Why Newt Gingrich Is Wrong About Capital Gains Taxes

Our guest blogger is Michael Ettlinger, Vice President for Economic Policy at the Center for American Progress Action Fund.

In the movie “My Big Fat Greek Wedding,” an ongoing joke is that the patriarch of the family solves any problem by spraying Windex on it. The equivalent among the “tax cuts are the answer to everything” crowd is cutting the tax rate on capital gains.

The latest idea from Newt Gingrich — which he pitched on Fox News last night — is to cut the capital gains tax rate to zero. He argues that cutting the capital gains tax will cause private capital to flood into Wall Street and rescue the capital markets, which will do so much good for the economy that revenue will go up. Gingrich’s proposal is echoed by the conservative Club for Growth, which today advocated suspending the capital gains tax, saying that such an action “would bring as much as a trillion dollars of capital sitting on the sidelines back into the market.”

There are, to say the least, flaws in this argument:

1. Capital Gains Cuts Mostly Benefit The Wealthy: If you care about who benefits from tax cuts, and don’t think it should mainly be the rich, and in particular if right now you’re not so crazy about cutting taxes on the people on Wall Street who are responsible for getting the country into the huge financial mess it’s in, this probably isn’t your favorite tax change. The benefits of capital gains tax cuts overwhelmingly go to those who own capital assets outside of retirement and other tax-protected accounts. By definition it is the rich who own most capital assets.

2. Tax Cuts Don’t Pay For Themselves Or Produce Growth: The idea is brought to you by the same crowd that has been promising that tax cuts for the wealthy pay for themselves since the late 1970s. Instead, these policies have produced trillions of dollars of government debt. And, for all that debt, what they haven’t produced is particularly strong economic growth. In particular, they haven’t produced the investment growth bragged about.

3. The Incentive Will Be To Change Income To Capital Gains: You may have heard about the break that hedge fund managers get. There’s an attempt to legislatively stop that, but its underlying cause is that capital gains are already taxed at a lower rate than ordinary income. So people who can change, on paper, the characterization of their income from wages, dividends, interest, etc. to capital gains do so. Thus, these people don’t just get a tax cut on their capital gains income, they get a tax cut on much more of their income than that. That’s what accountants are for. If you think it’s bad now — with a capital gains rate at a little less than half the rate of ordinary income — imagine if the rate were 0%. 4. Capital Income Won’t Be Drawn Into The Market: The notion that this will draw capital income into the stock market is an odd one. Where does Newt think these people are putting their money now? Under their beds? This money would have to come from somewhere. If it’s interest bearing accounts, the banks would be hurt by as much as Wall Street benefited. If it’s treasury bills, the cost of government borrowing will go up. And there’s nothing about a capital gains tax cut that brings back money invested overseas — the break would apply to capital income, no matter where it’s earned. No, a capital gains tax cut doesn’t produce money out of thin air.

5. There Aren’t Profits To Be Had: And, the truth is, the wealthy who are supposedly going to flood Wall Street with their money aren’t going to unless they think they’re going to make money. And if they aren’t, then they wouldn’t have to pay any capital gains taxes anyway. No, the problem with the market isn’t that people are worried about paying taxes on their profits. The problem is that they don’t think there are profits to be had.

6. The Incentive Will Be To Sell: A 0% capital gains rate would in fact be a disaster for the market. One virtue of having a tax on capital gains is that it dampens volatility and promotes longer-term investing. That is, if you pay tax on profitable trades, you’re less likely to make moves based on short term movements on the market. Given the uncertain times we face, it’s far more likely that a zero rate on capital gains would prompt a massive exodus from the market than a massive entry into it. In fact, if you think about it, the immediate motivation of a 0% capital gains tax rate is to sell — not buy.

7. There Will Be No Incentive To Save: We worry all the time about insufficient savings in this country for retirement and education. One of the ways in which we encourage saving is to create no-tax retirement and education accounts. If all accounts are no-tax, money will likely not be put into these forms, which it’s much harder to pull out of.