, wage taxes and dividend taxes -- all generated by new
economic activity.
The cap-gains tax is a poor revenue raiser, because any given capital gain
is a one-time event that can only be taxed once, and in many cases, ends up
not being taxed at all. Consider Microsoft. Since the company went public 20
years ago, its market value has increased by about $275 billion. A generous
estimate of the cap-gains tax revenues we could expect from this increase is
about $40 billion.
Actual collections will surely be less. Many shares will never be sold --
held by founders who wish to retain control, or by people who wish to avoid
paying taxes. Many shares will be gifted to charitable foundations, as Bill
Gates has done for the Bill and Melinda Gates Foundation, out of the tax
collector's reach. Even for those shares that will eventually be sold, from
today's perspective the resulting tax revenues have to be discounted, as
they won't be collected for years.
At the same time, Microsoft has been a fountain of other tax revenues. Since
the company went public, I estimate that, in cumulative present-value terms,
corporate taxes already paid total roughly $60 billion; sales taxes paid by
Microsoft's customers total roughly $11 billion; income taxes paid by
Microsoft's employees total roughly $12 billion, and dividend taxes paid by
Microsoft's shareholders total about $3 billion. These four sources of tax
revenues over the last 20 years total $86 billion -- more than twice our
generous estimate of the notional cap-gains tax revenues ($40 billion) for
the same period.
Moreover, unless Microsoft's stock price increases -- which it's had a hard
time doing the last couple years -- the estimated $40 billion in cap-gains
tax revenues will never grow to a larger number. But corporate taxes, sales
taxes, income taxes and dividend taxes will continue to be generated year
after year. Even if assuming Microsoft's business stops growing (it has been
reliably growing at better than 10% per year), the present value of the tax
revenues from these other sources is roughly $182 billion. Added to the
revenues already collected, the total is $268 billion.
There is also all the new taxable economic activity enabled by Microsoft's
products. It's impossible to estimate a dollar value for it, but we can be
sure it is a multiple of the value created within Microsoft. In this
context, there is nothing unique about Microsoft. Anytime capital is
invested, the small, deferred and non-recurring revenues that can be
expected from the cap-gains tax are a tiny fraction of the perpetual
revenues from other economic activities, generated directly and indirectly.
While eliminating the cap-gains tax may well induce companies like Microsoft
to generate additional taxable activity, there's a more important
opportunity here. Eliminating the cap-gains tax will cause the economy to
generate more innovators like Microsoft.
For each new Microsoft, the cost to government would mean $40 billion in
foregone revenues. But for those new Microsofts that wouldn't have existed
otherwise, the payoff would mean raking in $268 billion.
That's a smart trade-off. If the Democrats were really interested in raising
revenues -- and not just making life harder for a handful of wealthy private
equity players -- it's a trade-off they should eagerly make.
Mr. Luskin is chief investment officer of Trend Macrolytics LLC. |
