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Author Topic: Does raising tax rates on capital gains raise revenue?  (Read 1268 times)
Torie
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« on: April 13, 2012, 09:27:55 am »
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Obama has made famous the Buffet rule, which is really a massive tax rate increases on capital gains if you generate enough of them to get into the "soak the rich" zone. It effectively raises the marginal rate on capital gains for these folks from 15% to 30%, exclusive of whatever the states levy (if Jerry Brown in CA has his way, in CA that would be another 13%).  Capital gains are a special category of income, because you take a risk with your investment, can avoid recognition of gain by just holding the asset (and borrowing against it if need be to raise cash), and avoid it entirely if you hang on to the asset until death (as I plan to do with my real estate assets). 

Anyway, Krauthammer and Barone claim no, it won't generate more revenue, it is just populist demogoguery. So I did a google to see what is out there as to what the data might actually reflect, and came up with this article. It seems that the rate on capital gains does not really generate more revenue, although there is a lot of noise in the data due to the variation in how much gain is out there to realize, and the timing games folks play as to when and if to recognize capital gains as capital gains tax rates go up and down. There also may not be enough data points to be very confident in making predictions.

The purpose of this thread is to have a substantive and data based discussion of this issue, as opposed to engaging in ideological rhetoric. So if anyone finds other econometric articles on this topic, I suggest that this thread by the place to put them.

In the meantime, I am surprised the Pubs have not characterized the Buffet Rule for what it really is - a massive tax increase on capital gains. When it comes to other forms of income, the rich pay a 35% marginal tax rate, going up to 39.6% at the end of the year, so the Buffet Rule just isn't applicable to anything but capital gains.
« Last Edit: April 13, 2012, 09:30:33 am by Torie »Logged

Grumps
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« Reply #1 on: April 13, 2012, 09:33:32 am »
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Hasn't the IRS itself admitted when the rate goes down revenues increase?
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Torie
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« Reply #2 on: April 13, 2012, 09:41:22 am »
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Hasn't the IRS itself admitted when the rate goes down revenues increase?

On capital gains?  I don't know. Find a link Grumps!  Do it nowSmiley
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« Reply #3 on: April 13, 2012, 09:51:21 am »
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Hasn't the IRS itself admitted when the rate goes down revenues increase?

On capital gains?  I don't know. Find a link Grumps!  Do it now!  Smiley

When I get a chance.  I remember also hearing this from some former IRS people.....the logic being, the rich don't need to pay the tax, they'll hold on to whatever is the subject of the tax until the tax rate is more favorable.  It made sense when they told me.......I'll try and find a link.
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« Reply #4 on: April 13, 2012, 09:57:51 am »
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Try this for starters....... http://www.econdataus.com/cgtax05.html
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« Reply #5 on: April 13, 2012, 10:05:57 am »
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I would draw a couple of inferences from the article.

1) The elasticity of capital compared to labor is reflected in the volatility of capital gains taxes in advance of a rate hike and following a rate cut.

2) Gradual rate changes in capital gains rates should reduce volatility by making the arbitrage of tax rate timing less of a factor compared to true market timing.

3) Some fraction of capital elasticity is due to income sheltering to take advantage of the large gap between income and capital gains rates.

Unsaid in the article, but noted by commentators defending the lower capital gains rate is that capital gains due to dividend income has already been taxed once on the corporate side. Also a frequent observation of tax cutters is that the US has a relatively high corporate rate compared to other industrialized nations.

The above collection of thoughts and observation would tend to argue for a system of minimal corporate taxation but treatment of capital gains as ordinary income. A change to such a system would need be phased in over a period as long as a decade or more. Long term capital asset value would need an inflation adjustment so that the dollar value of the gains were comparable to dollars earned in the current tax year.
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« Reply #6 on: April 13, 2012, 10:10:38 am »
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Yes- great point What is the Obama quote about how doing so would still be better since it is "fair"?

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« Reply #7 on: April 13, 2012, 10:19:59 am »
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Remind us why you are not on Capitol Hill, muon?  Smiley
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Torie
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« Reply #8 on: April 13, 2012, 10:21:34 am »
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Muon2, it  might be useful to separate capital gains from dividends (both of which get the favorable 15% rate at the moment).  Sure, the rationale for a lower rate for dividends disappears if you gut the C Corp tax rate. However, if you want to adjust your basis for inflation, that rationale applies equally to interest income. Probably the most efficient, is to adjust both for inflation, and tax as ordinary income. However, the revenue loss might be quite large.

As to capital gains recognized from the sale of an asset, I don't see how you can get around the avoidance of recognition issue as rates go up. The issue is just how much avoidance is manifested when. And you have like kind exchanges, and the timing of gains to be offset by losses, and on and on. One thing I do know. If the favorable capital gains rate disappears, then "everybody" with any financial smarts will put all their stock assets in a pension plan, and carry bonds in their taxable account.  That will be another offsetting factor. So in the end, we are down to what the empirical evidence shows as to actual behavior which measures such "elasticities."

Right now, I have most of my equities in a taxable account (broad based index funds that I never sell like the total stock market Vanguard index fund, which generate a minimum of capital gains, since they are passively managed; I just put value/emerging market funds that generate a lot of taxable activity in my pension plan).

Speaking of pension plans, that is the biggest loophole for "the rich" of all. I wonder why team Obama has not gotten around to that issue yet?  He would have a much better case to make there, then this hawking of the Buffet Rule, which beyond everything else, might increase the cost of capital, and reduce future economic growth.

Hey, did you get my email with my most massive matrix chart that I have constructed yet?  It's even bigger than the US deficit as it were. Tongue
« Last Edit: April 13, 2012, 10:38:13 am by Torie »Logged

Torie
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« Reply #9 on: April 13, 2012, 10:27:06 am »
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Remind us why you are not on Capitol Hill, muon?  Smiley

Hey, maybe when that burnt out old once dope smoking libertarian hipster who when he got flabby and soft discovered the evils of porn retires, I can run for Congress from my little satrapy (love that jungle primary, where I might get Dems to put me over the top against another Pub, hehe), and join Muon2 in Congress. Maybe we can both get on the Ways and Means Committee, and piss everybody off as we keep demanding data, or attacking data, and so forth. I wonder if they have a rule against smoking pot in the Capitol building. Tongue
« Last Edit: April 13, 2012, 10:41:13 am by Torie »Logged

Torie
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« Reply #10 on: April 13, 2012, 10:29:53 am »
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Try this for starters....... http://www.econdataus.com/cgtax05.html

Nice work Grumps. Alas, there are not enough data points for all of those variables (amount or recognized gain, amount of unrecognized gain (or dear, we don't have that variable on the chart), absolute rate, change of rate, etc.) operating at once I suspect, but that chart cries out for being slapped on a spreadsheet, and the "Regression Analysis" statistical button pushed, which generates a trend line and a coefficient formula like magic.  It is almost as good and magical as electricity in my world. Smiley

Another issue to tackle while we are at it, is just how much of the C Corp tax is a tax on capital, and how much of it is passed on in higher product prices, and thus acts as a regressive national sales tax. I want answers to that one too, and I am tired of waiting for them. It is time for gratification. I don't have all that much time left. Sad
« Last Edit: April 13, 2012, 10:41:39 am by Torie »Logged

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« Reply #11 on: April 13, 2012, 01:44:43 pm »
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There are some issues with the paper. The biggest issue is where he assumes that the cost of equity is an accurate proxy of the cost of capital across the economy. How often do you see companies selling stock to raise capital, in proportion to the total amount of capital raising that occurs in the economy? Hardly ever. Mostly when you hear about something like this, it's a bank whose assets have gone toxic. The reason is obvious-- no company wants to penalize shareholders by raising capital in this way. More often (as you see with Apple and Google) companies with super-low debt costs of capital are sitting on zounds of cash for which they can apparently see no more worthwhile investment than to pay out as dividends.

In fact, the author uses some weasel words at the end of which assures the reader that he must be aware of the formula for the weighted average cost of capital (WACC), but it would be too inconveient to insert it explicitly into his model, so he would rather just dismiss it with a rhetorical flourish (hopefully, by the time the reader is finished plodding through his piles of data explicating the negative effect of a 3.4% decrease in GDP on wages, income, taxes, and everything else under the sun, he or she will be too burnt out to catch this.) But simply put, firms obviously substitute their sources of capital between equity and debt so that their total average cost of capital is minimized, just as I substitute between 7-Eleven brand ice cream and Ben and Jerry's ice cream. Ice cream is ice cream, and capital is capital (controlling for risk, of course-- but from the firm's perspective, debt is a risk of the creditor).

In other words, a 10% increase in the equity cost of capital does not equate to a 10% increase in the cost of capital across the board in the economy. Not even close. There are other problems with the paper which touch on some of the things mentioned in the above discussion which I won't even get into right now. I find all this whining and wailing about the poor corporations and their cost of capital and how they are getting raped under Obama to be grotesque, absurd, and outrageous. That 'study' was just a piece of excrement dressed up in fancing clothing. Look at what corporate bond yields are right now (yes, that is how corporations raise capital these days), look at what they were when Obama took office. Look at what corporate assets and profits are right now, and look at what they were when Obama took office. The stock market has doubled since March 2009. The Nasdaq, which broadly represents the areas of the economy most likely to have productive investments since they are in the areas where technology is expanding, is at its highest level since the last Democratic President. Except, check what the P/E ratio of the Nasdaq was then, and check what it is now. When this President took office he could have easily destroyed corporate America. It was on the verge of a complete collapse, no hyperbole. Not every President can say that. Instead, he has been the best President for corporate America, in possibly America's history.

Let's face it. We don't want corporations to pay out a lot of dividends. We want them to retain their earnings and reinvest it into productive assets. And if they have nothing productive to invest in, then we lose nothing by taxing the hell out of them.

P.S. There is a careful line that you have to walk in econometric studies between providing something useful and throwing out something that is far, far too dependent on the assumptions you use for its conclusions and thus could be manipulated to any end (e.g., lying with statistics). Microeconomic estimates are generally much eaiser than macroeconomic estimations, so I think the government is on the right path by trying to avoid "dynamic" estimation, and focusing on short-term avoidance effects instead (what they call "static" estimation).
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« Reply #12 on: April 13, 2012, 02:22:05 pm »
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I love how leftists are still in love with the bizarro Stalinist "productive assets" BS...  I wonder by what percentage the production of pig iron will increase after the Five Year Plan?

(The reasoning is extremely specious anyway, but that's another story).
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Torie
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« Reply #13 on: April 13, 2012, 02:33:06 pm »
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Beet, economic theory teaches that adjusted for risk, the cost of debt and equity should be the same. There used to be some chatter that that only applied pre tax, and not after tax, but that chatter has died down. The tax advantages or disadvantages of debt versus equity are priced into expected rate of return, so it's a wash.

It probably should be a law, that everyone has to get an MBA with a major in finance. It isn't that hard a field really.  Law was much trickier, trust me.

Oh the dividend thing.  Tax them enough, and  corps will just buy back their own stock in lieu of dividends, and the shareholders will in exchange, get more share price appreciation. That is why Microsoft never paid any dividends forever and ever, until the tax rate on dividends (income already taxed at the corporate level at 35%, some of which is not recovered in the form of higher prices) was slashed.
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« Reply #14 on: April 13, 2012, 02:58:36 pm »
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Beet, economic theory teaches that adjusted for risk, the cost of debt and equity should be the same. There used to be some chatter that that only applied pre tax, and not after tax, but that chatter has died down. The tax advantages or disadvantages of debt versus equity are priced into expected rate of return, so it's a wash.

It probably should be a law, that everyone has to get an MBA with a major in finance. It isn't that hard a field really.  Law was much trickier, trust me.

Torie. If the marginal cost of debt is 2%, and the marginal cost of equity is 2%, and there is a shock to the equilibrium so the marginal cost of equity goes to 2.5%, that does not mean that the marginal cost of capital goes to 2.5%. Firms will re-adjust their composition of equity and debt so that the marginal cost of capital goes up by an interminate amount less than 0.5%. Based on empirical evidence, large firms overwhelmingly finance new projects with debt, so the increase in the total cost of capital is far less than the increase in the cost of equity capital. The equality of cost rule between the two types of capital does not affect my argument.

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Oh the dividend thing.  Tax them enough, and  corps will just buy back their own stock in lieu of dividends, and the shareholders will in exchange, get more share price appreciation.

The share price is based on expected future payments, just like any other asset. Absent the "Keynesian beauty contest" - at which one might as well reduce all of Wall Stree to a casino, the only reason it would appreciate is in anticipation of future dividend payments.

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productive assets

"Productive assets" is Stalinism? Ho hey! There you go. I also assert that Kamenev was a traitor who deserved to die. I am a good Stalinist!
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Torie
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« Reply #15 on: April 13, 2012, 03:12:06 pm »
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If the cost of debt and equity are the same (and they are on a risk adjusted basis, so the more debt you have, the higher the return demanded on the stock), then adjusting the mix does not change the cost of capital. 

My comment on dividends is a mathematical truism. If someone wants some cash, they can just sell a few shares. The result is exactly the same economically.
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« Reply #16 on: April 13, 2012, 03:32:10 pm »
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If the cost of debt and equity are the same (and they are on a risk adjusted basis, so the more debt you have, the higher the return demanded on the stock), then adjusting the mix does not change the cost of capital.
 

The cost of capital = (equity share of financing) * (cost of equity) + (debt share of financing) * (cost of debt minus tax deduction on interest payments).

From this formula it should be self-evident that there is not a 1:1 relationship between the total cost of equity and the cost of capital. Of course if the cost of equity increases this will be unfavorable, but the firm will simply shift a portion of its capital structure into debt, and continue to adjust its capital structure until the cost of the two forms of financing are equalized, in accordance with theory. The paper is absurd on face. It tries to argue that a $77 billion tax will result in a $500 billion decline in economic activity. How anyone can not be skeptical of that is a wonder.

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My comment on dividends is a mathematical truism. If someone wants some cash, they can just sell a few shares. The result is exactly the same economically.

Um, I don't know what to say to this. Retaining profits is not ultimately an effective way of avoiding the dividend tax because shareholdres' value to the firm is entirely based on their net expected future cash flow from the firm, and if the firm does not pay dividends, that value is zero. One person can sell shares at a profit, yes, but the next buyer must find another person to sell to, and so on and so on... the final investor must see cash flow. There is no getting around that. Microsoft is a company in the middle of its life cycle. It was transitioning from the growth phase to the mature phase. A better example would be Altria (MO), which is in the liquidation phase. It pays out a high dividend because it knows the US market for cigarettes is a dead end.
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« Reply #17 on: April 13, 2012, 03:41:02 pm »
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But I told you the tax deduction bit is passe. Interest rates are higher to offset the negative ordinary tax income that cannot be time or deferred, for the recipients. So the cost of debt and equity are the same pretax, and after tax.

We don't seem to agree on much of anything do we Beet, when it comes to economics?  Tongue
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« Reply #18 on: April 13, 2012, 03:50:52 pm »
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But I told you the tax deduction bit is passe. Interest rates are higher to offset the negative ordinary tax income that cannot be time or deferred, for the recipients. So the cost of debt and equity are the same pretax, and after tax.

We don't seem to agree on much of anything do we Beet, when it comes to economics?  Tongue

Don't worry. We both agree that Romney is the best out of the four clowns that your party could have nominated, both most likely to win and the least insane. This way if Spain blowing up this years tips the economy into a double dip and the election to the GOP, I will be less upset having lost to Romney than I would if it were Santorum, Gingrich or Paul. We will, like Hoover, blame Europe. Smiley
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« Reply #19 on: April 13, 2012, 06:48:12 pm »
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There's no way to prove anything in economics. Nothing happens in a vacuum. But if you must, you're the one making the counter-intuitive claim. The burden of proof is on you.
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Beet
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« Reply #20 on: April 13, 2012, 06:55:34 pm »
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By the way, the following is contained in the link you provided:

"The non-partisan Congressional Budget Office (CBO) and the Joint Committee on Taxation have estimated that extending the capital gains tax cut enacted in 2003 would cost $100 billion over the next decade.  The Administration’s Office of Management and Budget included a similar estimate in the President’s budget.

After reviewing numerous studies of how investors respond to capital gains tax cuts, CBO commented that “the best estimates of taxpayers’ response to changes in the capital gains rate do not suggest a large revenue increase from additional realizations of capital gains — and certainly not an increase large enough to offset the losses from a lower rate.”

The Bush Administration Treasury Department examined the economic effects of extending the capital gains and dividend tax cuts.  Even under the Treasury’s most optimistic scenario about the economic effects of these tax cuts, the tax cuts would not generate anywhere close to enough added economic growth to pay for themselves — and would thus lose money."

http://www.cbpp.org/cms/?fa=view&id=1286

Even the Bush administration had to admit that their own policy sucked. That's saying something.
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Torie
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« Reply #21 on: April 13, 2012, 07:11:17 pm »
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By the way, the following is contained in the link you provided:

"The non-partisan Congressional Budget Office (CBO) and the Joint Committee on Taxation have estimated that extending the capital gains tax cut enacted in 2003 would cost $100 billion over the next decade.  The Administration’s Office of Management and Budget included a similar estimate in the President’s budget.

After reviewing numerous studies of how investors respond to capital gains tax cuts, CBO commented that “the best estimates of taxpayers’ response to changes in the capital gains rate do not suggest a large revenue increase from additional realizations of capital gains — and certainly not an increase large enough to offset the losses from a lower rate.”

The Bush Administration Treasury Department examined the economic effects of extending the capital gains and dividend tax cuts.  Even under the Treasury’s most optimistic scenario about the economic effects of these tax cuts, the tax cuts would not generate anywhere close to enough added economic growth to pay for themselves — and would thus lose money."

http://www.cbpp.org/cms/?fa=view&id=1286

Even the Bush administration had to admit that their own policy sucked. That's saying something.

Old stuff. The new number for the Buffet Rule is about 6 billion a year over 10 years (whether that is a static analysis number of a dynamic one, I don't know), which is next to nothing, and if you reduce the corporate rate, and tax dividends the same as interest, it probably erodes down to next to nothing. The Buffet rule only applies to those earning over a million. I consider dividends to be a different animal from capital gains.
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« Reply #22 on: April 13, 2012, 09:55:10 pm »
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By the way, the following is contained in the link you provided:

"The non-partisan Congressional Budget Office (CBO) and the Joint Committee on Taxation have estimated that extending the capital gains tax cut enacted in 2003 would cost $100 billion over the next decade.  The Administration’s Office of Management and Budget included a similar estimate in the President’s budget.

After reviewing numerous studies of how investors respond to capital gains tax cuts, CBO commented that “the best estimates of taxpayers’ response to changes in the capital gains rate do not suggest a large revenue increase from additional realizations of capital gains — and certainly not an increase large enough to offset the losses from a lower rate.”

The Bush Administration Treasury Department examined the economic effects of extending the capital gains and dividend tax cuts.  Even under the Treasury’s most optimistic scenario about the economic effects of these tax cuts, the tax cuts would not generate anywhere close to enough added economic growth to pay for themselves — and would thus lose money."

http://www.cbpp.org/cms/?fa=view&id=1286

Even the Bush administration had to admit that their own policy sucked. That's saying something.

Old stuff. The new number for the Buffet Rule is about 6 billion a year over 10 years (whether that is a static analysis number of a dynamic one, I don't know), which is next to nothing, and if you reduce the corporate rate, and tax dividends the same as interest, it probably erodes down to next to nothing. The Buffet rule only applies to those earning over a million. I consider dividends to be a different animal from capital gains.

The point was that even the Bush administration conceded a positive relationship between the capital gains tax and revenue. That answers the question to the thread "Does raising tax rates on capital gains raise revenue?"). The "new number" you just cited says the same thing: a small hike in the capital gains tax raises revenue by a small amount. Presumably, a larger hike would raise revenue by a larger amount.

The Buffett rule is like a guy with a bad heart eating healthier one day out of the month. He really needs to eat healthier every day of the month, but in order to eat healthy every day of the month, he needs to first eat healthy on the first day of the month. If he can't even eat healthy the first day, how can he expect to eat healthy the other 29 days? No one says that this rule would magically solve all of our budget problems. No single change is likely to do so. I happen to think that it's way too small-- capital gains taxes should be raised for everyone, as should dividend taxes. That would be the logical next step.
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« Reply #23 on: April 13, 2012, 10:14:45 pm »
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I obviously without reading it, cannot comment on the merits of the CBO statement,  or what its assumptions were, etc. I will say this though. You think a doubling of the capital gains tax is a small matter (which is what the Buffet rule does, from 15% to 30%), when it comes to distortions of economic behavior, even assuming that it nets some rather uninspiring amount of revenue after factoring in tax avoidance behavior (and thus the attendant economic distortions)?
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« Reply #24 on: April 13, 2012, 10:24:28 pm »
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You're trying to, to unfortunately use an overused expression, have your cake and eat it too. You can't argue on one hand, that it brings in little revenue so it's insignificant, and second, that it massively alters behavior so it's super-significant. Remember, the tax only affects about 100,000 households; it doesn't even affect the capital gains tax for 99% of the country. But if it did, so what? The capital gains tax rates of the Clinton era hardly represented corporate soul-crushing socialism.
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