Does raising tax rates on capital gains raise revenue?

[Beet]

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).

[Beet]

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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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" is Stalinism? Ho hey! There you go. I also assert that Kamenev was a traitor who deserved to die. I am a good Stalinist!

[Beet]

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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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.

[Beet]

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? 

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.

[Beet]

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.

[Beet]

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.

[Beet]

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.

[Beet]

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.

Sure, the economic distortions could be large, leaving the amount of revenue gained small, both at the same time, in fact one causing the other.

In theory yes, but apparently this estimate was made with an elasticity of 0.7. That means the ratio of the percent change in the dependent variable changes by 0.7 units for every 1 unit change in the independent variable. I'd have to look at the study itself to find out what these variables were in terms of units of measure, but that's not huge. You don't get a bajillion-dollar change in the dependent variable for a miniscule change in the independent variable at an elasticity of 0.7.