Cutting the capital gains tax will raise tax revenue

Last Thursday, the House Ways and Means committee approved several tax reform bills collectively known as Tax Reform 2.0. These bills now move to the full House of Representatives where approval is likely. Then, the bill moves to the Senate where 60 votes are required for passage.

The Senate vote will occur after the election next month. Unless the GOP can get 60 Senate seats, which is a possibility, the tax reform bill will die in the Senate. Even with 60 GOP senators, the bill my not pass the house because of a cap on deductions for homeowners.

The bills have three parts.

{mosads}First, it makes portions of last year’s tax reform bill permanent. Temporary tax cuts set to expire in 2025 will be made permanent as will the $10,000 cap on deductible homeowner expenses. Also, temporary deductions for pass-through business would become permanent. 

Next, the bill encourages family savings by creating tax-deferred savings accounts. Lastly, the bill increases deductions for new businesses to encourage innovation. All three parts of the bill are generally viewed as positive, except it is believed that the deficit will increase.

The Congressional Budget Office estimates that this bill will increase the deficit by just over $60 billion per year. So is this bill a good idea? 

It is a good idea because tax cuts do not cause deficits. Opponents will argue that, after the Reagan tax cut in 1981, deficits soared. Taxes were cut for this year, and the deficit increased by $114 billion. 

However, after the tax cut in 1981, tax revenue was higher in all of the subsequent years. Taxes were cut this year, and for the first half of 2018, tax revenue increased by about 1 percent over last year.

Deficits increased because government spending increased. That’s what happened in the 1980s as Reagan spent to rebuild the military, and that happened again in 2018. If Congress could control spending, the deficit would not have grown. 

Tax Reform 2.0 should lower the capital gains tax rate.

Prior to President Obama’s huge increase in government spending, the capital gain tax rate was 15 percent. Shortly after Congress passed the Affordable Care Act and the Dodd-Frank bill, the rate was increased to 20 percent, and for some higher income earners, the rate increased to 23.8 percent.

Through executive order, President Trump has reversed hundreds of counterproductive, growth-stifling regulations imposed by the prior administration. By the second quarter of 2017, the economy was growing at more than a 3-percent annual rate. 

Last November, Trump convinced Congress to reduce income tax rates for all individuals. He also convinced Congress to repeal portions of the growth stifling Dodd-Frank bill. The changes went into effect in January 2018. By the second quarter of this year, the economy started growing at more than a 4-percent rate. 

The next step to have growth go even higher is to reduce the capital gains tax rate back to 15 percent. This would stimulate non-inflationary economic growth, and it would result in the government collecting more revenue from the capital gains tax.

In 1997, President Clinton reduced the capital gains tax rate from 28 percent to 20 percent. The result was that the somewhat sluggish economy grew at a 4.5-percent annual rate for the next four years, and tax revenue from capital gains increased substantially in the immediate aftermath. 

That’s because the lower rate ended up creating more capital for growth. As the economy grew and capital investment increased, total revenue increased. After all isn’t 20 percent of $1,500 ($300) greater than 28 percent of $1,000 ($280).

The opposition will claim this is just another tax cut for the wealthy. That is true because nearly all of the capital gains taxes are paid by the top 20 percent of income earners. But if the goal is to raise tax revenue and increase economic growth, taxes have to be cut for the people who actually pay the taxes.

The entire economy benefits by increased tax revenue and an even higher rate of economic growth. It is clearly a win-win situation. 

Tell Congress to cut the capital gains tax rate as part of Tax Reform 2.0.

Michael Busler, Ph.D., is a public policy analyst and a professor of finance at Stockton University where he teaches undergraduate and graduate courses in finance and economics.