Capital Gains Nonsense

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To anyone with knowledge of public finance theory, reading media reports of capital gains taxation is almost painful. Here’s an example from Bloomberg:

A group of economists recently argued in the Chicago Booth Review that the prevailing wisdom among scorekeepers that the revenue-maximizing rate is about 30% may be misplaced — and could allow for an even higher rate. A pair of Princeton University economists published research in December showing that hikes may raise “substantially more tax revenue” than scorekeepers currently believe and that the revenue-maximizing rate may be about 40% — almost exactly where Biden’s proposal falls.

Economists and analysts have also made the case that cuts in capital gains rates have a negligible impact on investment decisions and economic growth. (Though, like much around capital gains, that debate isn’t entirely settled.)

If capital gains taxes have almost no impact on behavior, then why isn’t the revenue-maximizing rate 100%? And why does the revenue-maximizing rate even matter? I don’t know of any public finance model where the optimal tax rate is the revenue-maximizing rate.

You also see the media discuss the “principle” that capital gains should be taxed the same as wage income. That’s about as sensible as saying that “in principle”, a gallon of gasoline should pay the same tax as a gallon of Scotch whiskey. Exactly what principle is that? Capital gains income is nothing like wage income, indeed calling both “income” is nonsensical. For instance, the real and nominal tax rate on wage income is identical, and the real and nominal tax rate on capital gains is very different. So if it’s a matter of “principle”, then why should we set the nominal tax rates equal? Why not equalize the real tax rates? And if they are merely two forms of “income”, then why don’t we allow full deduction of capital losses from wage income?

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