Obama is intentionally sacrificing jobs in the pursuit of his own notions of fairness with little or no hope of increasing revenues in the process.

J.D. Foster, Ph.D. at Heritage Foundation reports:

Abstract: President Obama has proposed raising the capital gains tax rate to generate billions in new revenues for the federal government. However, according to data included in the President’s own budget, if implemented this tax increase would—at best—offset the tax revenue from other sources that would be lost because of reduced total income, output, and jobs in the economy. Thus, the President is intentionally sacrificing jobs in the pursuit of his own notions of fairness with little or no hope of increasing revenues in the process. Further, this proposal is coupled with a proposed dividend tax rate hike that would also cost jobs for little or no gain in revenues. If the President is serious about making jobs his “number one priority,” he should instead propose reducing the capital gains and dividend tax rates to stimulate the economy.

President Obama has proposed raising the capital gains tax rate from 15 percent to 20 percent for married filers with incomes above $250,000. This proposal continues a long tradition of changing the taxation of capital gains, but government figures suggest it is unlikely to increase total tax revenues.

The longstanding policy tug-of-war over the capital gains tax reflects a classic tradeoff between tax revenues on one hand and economic growth and jobs on the other. A higher tax rate is usually intended to increase federal revenues, accepting the slower economic growth that follows. Proponents of higher rates argue that the revenue gains are worth the meager losses in jobs, while opponents argue the revenue gains are meager, at best, because the economic effects are substantial.

The President’s proposal to raise the capital gains tax is coupled with a similar proposal to raise the tax on dividend income from 15 percent to 20 percent for married filers with incomes above $250,000. Combined, they are expected to raise $105.4 billion from 2011 to 2020. However, this estimate ignores the dampening effects that such a policy will have on the economy. During the 2008 presidential campaign, Barack Obama acknowledged that raising the capital gains tax rate could reduce revenues, but he remained interested in raising the rate “for purposes of fairness.”[1]

A general consensus exists that a higher capital gains tax rate would harm the economy, but at what point would the revenues lost due to slower economic growth exceed the revenues gained from the higher tax rate? How many jobs would be lost and how many wage gains would be missed to implement the President’s notion of tax “fairness”? Analysis by the Office of Management and Budget (OMB) in the President’s budget provides the basis to answer these questions: Only a slight reduction in economic growth will offset the revenue gained from raising the capital gains tax, producing little tax revenue on net. It is more likely to reduce total federal receipts.

Capital Gains Rates and Revenues

A capital gain occurs when an asset increases in value. Under most circumstances, this event is taxable only when the asset is sold and the gain (or loss) is realized. In the President’s budget, the traditional revenue estimate associated with increasing the capital gains tax rate reflects an effective tax rate applied to a projection of aggregate realized capital gains.

However, projecting capital gains revenues is problematic because it requires educated guesses about the existing inventory of unrealized gains, whether that inventory is changing in size over time and the rate at which gains will be realized. Changes in the statutory tax rate add an additional complication in that changing the tax rate also changes the aggregate value of outstanding gains. For example, a higher rate reduces asset values and thus shrinks the inventory of unrealized gains.

A further complication is that investors will adjust their behavior both before and after a rate hike. Asset owners anticipating a rate hike are prone to realize gains before the higher rate goes into effect, pumping up their capital gains receipts before the rate hike and shrinking their inventory of unrealized gains subject to the new, higher rate. The Administration has proposed raising both the capital gains tax rate and the tax on dividends for certain upper-income taxpayers from 15 percent to 20 percent. The Administration estimates that both tax rate hikes would increase revenue by $105.4 billion over 10 years, as shown in Row 1 of Table 1.[2]

Economists have debated for years how a higher capital gains tax rate affects receipts from the capital gains tax. However, perhaps more important for federal revenues are the deleterious effects on the real economy—reduced total income, output, and jobs—arising from a higher capital gains tax rate. The Administration’s official revenue estimates explicitly exclude any changes in other tax receipts that result from lower levels of output and income. To this extent, the official estimates are static and fundamentally deficient and misleading because changes in economic performance can substantially affect the full gamut of federal revenue sources, especially individual and corporate income tax receipts and payroll tax receipts.

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