|
|
Capital Gains Taxation and U.S. Economic
Growth
Testimony Before the Standing Committee
on Banking,
Trade and Commerce of the Senate of Canada
December
16, 1999
Published by the American Council for Capital Formation. The
Council's mission is to promote economic growth through sound tax,
trade, and environmental policies. Contact the Council for reprint
permission.
ACCF Senior Vice President and Chief Economist Dr. Margo Thorning
testified as an invited witness on December 16, 1999, before the
Standing Committee on Banking, Trade and Commerce of the Senate
of Canada as the Canadian Parliament considers tax reform proposals
including capital gains reductions. The executive summary and full
text of the ACCF's testimony are presented here.
1. Overview. I am honored to be
invited to address this committee on the U.S. experience with capital
gains taxation and to outline the ACCF's goals for future pro-capital
formation tax changes. The ACCF's research shows the positive impact
of capital gains tax reductions on capital costs, saving, investment,
and entrepreneurial activity.
2. Tax Policy and Economic Growth. To those
who favor a truly level playing field over time to encourage individual
and business decisions to save and invest, stimulate economic growth,
and create new and better jobs, capital gains (and other forms of
saving) should not be taxed at all. This view was held by top economists
in the past and is held by many mainstream economists today.
3. Macroeconomic Impact of Capital Gains Tax Reductions.
- Enhance Economic Growth. New research by Dr.
David Wyss, chief economist of Standard & Poor's DRI and a
top public finance expert, finds that the Taxpayer Relief Act
of 1997, enacted by the U.S. Congress, which reduced the long-term
individual capital gains tax rate from a top rate of 28 percent
to 20 percent, has had several favorable impacts on the American
economy in the intervening two years.
- Encourage Entrepreneurship. Capital gains
taxation has a particularly powerful impact on the nation's entrepreneurs,
a major, driving force for technological breakthroughs, new start-up
companies, and the creation of high-paying jobs. Starting new
businesses involves not only entrepreneurs but also informal investors,
venture capital pools, and a healthy public market.
- Benefit Middle-Income Taxpayers. Investments
in capital assets are widely held by the middle class. A new study
by Leonard E. Burman, deputy assistant secretary for tax analysis
at the U.S. Department of the Treasury, states that in 1992 about
three-quarters of all families in the United States owned stocks,
bonds, business property, real estate, or houses.
Middle- and low-income taxpayers also hold a significant share
of the total dollar value of capital assets, even when personal
residences are excluded. Dr. Burman's study shows that 30 percent
of the dollar value of such assets was held by families with incomes
of $50,000 or less in 1992.
4. International Comparison of Capital Gains Tax Rates. Both
short- and long-term individual capital gains on equities are taxed
at higher rates in the United States than in most of the other 23
countries surveyed. Short-term gains are taxed at 39.6 percent in
the United States compared to an average of 18.4 percent for the
sample as a whole. Long-term individual gains face a tax rate of
20 percent in the United States versus an average of 14.8 percent
for all the countries in the survey.
5. Economic Impact of Further Capital Gains Tax Reductions. A
preliminary analysis of the capital gains tax reductions included
in the "Taxpayer Refund and Relief Act of 1999" (H.R.
2488) by Dr. Allen Sinai, chief global economist, Primark Decision
Economics, shows that reducing the individual long-term rates from
20/10 percent to 18/8 percent would have a significant, positive
impact. (H.R. 2488 was vetoed by President Clinton in September,
1999.)
6. Conclusion. Recent 1997 and 1998 individual
capital gains tax reductions and shortening of the holding period
have had a positive impact on the U.S. economy. Further capital
gains tax reductions could significantly enhance economic growth.
ACCF TESTIMONY
My name is Margo Thorning. I am Senior Vice President and
Chief Economist of the American Council for Capital Formation. I am
honored to be invited to address this committee on the U.S. experience
with capital gains taxation and outline the ACCF's goals for future
pro-capital formation tax changes.
The ACCF represents a broad cross-section of the American business
community, including the manufacturing and financial sectors, Fortune
500 companies and smaller firms, investors, and associations from
all sectors of the economy. Our distinguished board of directors includes
cabinet members of prior Republican and Democratic administrations,
former members of Congress, prominent business leaders, and public
finance experts.
The American Council for Capital Formation has led the private-sector
Capital Gains Coalition since 1978, when the first major post-World
War II capital gains tax cut was enacted. The Coalition brings together
in support of capital gains tax relief diverse participants from all
sectors of the business community-venture capital, growth companies,
timber, farmers, ranchers, small business, real estate, securities
firms, and the banking and insurance industries.
Recent Evidence on the Impact of Tax Policy on Economic Growth
To those who favor a truly level playing field over time to encourage
individual and business decisions to save and invest, stimulate economic
growth, and create new and better jobs, saving (including capital
gains) should not be taxed at all. This view was held by top economists
in the past and is held by many mainstream economists today.
This is primarily because the income tax hits saving more than once-first
when income is earned, and again when interest and dividends on the
investment financed by saving are received, or when capital gains
from the investment are realized. The playing field is tilted away
from saving and investment because the individual or company that
saves and invests pays more taxes over time than if all income were
consumed and no saving took place. Taxes on income that is saved raise
the capital cost of new productive investment for both individuals
and corporations, thus dampening such investment. As a result, future
growth in output and living standards is impaired.
Several recent analyses by academic scholars and government policy
experts such as Professors Alan Auerbach of the University of California
and Laurence J. Kotlikoff of Boston University, and others whose studies
are cited in a 1997 study by the Joint Committee on Taxation of the
U.S. Congress, suggest that substituting a broad-based consumption
tax for the current federal income tax could have a positive impact
on economic growth and living standards. The macroeconomic models
used by the scholars in the studies described below incorporate feedback
and dynamic effects in simulating the impact of adopting either a
broad-based consumption tax or "pure" income tax.
The "pure" income tax eliminates all personal exemptions
and deductions, and taxes labor and capital income at a single rate.
The "pure" consumption tax differs from the pure income
tax by permitting expensing of new investment (meaning that the total
cost of the investment is deducted in the first year). This tax is
implemented as a tax on wages with all saving (including capital gains)
exempt from tax at the household level, and as a cash-flow tax on
businesses.
The effects of the consumption tax proposals on GDP are generally
positive over the medium and long terms, although the magnitude of
these effects varies widely (see Table 1). For example, the Jorgenson-Wilcoxen
model predicts that under a consumption tax, real GDP would be 3.3
percent higher each year in the long run compared to 1.3 percent higher
under a unified income tax. The Auerbach, Kotlikoff, Smetters, and
Walliser model predicts even greater gains in the long run (7.5 percent)
under a consumption tax and losses (-3.0 percent of GDP) under a unified
income tax. Similarly, the Engen-Gale analysis shows that the capital
stock would be 9.8 percent higher in the long run under a consumption
tax but 1.6 percent lower under a unified income tax compared to current
law. The consensus seems to be that the economy would fare better
under a "pure" consumption tax than under a "pure"
income tax or under current law. |
| Table 1 |
Impact of Tax Reform on GDP and Capital Stock
Growth
Percent differences from current tax code baseline |
| |
Consumption Tax |
Unified Income Tax |
| Summary variables |
2005 |
2010 |
Long run |
2005 |
2010 |
Long run |
|
REAL GDP:
|
| Fullerton-Rogers-low1 |
- |
- |
1.7 |
- |
- |
1.8 |
| Fullerton-Rogers-high2 |
- |
- |
5.8 |
- |
- |
3.8 |
Auerbach, Kotlikoff,
Smetters, & Walliser |
4.0 |
5.0 |
7.5 |
-1.7 |
-2.1 |
-3.0 |
| Engen-Gale |
1.8 |
2.1 |
2.4 |
-0.2 |
-0.3 |
-0.5 |
| Jorgenson-Wilcoxen |
3.6 |
3.3 |
3.3 |
1.6 |
1.4 |
1.3 |
Macroeconomic Advisers
(transition relief) |
1.4 |
1.3 |
5.4 |
- |
- |
- |
| Robbins |
16.4 |
16.9 |
- |
14.6 |
15.4 |
- |
| DRI Inc./McGraw-Hill |
4.7 |
- |
- |
-1.1 |
- |
- |
| DRI Inc./McGraw-Hill-"VAT" |
-4.2 |
- |
- |
- |
- |
- |
| Gravelle |
0.7 |
1.0 |
3.7 |
0.6 |
0.7 |
1.8 |
| Coopers & Lybrand |
1.2 |
- |
- |
1.1 |
- |
- |
|
CAPITAL STOCK:
|
| Fullerton-Rogers-low1 |
- |
- |
5.2 |
- |
- |
5.4 |
| Fullerton-Rogers-high2 |
- |
- |
23.8 |
- |
- |
11.8 |
Auerbach, Kotlikoff,
Smetters, & Walliser |
14.0 |
19.1 |
31.5 |
-4.2 |
-5.9 |
-10.5 |
| Engen-Gale |
7.0 |
7.6 |
9.8 |
-0.7 |
-1.0 |
-1.6 |
| Jorgenson-Wilcoxen |
0.9 |
0.6 |
0.3 |
-2.0 |
-2.3 |
-2.6 |
Macroeconomic Advisers
(transition relief) |
4.3 |
4.8 |
13.2 |
- |
- |
- |
| Robbins |
47.0 |
57.2 |
- |
38.8 |
48.6 |
- |
| DRI Inc./McGraw-Hill |
13.7 |
- |
- |
-1.5 |
- |
- |
| DRI Inc./McGraw-Hill-"VAT" |
-0.7 |
- |
- |
- |
- |
- |
| Gravelle |
1.7 |
2.7 |
11.2 |
0.5 |
0.9 |
4.1 |
| Coopers & Lybrand |
1.5 |
- |
- |
1.1 |
- |
- |
1. Assumes leisure-consumption (intratemporal)
and intertemporal elasticities both are 0.15.
2. Assumes leisure-consumption (intratemporal) and intertemporal elasticities
both are 0.50.
Source: Adapted from Joint Committee on Taxation, "Tax Modeling
Project and 1997 Tax Symposium Papers," November 20, 1997. |
Thus, in the ACCF's view, the long-run goal of U.S.
federal tax policy should be to shift toward a broad-based consumption
tax under which all income that is saved, including that from capital
gains, is exempt from tax.
Trends in U.S. Capital Gains Tax Policy
Historical Perspective
During the last half of the century, the U.S. Congress has acted several
times to increase or decrease individual and corporate capital gains
tax rates and to raise or lower the holding period requirement for
capital gains treatment (see Table 2). The top marginal federal statutory
rate on individual capital gains has ranged from as high as 35 percent
to the current low of 20 percent. Corporate capital gains tax rates
have ranged from 25 percent to the current-law 35 percent. Holding
period requirements have varied from 6 months to as long as 18 months;
currently the holding period is one year. |
| Table 2 |
History of U.S. Federal
Capital Gains Tax Rates |
| Years |
Holding Period |
INDIVIDUALS |
CORPORATIONS |
| Top Income Tax Rate (%) |
Top Capital Gains Tax Rate (%)a |
Capital Gains Differential (%)b |
Top Income Tax Rate (%) |
Top Capital Gains Tax Rate (%)a |
Capital Gains Differential (%)b |
| 1942-43 |
6 months |
88.0 |
25.0 |
63.0 |
40.0 |
25.0 |
15.0 |
| 1944-45 |
6 months |
94.0 |
25.0 |
69.0 |
40.0 |
25.0 |
15.0 |
| 1946-50 |
6 months |
91.0 |
25.0 |
66.0 |
38.0 |
25.0 |
13.0 |
| 1951 |
6 months |
87.2 |
25.0 |
62.2 |
50.8 |
25.0 |
25.8 |
| 1952-53 |
6 months |
88.0 |
26.0 |
62.0 |
52.0 |
26.0 |
26.0 |
| 1954 |
6 months |
87.0 |
26.0 |
61.0 |
52.0 |
26.0 |
26.0 |
| 1955-63 |
6 months |
87.0 |
25.0 |
62.0 |
52.0 |
25.0 |
27.0 |
| 1964 |
6 months |
77.0 |
25.0 |
52.0 |
50.0 |
25.0 |
25.0 |
| 1965-67 |
6 months |
70.0 |
25.0 |
45.0 |
48.0 |
25.0 |
23.0 |
| 1968-69 |
6 months |
70.0 |
25.0 |
45.0 |
48.0 |
27.5g |
20.5 |
| 1970 |
6 months |
70.0 |
29.5 |
40.5 |
48.0 |
28.0 |
20.0 |
| 1971 |
6 months |
70.0 |
32.5 |
37.5 |
48.0 |
30.0 |
18.0 |
| 1972-76 |
6 months |
70.0 |
35.0c |
35.0 |
48.0 |
30.0 |
18.0 |
| 1977 |
9 months |
70.0 |
35.0 |
35.0 |
48.0 |
30.0 |
18.0 |
| 1978-10/31/78 |
1 year |
70.0 |
35.0 |
35.0 |
48.0 |
30.0 |
18.0 |
| 11/1/78-6/9/81 |
1 year |
70.0 |
28.0 |
42.0 |
46.0 |
28.0 |
18.0 |
| 6/10/81-6/22/84 |
1 year |
50.0 |
20.0 |
30.0 |
46.0 |
28.0 |
18.0 |
| 6/23/84-86 |
6 months |
50.0 |
20.0 |
30.0 |
46.0 |
28.0 |
18.0 |
| 1987 |
6 months |
38.5 |
28.0 |
10.5 |
40.0 |
34.0 |
6.0 |
| 1988-89 |
1 year |
33.0d,e |
33.0d,e |
0 |
34.0 |
34.0 |
0 |
| 1990-92 |
1 year |
31.0f |
28.0f |
3.0 |
34.0 |
34.0 |
0 |
| 1993-5/6/97 |
1 year |
39.6 |
28.0 |
11.6 |
35.0 |
35.0 |
0 |
| 5/7/97-7/21/98 |
18 months |
39.6 |
20.0 |
19.6 |
35.0 |
35.0 |
0 |
| 7/22/98 |
1 year |
39.6 |
20.0h |
19.6 |
35.0 |
35.0 |
0 |
a. Maximum capital gains tax rate.
b. Differential between marginal income tax rate and capital
gains rate.
c. Interplay of minimum tax and maximum tax on earned income
results in a marginal rate of 49.125 percent.
d. Statutory maximum of 28 percent but "phase-out"
notch increases rate to 33 percent.
e. Interplay of all "phaseouts" can increase marginal
rate to 49.5 percent.
f. The Budget Act of 1990 increased the statutory rate to 31.0
percent, and capped the marginal rate on capital gains at 28.0 percent.
Until 1996, however, some taxpayers will face effective marginal rates
of more than 34.0 percent due to the phase-out of personal exemptions
and itemized deductions.
g. Includes a 10 percent surcharge.
h. The IRS Restructuring and Reform Act of 1998 reduced the holding
period required to qualify for the 20 percent long-term capital gains
rate from 18 months to 12 months for gains properly taken into account
on or after January 1, 1998.
Prepared by the ACCF Center for Policy Research, Washington, D.C. |
|
Current U.S. Capital Gains Tax Provisions
- Individual Capital Gains Tax Rates
The Taxpayer Relief Act of 1997 reduced the top individual capital
gains tax rate to 20 percent (10 percent for individuals in the
15 percent bracket). A special lower rate of 18 percent (8 percent
for individuals in a 15 percent tax bracket) applies to transactions
after December 31, 2000, when the asset was held more than five
years.
- Corporate Capital Gains Tax Rates
Corporate capital gains are taxed at a rate of 35 percent (the
same as the top tax rate on ordinary corporate income).
- Netting of Gains and Losses
Gain or loss from the sale or exchange of a capital asset is characterized
as either short term or long term depending on how long the asset
was held by the taxpayer. If a taxpayer has both long-term and
short-term transactions during the year, each type is reported
separately and gains and losses from each type are netted separately.
The net long-term capital gain or loss for the year is then combined
with the net short-term capital gain or loss for the year to arrive
at an overall (net) capital gain or loss. If capital gains exceed
capital losses, the overall gain is included with the taxpayer's
other income but is generally subject to a maximum tax rate of
20 percent for sales of long-term capital assets and 35 percent
for corporations. If capital losses exceed capital gains, the
overall losses are subject to deduction limitations ($3,000 per
year for individuals). A corporation can use capital losses for
a tax year only to offset capital gains in that year.
The Impact of Capital Gains Tax Reductions on the U.S.
Economy
Searching for methods of stimulating saving, investment, and economic
growth, policymakers enacted a significant capital gains tax reductions
for individuals in 1997 (described above).
Lower capital gains taxes not only treat savers more fairly but
also help hold down capital costs. Public finance economists refer
to the tax on capital gains as a tax on retained income. It is retained
income that funds a large part of business investment. The higher
the capital gains tax, the more difficult it is for management to
retain earnings (rather than pay out dividends) for real investment
in productive projects.
Although the short-term outlook for the U.S. economy is favorable,
worries about the future appear to be multiplying. For example,
many public finance experts such as Stanford University's Professor
John Shoven conclude that this country's long-term strength and
economic stability depend on increasing saving and investment to
ensure that the retirement of the baby boom generation does not
sink the economy into a sea of red ink. While the 1997 cut in the
top marginal capital gains tax rate from 28 to 20 percent was not
an economic panacea, it has helped to encourage saving, maintain
the values of capital assets (e.g. real estate and stocks), promote
investment by both mature and new businesses, and more fairly tax
individual savings.
Macroeconomic Effects of 1997 Capital Gains Tax Cut
Reducing the individual capital gains tax from a top rate of 28
percent to 20 percent in 1997 reduced the net cost of capital for
new investment by about 3 percent, according to a new macroeconomic
analysis of the economic and revenue impact of the tax cut prepared
by Dr. David Wyss, chief economist of Standard & Poor's DRI
and a top public finance expert.
Dr. Wyss's study shows that reducing capital costs will, other things
being equal, raise business investment by 1.5 percent per year.
Over a 10-year period, the capital stock will rise by 1.2 percent
and productivity and real GDP will increase by 0.4 percent relative
to the baseline forecast (see Table 3). This productivity increase
allows living standards to rise; for example, U.S. household income
will be $309 higher each year and the average worker's real wage
will be $250 higher in 2007 and in each succeeding year (see Figure
1).
|
| Table 3 |
Economic Impact of the 1997 Capital Gains Tax Reduction
Compared to the baseline forecast |
|
Total
1998-2009 |
| Real GDP (% increase by 2009) |
0.4 |
Investment (% per year increase) |
1.5 |
Capital stock (% difference by 2009) |
1.2 |
Productivity (% increase by 2009) |
0.4 |
Cost of capital (% difference) |
-3.0 |
Total federal tax receipts
(billions of 1997 dollars) |
$5.0 |
| Source: Capital Gains Taxes and the Economy: A
Retrospective Look, June, 1999. Standard & Poor's DRI,
Lexington, Mass. |
| Figure 1 |
1997 Capital Gains Tax Cut: Impact on U.S. Wages and Household
Income in 2007 and Beyond
1999 dollars |
 |
Note: The DRI study shows that productivity increases
by 0.4 percent by 2007 due to the 1997 capital gains tax cut. Higher
productivity growth permits real wages and household income to increase
relative to the baseline (no 1997 capital gains tax cut).
Source: Capital Gains Taxes and the Economy: A Retrospective
Look, June, 1999. Standard & Poor's DRI, Lexington, Mass. |
In addition, a significant share of the increase in stock prices since
1997 (about 25 percent) is due to lower taxes on individual capital
gains realizations (see Figure 2). Lower capital gains taxes increase
the after-tax rate of return on equities, thus stock prices must rise
to re-equilibrate the risk-adjusted after-tax return with the rate
available on other assets, such as bonds. |
| Figure 2 |
1997 Capital Gains Tax Cut: Impact on Stock Prices From
1997 to 1999
S&P index of 500 common stocks |
 |
| Source: Capital Gains Taxes and the Economy: A
Retrospective Look, June, 1999. Standard & Poor's DRI,
Lexington, Mass. |
Finally, a dynamic rather than static analysis of the impact of the
cut on federal revenues shows that the stronger growth in the economy
adds to federal revenues over the long run.
Impact on Entrepreneurship and Venture Capital
Capital gains taxation has a particularly powerful impact on entrepreneurs.
These individuals are a major driving force for technological breakthroughs,
new start-up companies, and the creation of high-paying jobs. Starting
new businesses involves not only entrepreneurs but also informal investors,
venture capital pools, and a healthy public market. All taxable participants
are sensitive to after-tax rates of return, which is why the level
of capital gains taxation is so important.
Foremost is the entrepreneur. If the tax on potential capital gains
is a higher rate, either the pool of qualified entrepreneurs will
decline or taxable investors will have to accept a lower rate of return.
In either case, the implications for the economy are clearly negative.
To be successful, the entrepreneur needs capital. Fledgling start-ups
depend heavily upon equity financing from family, friends, and other
informal sources. Professors William Wetzel and John Freear of the
University of New Hampshire, in a survey of 284 new companies undertaken
in the late 1980s, found taxable individuals to be the major sources
of funds for those raising $500,000 or less at a time. The point to
be stressed is that individuals providing start-up capital for these
new companies pay capital gains taxes and are sensitive to the capital
gains tax rate.
The important role of taxable "angels" in providing "seed
money" for startups is also documented in a new report by Dr.
Stephen Prowse of the Federal Reserve Board of Dallas presented at
a 1998 conference sponsored by the Federal Reserve Bank of Kansas
City. Dr. Prowse notes that the angel capital market appears to be
growing in importance, although it operates in almost total obscurity.
He points out that there are wide-ranging estimates of its size-from
as little as $3 billion per year invested to as much as $20 billion.
Whatever its actual size, the market appears to be an essential source
of funds for entrepreneurs in many different industries. In one study
of high-tech start-up companies, for instance, Dr. Prowse found that
more than half the companies sampled had used angel investors as a
source for at least part of their capital base, and a fifth had relied
exclusively on angels. Small businesses and entrepreneurs face higher
capital costs than Fortune 500 companies. For them, a significant
capital gains tax differential can make a big difference in their
decisions affecting jobs and growth.
According to DRI's Dr. Wyss, there are two primary reasons for encouraging
venture investment: First, it is critical to the economy since innovation
and job creation come disproportionately from new start-ups; and second,
the private market will tend to under-invest. Thus, start-ups need
to be encouraged. Innovation and new company formation are inherently
risky; only about one in three new start-ups succeed; individual investors
are risk averse, and since they cannot invest in every start-up, must
balance the high risk by the hope of high returns. Society should
not be risk averse, since on an actuarial basis it knows start-ups
will be winners; the success of the one will more than offset the
failure of the two losers. Since society effectively "invests"
in every start-up, it should not be averse to the risks. Every stop
should be pulled out to encourage more new business, because these
new ventures are so high-risk, and return such a high reward, they
need to be pushed even harder by society, Dr. Wyss concludes.
Impact on Middle-Income Taxpayers
Investments in capital assets are widely held by middle-income taxpayers.
A new study by Leonard E. Burman, deputy assistant secretary for tax
analysis at the U.S. Department of the Treasury, states that in 1992
about three-quarters of all families in the United States owned stocks,
bonds, business property, real estate, or houses.
Middle- and low-income taxpayers also hold a significant share of
the total dollar value of capital assets, even when personal residences
are excluded. Dr. Burman's study shows that 30 percent of the dollar
value of such assets was held by families with incomes of $50,000
or less in 1992.
In addition, a 1999 survey by the Investment Company Institute and
the Securities Industry Association shows that almost half of all
U.S. households own equities.
U.S. Capital Gains Tax Policy: Strategies to Enhance U.S.
Economic Growth
The individual capital gains tax rate reductions in the Taxpayer Relief
Act of 1997 and the shortening of the holding period in the IRS Restructuring
and Reform Act of 1998 were positive steps that reduced U.S. capital
costs, increased investment, real income, productivity growth, and
federal budget receipts. However, many public finance experts suggest
that additional capital gains rate reductions would have a positive
impact on the U.S. economic growth, job creation, and entrepreneurship.
International Comparison of Capital Gains Tax Rates
U.S. capital gains tax rates, which affect the cost of capital and
therefore investment and economic growth, are still high compared
to those of other countries. In fact, most industrial and developing
countries tax individual and corporate capital gains more lightly
than does the United States, according to a survey of 24 industrialized
and developing countries that the ACCF Center for Policy Research
commissioned from Arthur Andersen LLP.
Both short- and long-term individual capital gains on equities are
taxed at higher rates in the United States than in most of the other
23 countries surveyed (see Table 4). Short-term gains are taxed at
39.6 percent in the United States compared to an average of 18.4 percent
for the sample as a whole. Long-term individual gains face a tax rate
of 20 percent in the United States versus an average of 14.8 percent
for all the countries in the survey. Thus, U.S. taxpayers face tax
rates on long-term gains that are 35 percent higher than those paid
by the average investor in other countries. In addition, the United
States is one of only five countries surveyed with a holding period
requirement in order for the investment to qualify as a capital asset. |
Table
4: International Comparison of Individual Capital Gains:
Maximum Federal Tax Rates on Equities
(*indicates
note) |
| Country |
Maximum Individual Tax Rate |
Individual Capital Gains: Max. Tax
Rate on Equities |
Individual Holding Period |
| Short-term |
Long-term |
| Argentina |
33.0 |
Exempt |
Exempt |
No |
| Australia |
48.5 |
24.0 |
24.0 |
No |
| Belgium |
56.7 |
Exempt |
Exempt |
No |
| Brazil |
27.5 |
15.0 |
15.0 |
No |
| Canada |
31.3 |
14.5
(updated 2-01) |
14.5
(updated 2-01)
|
No |
| Chile |
45.0 |
45.0; annual exclusion of $6,600 |
45.0; annual exclusion of $6,600 |
No |
| China |
45.0 |
20.0; shares traded on major exchange
exempt |
20.0; shares traded on major exchange
exempt |
No |
| Denmark |
61.7 |
40.0 |
40.0; shares valued at less than $16,000
exempt if held 3+ years |
Yes, 3 years* |
| France |
58.1 |
26.0; annual exclusion of $8,315 |
26.0; annual exclusion of $8,315 |
No |
| Germany |
55.9 |
55.9 |
Exempt |
Yes, 6 months |
| Hong Kong |
20.0* |
Exempt |
Exempt |
No |
| India |
30.0 |
30.0 |
20.0 |
Yes, 1 year |
| Indonesia |
30.0 |
0.1 |
0.1 |
No |
| Italy |
46.0 |
12.5 |
12.5 |
No |
| Japan |
50.0 |
1.25% of sales price or 20% of net gain |
1.25% of sales price or 20% of net gain |
No |
| Korea |
40.0 |
20.0; shares traded on major exchange
exempt |
20.0; shares traded on major exchange
exempt |
No |
| Mexico |
35.0 |
Exempt |
Exempt |
No |
| Netherlands |
60.0 |
Exempt |
Exempt |
No |
| Poland |
40.0 |
Exempt |
Exempt |
No |
| Singapore |
28.0 |
Exempt |
Exempt |
No |
| Sweden |
57.0 |
30.0 |
30.0 |
No |
| Taiwan |
40.0 |
Exempt (local company shares) |
Exempt (local company shares) |
No |
| United Kingdom |
40.0 |
40.0; shares valued at less than $11,225
exempt |
40.0; shares valued at less than $11,225
exempt |
Yes, 1 to 10 years* |
| United States |
39.6 |
39.6 |
20.0 |
Yes, 1 year* |
| Average |
42.4 |
18.0
(updated 2-01) |
14.5
(updated 2-01) |
79.2% have no holding period |
| Source: ACCF Center for Policy Research,
Washington, D.C., updated February, 2001 |
Table 5: International Comparison of Corporate Capital Gains:
Maximum Federal Tax Rates on Equities
(*indicates
note) |
| Country |
Corporate Capital Gains: Maximum Tax Rate
on Equities |
Corporate Holding Period |
| Short-term |
Long-term |
| Argentina |
33.0 |
33.0 |
No |
| Australia |
30.0, phased in over two years |
30.0; phased in over two years |
No |
| Belgium |
Exempt |
Exempt |
No |
| Brazil |
33.0 |
33.0 |
No |
| Canada |
21.8 |
21.8 |
No |
| Chile |
15.0 |
15.0; asset cost is indexed |
No |
| China |
33.0; shares traded on major exchange
exempt |
33.0; shares traded on major exchange
exempt |
No |
| Denmark |
34.0 |
Exempt* |
Yes, 3 years* |
| France |
41.7 |
23.8 |
Yes, 2 years |
| Germany |
45.0 |
45.0 |
No |
| Hong Kong |
Exempt |
Exempt |
No |
| India |
35.0 |
20.0* |
Yes, 1 year |
| Indonesia |
0.1* |
0.1* |
No |
| Italy |
37.0 |
27.0* |
Yes, 3 years |
| Japan |
34.5 |
34.5 |
No |
| Korea |
20.0; shares traded on major exchange
exempt |
20.0; shares traded on major exchange
exempt |
No |
| Mexico |
34.0 |
34.0 |
No |
| Netherlands |
Exempt |
Exempt |
No |
| Poland |
Exempt |
Exempt |
No |
| Singapore |
Exempt |
Exempt |
No |
| Sweden |
28.0 |
28.0 |
No |
| Taiwan |
Exempt (local company shares) |
Exempt (local company shares) |
No |
| United Kingdom |
31.0* |
31.0*; asset cost is indexed |
No |
| United States |
35.0 |
35.0 |
No |
| Average |
22.5 |
19.3 |
83% have no holding period |
| Source: ACCF Center for Policy Research,
Washington, D.C., updated December, 1999 |
| *Notes
on Tables 4 & 5 |
| Maximum Individual Tax Rate |
| Hong Kong |
Maximum marginal tax rate is 20 percent for the assessment year
1997/1998 and 17 percent for 1998/1999. |
| Individual Capital Gains |
| Denmark |
Gains on shares held three or more years are tax exempt if taxpayer
owns less than US $16,000 of the company's shares. |
| U. Kingdom |
Sliding scale of rates applies to 1 to 10 years of ownership through
an exclusion that rises gradually to 75 percent for assets held 10
or more years. Thus, assets held 10 or more years face a top marginal
rate of 10 percent. |
| United States |
Shares held 12 months or more are taxed at a rate lower than that
on ordinary income under the IRS Restructuring and Reform Act of 1998. |
| Maximum Corporate Income Tax Rates |
| Hong Kong |
Maximum corporate rate is 16 percent for the assessment year 1998/99
and 16.5 percent for 1997/98. |
| Poland |
The corporate rate will be reduced to 34 percent in 1999 and to
32 percent for 2000 and beyond. |
| U. Kingdom |
The corporate rate will be reduced to 30 percent effective from
April 1999. |
| Corporate Capital Gains |
| Denmark |
For corporations, capital gains are tax exempt if the holding period
is longer than three years. |
| India |
Capital gains from sale of equity investments and securities listed
on stock exchange and held for more than one year are taxed at 20
percent. |
| Indonesia |
An additional tax of 0.5 percent applies to the disposition of founder
shares (effective as of May 29, 1997). In this case, if the taxpayer
does not want to use the facility of 0.5 percent, the normal progressive
tax rate of 30 percent is applied. |
| Italy |
For corporations, a substitute tax of 27 percent applies on capital
gains arising from the transfer of shares held and accounted for as
financial assets for at least three years. |
| U. Kingdom |
The corporate rate will be reduced to 30 percent effective from
April 1999. |
Similarly, short- and long-term corporate capital
gains tax rates are higher in the United States than in most other
industrial and developing countries surveyed. Both short- and long-term
gains are taxed at a maximum rate of 35 percent in the United States,
compared to an average of 22.5 percent for short-term gains and 19.3
percent for long-term gains the sample as a whole (see Table 5). In
other words, U.S. corporations face long-term capital gains tax rates
almost 80 percent higher than those of all but one of the other countries
surveyed (Germany at 45 percent) and only four of the 24 countries
surveyed impose a holding period in order to be eligible for preferential
corporate capital gains tax rates.
The failure to reduce corporate capital gains tax rates in conjunction
with the 1997 individual rate cuts heightens the inequities already
inherent in the double taxation of corporate profits under current
law, leading to excessive tax planning, and may accentuate the trend
away from the traditional corporate form of organization.
Economic Impact of Further Capital Gains Tax Reductions
Many policy experts in the U.S. Congress, academic institutions, and
think tanks conclude that further reductions in federal taxes on individual
as well as corporate capital gains taxes will enhance U.S. saving,
investment, and GDP growth. For example, a preliminary analysis of
the capital gains tax reductions included in the "Taxpayer Refund
and Relief Act of 1999" (H.R. 2488) by Dr. Allen Sinai, chief
global economist, Primark Decision Economics, shows that reducing
the individual long-term rates from 20/10 percent to 18/8 percent
would have a significant, positive impact. (H.R. 2488 was vetoed by
President Clinton in September, 1999.)
Dr. Sinai's analysis indicates if the rate reductions in H.R. 2488
had been enacted, real GDP would $64.6 billion higher, and employment,
investment, new business formations, and national saving would be
greater over the 2000-2004 period compared to the baseline forecast
(see Table 6). In addition, U.S. capital costs would be slightly lower.
He concludes that the capital gains tax cut would have produced a
"significant bang for the buck." |
Table 6: Cumulative Impact of Capital Gains
Tax Reductions in H.R. 2488, the Taxpayer Refund and Relief Act of
1999
Compared to baseline forecast |
|
FY 2000-2004 |
Real GDP
(billions of 92$) |
$64.6 |
| (average change per year in GDP growth rate) |
0.1% |
Employment
(average change per year) |
112,000 |
Real business capital spending
Total (billions of 92$) |
$18.2 |
| Equipment |
$17.2 |
| Structures |
$2.0 |
| New Business Incorporations |
200,000 |
Cost of capital
Pretax return required by an investor
(average change per year) |
-0.13% |
S&P Stock Index
(average change per year) |
0.8% |
National Saving
(billions of $) |
$84.2 |
H.R. 2488 included a capital gains tax reduction from 20/10 percent
to 18/8 percent.
Source: Preliminary data from Dr. Allen Sinai, president and chief
global economist, Primark Decision Economics, Inc., December, 1999. |
Conclusion
Recent (1997 and 1998) individual capital gains tax reductions and
shortening of the holding period have boosted U.S. economic growth.
While the U.S. long-term tax policy goal should be fundamental tax
reform and more reliance on consumption taxes, the ACCF believes that
the short-run policy agenda in the United States should include additional
capital tax cuts.
A soundly structured, broad-based cut in individual and corporate
tax rates on capital gains would significantly benefit all taxpayers.
By reducing the cost of capital, it would promote the type of productive
business investment that fosters growth in output and high-paying
jobs. By increasing the mobility of capital, it would help assure
that scarce saving is used in the most productive manner. By raising
the value of equities, it would help support values in capital asset
markets in general and the stock market in particular. By increasing
the availability and lowering the cost of capital, it would aid entrepreneurs
in their vital efforts to promote technological advances in products
and services that people need and want. By reducing taxes on their
savings, it would treat fairly those thrifty taxpayers who must bear
a heavier tax burden than the profligate. And, because of the combined
impacts of unlocking and macroeconomic feedback, a broad-based capital
gains tax cut is likely to increase government revenues.
Sources
Alan J. Auerbach, David Altig, Laurence J. Kotlikoff, Kent A. Smetters,
and Jan Walliser, "Stimulating U.S. Tax Reform," NBER Working
Paper No. 6248 (Cambridge, Mass.: National Bureau of Economic Research,
October 1997).
Joint Committee on Taxation, "Tax Modeling Project and 1997 Tax
Symposium Papers," November 20, 1997.
Leonard E. Burman, The Labyrinth of Capital Gains Tax Policy
(Washington, D.C.: Brookings Institution Press, 1999), p. 88.
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