Charles Gibson: Wrong on Capital Gains Question

21 April 2008

At the ABC debate, in between questions about flag pins, Charles Gibson made some eyebrow-raising claims about the capital gains tax and how he thinks it leads to increases in revenue. However, his claims were highly misleading. This is what the Center on Budget and Policy Priorities found:

Cutting capital gains rates reduces revenues over the long run. That’s the conclusion of the federal government’s official revenue-estimating agencies, as well as outside experts and the Bush Administration’s own Treasury Department.

  • The non-partisan Congressional Budget Office (CBO) and the Joint Committee on Taxation have estimated that extending the capital gains tax cut enacted in 2003 would cost $100 billion over the next decade. The Administration’s Office of Management and Budget included a similar estimate in the President’s budget.
  • After reviewing numerous studies of how investors respond to capital gains tax cuts, the non-partisan Congressional Research Service concluded that cutting capital gains taxes loses revenue over the long run.
  • The Bush Administration Treasury Department examined the economic effects of extending the capital gains and dividend tax cuts. Even under the Treasury’s most optimistic scenario about the economic effects of these tax cuts, the tax cuts would not generate anywhere close to enough added economic growth to pay for themselves — and would thus lose money.

Gibson's claim was highly misleading, since the spike in revenue is only the short-term effect of investors reacting to a sudden change in tax rates:

While a capital gains tax cut can lead investors to rush to “cash in” their capital gains when the lower rate first takes effect, it does not raise revenue over the long run.

  • Especially when a capital gains cut is temporary, like the 2003 tax cut that Gibson cited, investors have a strong incentive to sell stocks and other assets in order to realize their capital gains before the capital gains tax rate increases. This can cause a short-term increase in capital gains tax revenues, as happened after the 2003 tax cut.
  • Capital gains revenues also increased after 2003 because the stock market went up. But the stock market increase was not a result of the 2003 tax cut, as a study by Federal Reserve economists found. European stocks, which did not benefit from the U.S. capital gains tax cut, performed as well as stocks in the U.S. market in the period following the tax cut.
  • To raise revenue over the long run, capital gains tax cuts would need to have extraordinary huge, positive effects on saving, investment, and economic growth that virtually no respected expert or institution believes they have. In fact, experts are not even sure that the long-term economic effects of these capital gains tax cuts are positive rather then negative.

    One reason is that preferential tax rates for capital gains encourage tax sheltering, by creating incentives for taxpayers to take often-convoluted steps to reclassify ordinary income as capital gains. This is economically unproductive and wastes resources. The Urban-Brookings Tax Policy Center’s director Leonard Burman, one of the nation’s leading tax experts, has explained, “shelter investments are invariably lousy, unproductive ventures that would never exist but for tax benefits.” Burman has concluded that, “capital gains tax cuts are as likely to depress the economy as to stimulate it.”

So in the end, ABC's questions were either trivial scandal-issues, or based on false premises. This is the journalism we have to put up with.

UPDATE: Brendan Nyhan points out that John McCain and The Wall Street Journal make the same claims.

Let me state that again. Once again, the supply-side argument has been undercut by the administration's own economists.

Of course, that didn't stop John McCain, who has frequently claimed that tax cuts increase revenue, from making the same argument on ABC's This Week today:

MCCAIN: And [Barack Obama] obviously doesn't understand the economy, because history shows every time you have cut capital gains taxes, revenues have increased, going back to Jack Kennedy.

The Wall Street Journal also made the same claim in an editorial Friday (subscription required). It's sad to see the mainstream media giving life to this kind of supply-side foolishness.


Cameron said...

Kudos. Informative piece.

Crazy Politico said...

Lots of folks are touting those CBO numbers, etc this week. The problem with them is they are static. If you look at the CBO prediction of the tax cuts effects (lost revenue) from 2001 and 2003, you see they are completely wrong.

The CBO, and OMB both use a static analysis model to predict outcome of tax hikes/cuts. In other words, if I hike taxes, I will assume that no one will change behavior because of it. Unfortunately, we live in a dynamic world. People do change behavior.

Take for instance, the ill fated mid 1990's "luxury tax" on higher priced cars and yachts. I brought in nearly no money, yet "The Rich" bought yachts and cars, in Mexico, and nearly shut down the US yacht making industry. After two years it was scrapped.

With capital gains it's was proven to work exactly how Gibson stated it during Clinton's presidency. the collections went up when the rate dropped to 20%, and sank when it went to 28%. People just held stocks for longer to avoid the tax.

Samuel Brainsample said...

Thanks, Cameron. That last debate was frustrating on so many levels, and it's pretty clear that nobody walked away from it better informed on issues that matter.

Samuel Brainsample said...

Thanks for the comment, Crazy. Do you have a source for the failed predictions in 2001 and 2003?

As far as behavioral responses go, I was under the impression that CBO took that into account. Of course it's hard to predict these things in advance with absolute accuracy, but isn't there some way to predict at least somewhere in the ballpark? If so, do you think they were low-balling the behavioral response?

Samuel Brainsample said...

There's also this from the original post:
"After reviewing numerous studies of how investors respond to capital gains tax cuts, the non-partisan Congressional Research Service concluded that cutting capital gains taxes loses revenue over the long run."