While I believe it’s true that heavy taxes on a specific behavior have a chilling effect on that behavior, I don’t think it follows that the effect is linear. If we were to increase the long- and short-term capital gains tax, what investment would be stifled? The taxes won’t eat all my profits, or even the majority.
Thanks,
Rob
The math on this is pretty straightforward for most investors. This is long term capital gains.
The historical average return is something like 10 % on equities.
So let us say our investor has 1,000,000 in the market. In one average year they will earn 100,000.
Now, inflation is roughly 3 to 4 percent on average. To keep the same buying power the principle will have to be increased to match inflation. 3.5% of 1,000,000 is 35,000. So
100,000 -35,000 == 65,000
Now, lets assume that the capital gains are taxed at 15% for the lowest earners (not including state taxes). So, we need to subtract out another 15,000.
70,000-15,000 == 50,000
There are additional fees and such for trading, having an account and trading. The average is about 2% or so.
50,000-2,000 == 48,000
Not bad, however it isn’t a boatload of money either.
Now, same math but at 30% tax.
100,000 - 35,000 = 65,000 - to keep up with inflation
65,000-30,000 = 35,000 - capital gains at 30%
35,000-2,000 = 33,000 - fees and such
Note, there are some costs which I am presently blanking on, so the actual number is a bit lower. And this isn’t including any taxes that the state may take out.
Now, if you are a billionaire then this isn’t a big deal. However, for the average ‘rich’ folks their worth is more along the lines of a million or two this tax increase can be a big hit.
Slee
Ok, so what is their alternative? If there’s not a better investment option out there, even if they’re making less than before they’ll continue to invest.
A hit to be sure, but still 33k is better than 0k. I can see that monkeying with the tax code would drive people to riskier investments.
Others have already mentioned this but the question was whether increasing the tax would stifle investment not whether it would be a “big hit”.
Economically, a tax increase will only stifle investment if it’s increased to the point where alternative investments produce better results. If your choice is between a forty percent return and a five percent return, you’ll happily pick the forty percent return. If your choice is between a ten percent return and a five percent return, you’ll grumble but you’ll still pick the ten percent return.
Capital gains rates during the Clinton years were higher than during the Bush years. Did this stifle investments. They rose again (for the rich) after 1/1/13. Any evidence that investment is being stifled?
If those asking for investments are forced to structure their deals to be more efficient and thus have a higher rate of return, is this bad?
Here is a somewhat complicated table of rates.
It can be. If all it does is create more work to get the same result, is that good?
The alternatives are consumption, other investments, and other countries. Rich people can always buy yachts or airplanes or cocaine instead of investing the money. They can buy tax accountants to structure their investments to avoid taxes, such as tax free bonds. They can invest their money overseas where they would be taxed less.
All this causes deadweight loss from an economy wide perspective. The higher the tax rates on capital gains the higher the losses from deadweight loss. All taxes suffer from this to one extent or another but capital gains is one of the most sensitive. This is because it is hard to change one’s job to adjust for income taxes, or to sell a house because of property taxes, but very easy to change investment strategies.
Consumption produces no return, however–yachts and airplanes depreciate. With modern tax treaties, investing overseas doesn’t have the same allure it did once upon a time (you’ll still owe U.S. tax at some point, no later than when you try to repatriate the money home). That just leaves other investments such as tax-free bonds.
An argument can be made that this is a positive good. People will tell you that the justification for our capitalist free market system is that people who’ve accumulated wealth under it must have been producing some valuable good or service to have earned that wealth.
So if their work was providing valuable good or services to society, then more work means more value. A system that gives incentives to these value producing people to work harder is better for everyone.
So when Sicks Ate asks what the alternative is when there’s not a better investment option out there, your answer is a better investment option.
It depends. If the money is used for higher return government investment in infrastructure or research versus lower return private investment, it might be good. However the question is whether an increase stifles investment - we have historical data showing that a moderate increase does not.
The rich have seen a massive increase in wealth and income. Has consumption increased in step? There is only so much they can consume. If they actually did consume as much as if the money were spread to those of lower incomes, we’d see a much improved economy.
Income from overseas investments does get taxed. Mine does. Companies can park overseas income in overseas subsidiaries, but it is harder for the rich to do so.
If the rich were to hire accountants to restructure investments when the tax is 20%, why wouldn’t they when the tax is 15%? The cost of the accountant is trivial. They did when the tax was well above 50%, but we are nowhere near that point.
If the rich buy an investment for $100,000 and next year it is worth $120,000 then the economy has grown. If the rich buy a Rolls Royce for $100,000 and the next year it is worth $80,000 then the economy has shrunk. Investment is what makes an economy grow.
Taking steps to avoid taxes makes more sense the higher the tax is. Hiring an accountant to save $100 makes no sense but hiring one to save $100,000 makes all the sense in the world. The margin where it makes sense is different for every investor but there is no reason to think there are no marginal cases between 15% and 20%.
There was a CBO paper on capital gains taxes in 2012. It found that " The preferred persistent elasticity estimate is -0.79, and the transitory estimate is -1.2. Those estimates are statistically significant and are robust to a number of sensitivity tests." This is very high degree of elasticity. For comparisons most estimates of the elasticity of taxable income is about half the persistent elasticity, .4. The estimates of the elasticity of property taxes are about .2.
You have an odd definition of economy. In your first example the market cap of the investment has grown, but I think most people refer to GDP when talking about the economy growing. Luckily for us GDP did not shrink as much as the market did in the Bush crash, unluckily for us it did not grow as much as the market in the Obama market boom. As for your second, product means product. I don’t ever recall depreciation being included in GDP calculations.
I’m sure there are. Some people save taxes by smuggling cigarettes. But I doubt this kind of increase would trigger massive evasion. I remember when taxes were very high, and there was a lot of talk about tax shelters. Not much now, not much in the '90s.
And this means what in absolute terms? Interesting that the elasticity of taxable income is only twice that of property taxes (which I would guess is not much of a factor in anyone moving.) Kind of falsifies the old tax the rich more and they’ll stop working argument doesn’t it?
In any case, at the moment we do not have an investment shortfall, still, more a consumption shortfall. So moving investment money into consumption won’t hurt. Startups in Silicon Valley are not having a hard time getting money, for example. Again, the massive investment, and perhaps overinvestment, in a time of higher capital gains taxes in the '90s shows a reasonable increase does not stifle investment.
Not necessarily. Suppose your net worth increases by a thousand dollars. Does that mean the economy has also grown by a thousand dollars? If you say yes, then let me go on to explain that I paid you a thousand dollars when you won a bet over a baseball game we had made. Your net worth increased and my net worth declined by an identical amount. Now would you say the economy grew?
Wealth can be created. But existing wealth can also be transferred from one owner to another. The former reflects economic growth while the latter does not.
This is actually a very complicated subject. The effect of raising capital gains taxes has two components: The first is the incentive effect of reducing realized gains from investment. The other is the effect of reducing the amount of capital available to the investor class by taxing it away.
The incentive effects are not simply calculated, as not all investments are the same. Buying a stock and flipping it overnight is not the same as investing in a high-risk venture that won’t see returns for years. Capital gains taxes can cause preference changes for one type of investment over another.
Aside from any incentive effects, taxes on private capital lower the amount of investment in the economy from private capital. There are few venture capital dollars to go around, so fewer startups are funded and fewer investments in upgrades and new products.
This assumes that pre-tax increase capital and investment opportunities are roughly in balance. If there is a lot more capital than opportunity, reducing the dollars to go around will not decrease funding. In fact, as we saw during the bubble, if the dollars must get smarter there might be a benefit in reducing investments in bad opportunities. VCs with a pot of money from investors are going to tend to put it in the next pets.com rather than park it in low yield T-bills or something.
When there is a dearth of capital, which has happened in my lifetime, then encouraging investment by a tax decrease makes a lot of sense.
Just introducing some real world experience, I can say that only once or twice has any client brought up capital gains in an investment discussion. It hasn’t stifled them choosing to invest, just in whether to sell out of a particular issue or not.
What it means in absolute numbers is that if you raise taxes on property 10% then people will adjust their behavior and the tax revenue will go up 8%, if you raise the rate on income tax revenue will go up 6% and if you raise the rate on capital gains 10% revenue will dip temporarily and then go up 2%. This proves the argument that if you tax the rich more they will stop working as much. Since the any reduction in the revenue raised is caused by foregone economic activity as a result of the tax then the smaller the elasticity the less economically harmful the tax is. Thus since elasticity is highest for capital gains, taxes for capital gains should be the lowest.
There is also an justice reason for treating different types of income differently, but that is outside of the scope of the thread. The Monopoly game was created to illustrate this.
GDP is made up of three parts, consumption, government and investment. Consumption is currently about 71% of GDP which is historically nearly an all time high, government spending is about 18%, and private investment is about 12.4% which is 12% lower than it was before the recession. Startups in Silicon Valley may be doing okay but business investment as a whole still has not recovered.