(Bloomberg Opinion) -- The elimination of payroll and capital gains taxes “must be put on the table” in negotiations over the next coronavirus relief package, says President Donald Trump. His emphasis on capital gains taxes is new, though they have long been a marquee issue for his party. That needs to change.
A running joke in Washington is that Republicans’ preferred solution to any problem, whether a recession or an alien invasion, is to cut the capital gains tax. As silly as that sounds there is, or at least was, a straightforward logic to it.
Investment — in new equipment, buildings or research — drives labor productivity growth, and productivity growth is the fundamental resource an economy needs not just to raise living standards but to adapt to changing conditions. Yet the U.S. federal tax code typically double taxes investment.
Investments in the market are funded by personal savings, which — outside of a 401(k) or other tax-preferred account — are taxed first when the investor earns the money, then again when the corporation earns a profit. If an investor wants access to her savings, she must sell her stock and pay a third layer of taxation, on the capital gains.
These multiple layers of taxation dramatically reduce the return on investment, according to the conventional wisdom, and therefore productivity growth. In the early 1980s, when Republicans’ tax-cutting orthodoxy was being forged, this narrative was particularly compelling.
Soaring consumer prices and sky-high interest rates had eaten deeply into investor returns. Adjusting for inflation, stock values in the first few months of 1980 were lower than in the last few months of 1965. Once capital gains taxes were factored in (they aren’t indexed for rising prices), an investor’s return in real dollars was negative over the 25-year period.
Today’s world is different, to put it mildly. Inflation has been tamed. Interest rates are at rock bottom and despite terrorist attacks, the worst recession in 75 years and now the worst pandemic in a century, stock values have quadrupled in real terms in the last 25 years. Most important, the world is awash in savings.
An aging global population and an integrated financial system mean that U.S. companies have access to an enormous pool of savings that they can use to fund their investments. In addition, the most profitable U.S. companies have accumulated revenue faster than they could find profitable investments, requiring them to become net hoarders of cash.
Lowering the capital gains rate in hopes of increasing the pool of savings, therefore, is like pushing on a string. There is no shortage to be eliminated. Even modern supply-side models of the economy suggest that a capital gains tax cut would have a tiny effect on long-term GDP.
There are still tax cuts that can increase investment. To be effective, however, they have to be help make U.S. companies more competitive. That’s particularly true for businesses with large investments in physical (as opposed to digital) infrastructure. There are ways to do that, but cutting the capital gains tax rate isn’t one of them.
So it’s past time for the Republican Party to shelve its long-time commitment to this cause. At some point in the future, savings may once again become scarce and investors may see their returns overwhelmed by inflation. Until then, Republicans might want to find a better use for their political capital than an anachronistic attempt to cut or eliminate the tax on capital gains.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith, a former assistant professor of economics at the University of North Carolina and founder of the blog Modeled Behavior, is vice president for federal policy at the Tax Foundation.
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