Raising the capital gains tax will not lead to 'fairness,' but only slam U.S. job creation

President Barack Obama says the Bush capital gains tax cut should be permitted to expire at the end of the year. This is part of his election-year tax package, which he says is designed to pursue “fairness.” In making this argument, Obama compares himself to Ronald Reagan, whom he called a “wild-eyed, socialist, tax-hiking class warrior.


Even the Washington Post’s “Fact Checker” had to give Obama “two Pinocchios” for this “misleading” comparison. His proposal would cause the tax rate on long-term capital gains to increase from the current 15 percent to 20 percent. In addition, there will be a 3 percent disallowance of itemized deductions for income earned above a threshold, bringing the effective rate to 21.2 percent, plus an additional 3.8 percent tax for Obamacare, bringing the total to 25 percent. If the President’s “Buffett rule” is enacted, those affected will face a minimum rate of 30 percent.

It is perhaps because businesses are wary of this looming “taxmageddon” that the U.S. investment is fleeing to countries with lower rates. As a result, since the housing bust and financial crisis, real annual GDP growth has averaged just 0.8 percent. Though the recession that began in December 2007 officially ended in June 2009, the “rebound” usually associated with recoveries has been conspicuously absent, keeping unemployment above 8 percent.

If history is any guide, Obama’s plan to hike the rate will depress economic growth even further. As illustrated in the graph below, in general, capital gains taxes and GDP have an inverse relationship: when the rate goes up, the economy goes down; when the rate goes down, the economy goes up.

In 1968-81, when capital gains taxes gradually rose from 25 percent to as high as 40 percent, average GDP growth fell from 3.8 percent to 3.1 percent per year (See table). Likewise, after 1987, when the rate increased from 20 percent to 29 percent, average annual growth declined from 3.5 percent back down to 3.1 percent.

If Obama wants to produce more jobs, he must grow the economy. To do that, instead of hiking the capital gains tax, he must cut it. After the devastating dot-com bust and terrorist attacks of 2001, annual growth averaged just 1.8 percent. But after George W. Bush gradually cut the rate (from 21.19 percent to 16.4 percent by 2003) average annual GDP growth increased a full percentage point, to 2.8 percent.

Similarly, when Bill Clinton cut the capital gains tax rate from 29 percent to 21 percent in 1997, economic growth rose from an average of 3.1 percent to 4.5 percent per year. The same thing happened when Ronald Reagan slashed the rate in half (from 40 percent to 20 percent) in 1981: average annual growth rose from 3.1 percent to 3.5 percent. In each case, economic growth brought more jobs.

Perhaps Obama is not as interested in jobs or growth as in increasing federal revenues. If so, he should know that, historically, capital gains tax rate hikes have not increased, but decreased revenues. In contrast, as ABC’s Charlie Gibson pointed out to Obama during a 2008 debate with Hillary Clinton, Reagan’s 1981 cut increased average annual revenue from capital gains from 0.42 percent to 0.68 percent of GDP; Clinton’s 1997 cut from 0.67 to 1.05 percent; and Bush’s 2003 cut from 0.52 percent to 0.9 percent. In each case, not only did the economic pie grow, but the government got a bigger slice of this larger pie.

Whether the President wants more jobs, economic growth, or just more government revenue, he should cut the capital gains tax rate. Forcing the unemployed unnecessarily to continue without jobs can hardly be called “fairness.”