Capital Gains Tax Rates and Savings

By James Kwak

Earlier this week, I  wrote my own “job creator’s” manifesto for The Atlantic, in response to Steven Pearlstein’s great parody. You can read it if you are interested in knowing what one “job creator” thinks our country needs.

There’s something I forgot to add, however. (Literally: while I was away from my computer I decided to add it, but then I forgot to do so before sending it to my editor.) As I’ve said before, the capital gains tax rate had no impact on my decision to start a company. It couldn’t have had any impact, because I didn’t know what it was.

In addition, the capital gains tax rate has no impact on the question of what I do with my money. My wife and I both have jobs, and we live in an area with a moderate cost of living, so we can basically fund our lifestyle out of current wage income. Everything else gets invested according to a few simple, fundamental principles—basically an approximative version of mean-variance optimization.

I don’t think, “The capital gains tax rate is going up next year, so I should sell a bunch of assets and increase consumption today.” I don’t need another car (I just replaced my thirteen-year-old Prizm with a Subaru Impreza), and there aren’t many expensive restaurants where we live, and with two small children we’re not about to go on an eco-safari in Africa. Barack Obama and Mitt Romney could jointly announce that they are eliminating all tax preferences for investment income, and it wouldn’t change my savings and investment decisions a bit.

Now, changes in investment income tax rates can affect the relative valuations of different types of investments, such as high-dividend vs. low-dividend stocks. But the point here is that if your consumption decisions don’t change, then the amount of capital you are making available for investment in the current period remains the same. There may be more sophisticated people out there who may buy more LVMH products when capital gains tax rates go up. I’m just not one of them.

37 thoughts on “Capital Gains Tax Rates and Savings

  1. You could have also mentioned that the vast bulk of capital is controlled by pension funds that don’t pay capital gains taxes and most individuals have their investment funds largely in IRAs and 401k’s that also don’t pay the capital gains tax. Lastly, unrealized gains aren’t taxed.

  2. You are right, of course. Far as I know, the studies of the Laffer curve have found that the peak is well to the right of 50%. Unless taxes get to confiscatory levels, people start and operate businesses. But the accountants who work for the born-rich, they do take capital gains taxes into account.

    And anon. is right. “Everybody knows the fight was fixed / The poor stay poor, the rich get rich. That’s how it goes / Everybody knows.”

  3. ‘…the vast bulk of capital is controlled by pension funds that don’t pay capital gains taxes….’

    There might be a lesson there. Something along the lines of, capital goes where it is most lightly taxed.

    Also, any CPAs here to tell us whether or not pension fund profits could be taxed at cap gains rates?

  4. Paddy opined after the last gulp of beer, “…There might be a lesson there. Something along the lines of, capital goes where it is most lightly taxed….”

    Indeed, “capital” went here:

    @The Raven sez, “And anon. is right. “Everybody knows the fight was fixed / The poor stay poor, the rich get rich. That’s how it goes / Everybody knows.”

    The psychological abuse that goes along with the rigged system is pure hedonistic indulgence in sadism – the misanthrope gone wild on “free speech”.


  5. Does anyone know what percentage of capital of the sort that would be taxed at the capital gains rate is held in untaxed forms (pension funds, IRAs, 401ks, etc)?

    In other words, what percentage of capital gains would actually be affected by a raise in that rate. That would be a <1 multiplier on any negative consequences that are claimed.

    Another aspect of this is, what percentage of the capital gains that would actually get hit by a higher rate are held by the 1% or the 0.1% richest people? And which institutions/companies? I have always been bothered by the stat that x% of stock is held by us commoners, when in fact, I have little choice if I want to get that extra x% (401k match) of my paycheck. It feels like a scheme to get our income into their system.

  6. Actually when the money finally leaves the pension fund or 401k it does get taxed at regular rates, so it is basically a postponement, moving the taxes to the future. One little change to help revenues is to change the treatment of inherited IRAs and 401ks so that they have to be paid out according to the founders required minimum distribution schedule, not the beneficiaries.

  7. Ah, thank you, I had forgotten that it was delayed and paid at regular tax rates. That makes me angry a bit, our retirement accounts are taxed as income, but hedge fund managers income is taxed at the lower rate? Yet another example of the less well off bearing a higher percentage of the tax burden (per dollar, not per person).

    Do the beneficiaries get to use the value at time of inheritance as the basis, so the gains made by the founder are never taxed?

  8. Kwak: “If your consumption decisions don’t change, then the amount of capital you are making available for investment in the current period remains the same.”

    Mr. Kwak, your argument is “If everyone is like me, and since I don’t change my investment decisions because of the capital gains tax rate, then higher rates don’t matter.” This is reinforced by your proclaimed ignorance of the CG rate when you started a business.

    So is everone like you? Are all businesses similar in type and scale to the one you started? Are all investors ignorant of the CG rate or the probability of a desireable return on their investment? If many people and business are not like you and yours, then what is the useful content of your argument?

    Point of interest: did your business require a large investment to start and run, or was it mostly a vehicle for professional services? The amount of investment makes a big difference.

    Daniel Mitchel explains why capital gain tax rates matter, and why they should be low or zero to promote the most prosperous economy.

  9. Mr. Garland, I’ve never heard of anyone who would refuse to start or operate a business because of taxes, unless those are confiscatory. Do you know of anyone who has?

  10. @James Kwak “we must preserve the equality of opportunity that makes it possible for any American to dream of success… We must fight discrimination in all its forms so that our society can benefit from the talents of all its member”

    And yet, even though Mr. Kwak is co-writing a blog that basically has to do with bank regulations, he cannot find it in him to criticize how bank regulators are discriminating the access to bank credit of small businesses and entrepreneurs, based only on these being perceived as “risky”.

    Might it have to do with the fact that his current income might not any longer come from a private enterprise?

  11. @ The Raven “Mr. Garland, I’ve never heard of anyone who would refuse to start or operate a business because of taxes, unless those are confiscatory. Do you know of anyone who has?”

    Half of Italy who decided to go underground

  12. Re Calvin, 401k withdrawals and the like are taxed as income in respect of decedent, so they are taxed at regular rates since the original basis of a regular 401k is zero. (Roths differ here) . The difference is if the beneficiary is younger they potenially have lower required minimum distributions, although a less generous table is used for withdrawals, it assumes a 2.9 year life expectancy at 100 where as the table for the founder assumes a 6.3 year life expectancy. At 70 it is 27.4 versus 17 years. (take 1/the life expectancy to get the amount required to be withdrawn annually)

  13. @Calvin, “…Yet another example of the less well off bearing a higher percentage of the tax burden (per dollar, not per person)….”

    This incessant psuedo-intellectual spin will definitely not work anymore when it comes to taxes. Grab a tax return from a nurse and then from a hedge fund manager who has a “business” that farms her out as a contractor at an hourly rate. It’s WORSE than slavery economics. And she no longer has representation in D.C.

    @Per – “Half of Italy who decided to go underground.”

    And that is my biggest complaint in a nutshell – the “black market” War/Drug/Slave Lords are thriving on the same scale as the 1% have int he past 4 years – the stat is they sopped up 93% of all “gains”. A heist of biblical proportions by the GLOBAL “Deliverance Boyz” – “squeeel like a pig, Annie”….


    Savage and primitive – so let’s go back to ancient times, first battle is to secure the watering hole from the predators….it’s probably the PLUMBERS in Italy who had to go into an underground economy in order to preserve their civilization’s indoor plumbing – not kidding….

  14. ‘Are all investors ignorant of the CG rate or the probability of a desireable return on their investment? ‘

    The more sophisticated the investor, the more aware of tax consequences they are. An obvious example; the kids who started Facebook might not even have known what a cap gain was, but the venture capitalists who provided the funding to get it out of the dorm room sure did.

  15. Capital gains might be THE most responsive to changes in tax rates of all taxes. (Here’s looking at you, Annie.)

    Economic Consequences of the Tax Plan
    The Romney plan would raise actual and potential GDP by about 7.4 percent over a five to ten year adjustment period. The private business sector would grow about 7.8 percent. About two-thirds of the growth in GDP would go to labor income, across the board, in the form of more hours worked and higher wages per hour. Total labor compensation in the private business sector would rise by 7.8 percent in line with GDP. About a third of the gain, pre-tax, would accrue to savers and investors. The plan would boost the capital stock by about 18.6 percent (over $5 trillion in additional investment), which is what drives the increase in productivity, wages, and hiring.

    The reduction in the corporate tax rate yields the largest improvement in GDP and wages, followed by the 20 percent reduction in individual tax rates and the elimination of the capital gains and dividend taxes on middle income taxpayers. However, relative to the static revenue loss, the biggest bang for the buck comes from the capital gains and dividend relief, followed by the corporate rate reduction and the elimination of the estate tax.

  16. Board of Directors from Paddy’s “Tax Foundation” sitting on trillions in cash reserves and still ELIMINATING JOBS in USA at a much higher rate than Main Street can “create” sustainable jobs. So all the Foundation is doing is finding a way not to pay forward any “rent” to the civilization that tax dollars built. Thanks for forwarding the list of names of the biggest thieves, Paddy:

    David P. Lewis (Chairman)
    Vice President – Global Taxes;
    Chief Tax Executive & Assistant Treasurer
    Eli Lilly and Company
    James W. Lintott (Treasurer)
    Sterling Foundation Management LLC
    The Honorable Bill Archer
    Senior Policy Analyst
    PriceWaterhouseCoopers LLP
    Douglas Holtz-Eakin
    DHE Consulting, LLC
    Sarah McGill
    Senior Vice President, Tax Planning
    PepsiCo, Inc.
    Pamela F. Olson
    U.S. Deputy Tax Leader & Washington National Tax Service (WNTS) Leader
    PriceWaterhouseCoopers LLP

  17. So no-one has given an example of anyone in the USA who has refused to start or expand a business because of high capital gains taxes. If there were actual examples of people doing it in any numbers, they’d be all over the internet by now. What I see instead is a huge volume of bluster. No amount of bluster changes the facts. The radical-right argument on the capital gains tax is dead, as far as I am concerned.


  18. Annie I insist you add me to your list of preditors, The war/drug/slave/ and now annie /time lords too, no one deserves to be left behind as much as you, so please at least include me with your list of other cult members. We can raise the ravens dead, then stone him to death again with taxes. Next he can consume his own like minded cohorts until he has no Food.

    Just don’t leave time behind like that!

  19. Challenge – What are the 3 categories of LIES?

    Answer – 1. Lies. 2. Damn lies. 3. Statistics

    You are out of time because you ran out of “space”:

    “…If the speed is constant, only multiplication is needed, but if the speed changes, then we need a more powerful method of finding the distance. One such method is to approximate the distance traveled by breaking up the time into many short intervals of time, then multiplying the time elapsed in each interval by one of the speeds in that interval, and then taking the sum (a Riemann sum) of the approximate distance traveled in each interval. The basic idea is that if only a short time elapses, then the speed will stay more or less the same. However, a Riemann sum only gives an approximation of the distance traveled. We must take the limit of all such Riemann sums to find the exact distance traveled…”

    I’ll be around LONG after the universe sheds the memory of your existence, filth – self-proclaimed leader of the toothless Deliverance Boyz….”squeel like a pig, Annie” You think I’m not locked and loaded against YOU, cretin? Keep pumping up the hate level ’till your money becomes no good anywhere…

  20. The tax laws are confusing when not deceptive. “Capital gains” or the change in the value of an asset between the date it is acquired and the date it is sold represents a change in wealth. Short term changes in wealth are treated as ordinary income and changes in wealth over a longer period — maybe six months (?) — are treated as changes in the value of an income-producing asset (capital gain). Actually, it is a wealth tax, not an income tax. (Or perhaps a tax on the current capitalized value of the expected future flow of net income from the asset in question, less the original price paid for the asset by the seller.)
    Presumably that asset would have been producing some flow of income during the owner’s tenure, and that flow would have been subject to income taxation. In some cases,naturally, that would have not been the case, e.g., a commercial forestry enterprise.
    I recall that years ago there was some discussion of “deflating” the nominal “capital gain” by an appropriate price index.

  21. Let’s get this straight. The blah blah about about capital gains is based on the Trickle Down Theory. If the richies have more money, they will invest it and create jobs. Presto!! End of recession. The problem is that the trickle down theory is a bunch of crap and it seems facts won’t kill it, so I’ll try one more time.

    Trickle Down Theory, one more time!!

    They are at it again. Cut the taxes on the richest of the rich and the corporations and they will spend their riches creating new jobs, and the resulting wealth will trickle down to the rest of us.

    A quick review is in order here. Jack Kemp, then a Congressman had lunch with Arthur Laffer, then an economist. The story is that Laffer drew a curve on a napkin to promote the theory that tax cuts for the rich produce economic growth and new jobs. That curve will forever be know as the Laffer Curve. Of course, the joke here is unintended.

    So here is your assignment. Take a look at corporate profits. They are high as they have ever been. Corporations are sitting on record amounts of cash and have been doing so for a number of years now.

    The 1% now have more money than they have ever had and their share of the wealth of the country is staggering.

    So where are all the new jobs that should have been trickling down to us since, oh say, the Bush tax cuts?????????????

    Even Mitt says that 23 million Americans are unemployed or under-employed, and nothing much has changed for five years now. Record numbers of people have been unemployed for over a year now.

    And yet there are still fools in Washington trying to sell us the Laffer Curve!! It is indeed a Laugh Curve, but the results ain’t funny. Tell them to stop trying to fool you. It ain’t pretty!!

  22. Mr Taylor,

    All tax rates, including the upper income tax rates, have been in place for 10 years. The legislation establishing those rates has a 10 year expiration because it passed under reconcilliation rules in the Senate. Tax rates were lowered for all income brackets.

    Technically, “current law” calls for higher rates on all income brackets starting in 2013. Obama wants to keep the lower rates for lower income brackets, changing current law for them. He wants to apply current law only to the highest brackets. Obama claims that keeping current tax rates for high income taxpayers is a tax break for the rich, but it would only keep the same rates as for the last 10 years.

    What happened after the Bush tax cuts?  [edited excerpt]
    === ===
    Let’s take a look at what Mr. Obama inherited from President Bush. Byron York, in the Washington Examiner, has the numbers.

    Revenues fell in Bush’s first two years because of a combination of the tech bust and the start of the tax cuts. But then things took off according to the Office of Management and Budget. Tax revnues:
    2003 $1.78 trillion
    2004 $1.88
    2005 $2.15
    2006 $2.40
    2007 $2.56
    That’s a 44% increase in revenue after lowering marginal tax rates for everyone.
    === ===

    Government revenue increased with increasing GDP and prosperity after the Bush tax rate cuts and a two year period of adjustment.

    You say that leaving the rates as they are is “trickle down” economics applied to the wealthy.
      (1)  The ordinary income of the wealthy is taxed at progressive rates, and capital gain income comes from investments at risk, subject to extra taxes due to inflation, made with money which has already been taxed, and based on the after-tax value of the profits earned by the investment. There are already taxes on everything.
      (2)  It is their money. It is a philosophy of “trickle down government” to believe that government spending is what produces a growing and productive economy. Where are the vibrant, profitable businessses created by government, and the efficient government departments?

    Just from a utilitarian perspective, what evidence do you refer to, to believe that transferring more money to government plans will produce a better future than leaving that money in private hands?

  23. Just from a utilitarian perspective, what evidence do you refer to, to believe that transferring more money to government plans will produce a better future than leaving that money in private hands?

    I’ll assume you mean gvt hands. And the guess there is that the gvt will do the right thing, -vs- the private hands which have been proved to take the greed/power trip route. Unfortunately, [for the gvt], I proved in 2008 that they won’t ever get around to doing the right thing although the promises keep coming. This just shows how deeply greed has worked its way into the political system. So it seems the utilitarian perspective is a lose -lose dealeo either way as their one track mind can only cipher a perceived risk-on or a perceived risk-off scenario for every situation that one can come up with.

    Annie that was one of your better responses although your concept of time differs from mine. No probs, I don’t quite see you living beyond my years, but if I though the universe was watching me or waiting for me to accomplish something, I might become a night watchmen so they couldn’t see me and thieve the last of my money. Remember that my money is a unit of time, if it were no good anywhere —-, it would have to be recreated again, and that coould leave you broke.

  24. Mr. Garland:

    “Government revenue increased with increasing GDP and prosperity after the Bush tax rate cuts and a two year period of adjustment.”

    Geez, what happened starting in 2003 and continued on until 2007 that obviously caused that revenue increase?

    Like Clinton’s “surplus” which was caused by added revenue by the boom, the increased revenue you attribute to tax policy was caused by the housing boom.

    Causation, Mr. Garland, not correlation. Especially not correlation based on ideology.

  25. One thing further.

    If I use the same exact formula you have used and apply it to the Clinton tax increase of 1993, I come up with an increase in revenue of 50%.

  26. Money has been “re-created” over and over again – who is using 2000 year old Roman coins today as life-maintenance currency?

    You don’t get it, filth – probably the inherent limitations in your Deliverance-boyz genetics. It’s not up to you how long I “live”. I’m already immortal. And anytime someone becomes so completely PSYCOTIC as to make it their life’s mission to live as a predator, there is a JUST WAR started. JUST WARS could be micro in scale – ie. get the mass murderer in your city/state – or they can get really big like China vs Japan over a disputed island.

    Now when 480 billionaires in USA are worth a collective amount of 2.08 TRILLIONS $$$$s, all they need is one enclave – one city – one hospital, a couple of genetherapy shamans and human organ harvestors – and then whatever other kinds of people they like to devour in the pursuit of their sick power-fetishes – probably a lot of young tender flesh they can rip into for sex. Saying that 480 FLAWED HUMAN BEINGS do everything BETTER than a GOVERNMENT forged by the people and for the people is not even within the realm of possibilities on even the most theoretical meanderings of their personal ass kissing “intellectuals”.

    The GOVERNMENT institutions did the basic and primary R&D for every single god-damn thing you have in the way of “modern” conveniences because it was all about DEFENSE. Who are you CRETINS trying to kid? YOU didn’t build ANY of it and everyone knows that.

    So the JUST WAR is on. No taxation without representation and with 93% of ALL “recovery” currency sucked up by 480 people it’s a BIG WAR ahead to take down those who WILLINGLY serve Caligastia. You got your Rethug Deliverance Boyz – heck, how many years was TORTURE discussed by the “political class” in governemnt? Seems to me you all still want “government” to do stuff – like torture everyone and rip food out of their mouths by taking away property and land.

    All the 300+ million other citizens have is each other and REAL leadership in the wings….Karol Woytila stayed alive long enough to get a chance to tell the planet – “Have no fear”….your Bishop depends on the oppsite schtick – “squeeeel like a pig, Annie, as we TAX you to death…”

    FU and the horse you rode in on.


  27. In terms of growth you attribute to tax policy:

    ” The basic story is very simple. (Remember, the purpose of economics is to make simple things complicated so as to exclude most of the public from debates on the most important policy issues that affect their lives.) The economy in the bubble years was driven by the bubble. The huge run-up in house prices led to an extraordinary building boom. Residential construction, which is ordinarily 3-4 percent of GDP rose to more than 6 percent of GDP at the peak of the boom in 2005.

    Bubble-inflated house prices created close to $8 trillion dollars of housing equity. The housing wealth effect implies that people would spend between 5 to 7 cents on the dollar of this additional wealth, creating between $400 billion and $560 billion in additional annual consumption. The property taxes on inflated house prices also helped support perhaps $80 billion or so in state and local government spending. For good measure there was a bubble in non-residential real estate that followed in the wake of the housing bubble, which created a boom in this sector as well.”


    WIthout the housing bubble, there would have been no growth during the five year period(which you cherry-picked) at all.

  28. More Fun With Ideologues

    Seems the cherry picking was actually worse than I thought.

    You skipped two years for “adjustments” and then counted 03-07 as revenue. But that onlyworks for the 2001 tax cut. The 2003 tax cut would have skipped 04and 05 and counted 06 to 09. In effect, there was a tax revenue decrease(almost even) in those years.

    So the 03 tax cut saw no increase in revenues at all. And the average of the revenue gain was 22% from the two Bush tax cuts.

    Or 28% less than the Clinton tax increases.


  29. As I said, The Trickle Down Theory seems to defy facts over and over again. Just read the comments here.

    But I will try one more time. This week’s Business Week carries an article entitled, “Keep Looking for the Economic Benefit-Sixty years of data cast doubt on the economic argument for treating capital gains differently.”

    On the VERY off chance someone might actually be interested in FACTS instead of political posturing, the article can be found at;

  30. Mr. Taylor, thank you for the Businessweek citatiion. That article states “the Bush administration’s basic logic: that a lower capital gains rate encourages investment, which creates jobs and helps the economy grow.” It cites a study by Prof. Burman which “plotted capital gains tax rates against economic growth from 1950 to 2011″. It points out that he found no statistically significant correlation between the two.” (He tried to accomodate lags between tax rates and growth rates by up to five years.”) Actually, the magazine probably meant to say that growth rates were the dependent variable and tax rates were the independent variable: to describe the regression equatiion as the magazine did makes no sense.
    The actual regression which should have been run is to make INVESTMENT the dependent variable and the capital gains tax rate the independent variable. Unfortunately, the regression which Businessweek ineptly describes incorporates the statistical “noise” between investment and growth rates.
    Brings back memories of Prof. Dale Jorgenson’s class at Berkeley!

  31. Annie, did you want some cheese to go with that wine? It seems you even blew the speakers out on my little red corvette. No probs though, i’m tired, i’m gonna get comfy on my mattress and call it a night.

  32. Dear Del

    What Leonard Burman did makes perfect sense. Also note that he made all of his work available to the entire economic community and nobody, including me, found any fault with it. Perhaps you might find it useful to dig out your old statistics textbook from Prof. Jorgenson’s class.

  33. Sorry Jim, but the good professor misspecified the nature of the relationship which should be tested in order to verify the original hypothesis, i.e., that the lower capital gains tax rate encourges investment, Ergo, one has no idea what the results of the calculation mean. (A separate specification would need to regress economic growth (dependent variable) on investment (independent variable) The Businessweek article reflects the low level of economic literacy among the professional journalists today. By the way, Prof. Jorgenson was a Professor of Econometrics, not of Statistics. (I am sure that you appreciate the distinction.)

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