This thread questions whether the lower long-term 20% capital gains rate is justifiable.
One of the arguments I’ve always heard for the lower rate is that stocks are riskier than fixed-income investments like bonds and bank accounts, so if they’re all taxed at the same rate, people won’t invest in stocks, leading to a shortage of capital, to the detriment of the economy.
One flaw I’ve always seen in this argument is that while stocks are riskier, they also offer greater long-term gain. So even without a lower tax rate, there already is an incentive to take the greater risk.
But I also submit that three changes in recent decades weaken this argument further:
Fixed-income investments (currently) pay less than they used to. So people are more willing to take the risk of putting their money in stocks;
Starting in 1974 (with Vanguard), low-fee index stock mutual funds have enabled investors to reduce the long-term risk of investing in stocks, reducing the need to incentivize stock investing over safer investments; and
A quick look at the stock markets indicates that there ain’t no shortage of capital. (This isn’t a third reason, as much as it is evidence supporting the first two). And yes, a great deal of this capital is invested through low-fee index funds.
I present no evidence of it, but it makes intuitive sense that under these newer conditions, the lower capital gains rates may actually be acting to artificially prop up stocks. If true, increasing capital gains taxes might eventually lead to more market stability (following short-term pain).
I acknowledge that current circumstances could change. Interest rates could rise, dampening stock market growth and making bonds and bank accounts more attractive. Baby boomer retirees could start pulling their money out of stocks.
I also acknowledge that not even a Democratic administration – forget a Republican one – would risk alienating the people this would affect (the rich and retired) by raising capital gains taxes. FWIW, I’m fairly rich and (soon to be) retired myself, and I have a lot of my money in the market. So I would definitely lose money if capital gains taxes were raised.
But that’s the debate: have recent changes in the financial environment weakened the argument for a lower capital gains tax?