Livinglies's Weblog

Anyone who saw the debate heard the question from Charlie Gibson: If revenue goes up when capital gains taxes are reduced, why would you want to increase it? The answer is that tax revenues don’t go up when the government lowers taxes, as any child with an allowance could tell you. Charlie needs to get his facts straight. Anyone who thinks like that is comparing taxes to a red light sale at K-Mart. Tax revenues don’t go up because taxes are reduced. Tax Revenues go down when tax rates are reduced.

The increase or decrease in taxes is related not to the rate of the tax, but rather the rate of activity that is being taxed. You could lower the capital gains taxes to 1% and there would be zero revenue if the market was down or very few people were trading securities. And business’ demand for capital from the capital markets does not exist when the economy is in the toilet and there is nothing to produce because there is nobody to buy anything. The cost of capital investment only begins with the purchase; then there is maintenance, insurance, training, increased labor costs all without producing one dime of revenue.

But here is why Charlie thought there was a correlation.

• Capital gains revenues go up when the market moves higher and volume of transactions goes up. When people sell stock at a profit they make money and that is taxed. When they sell stock and lose money, they get to write that off as a deduction and they pay less tax. The tax rate has NOTHING to do with it.
• When the market is going up, stock prices are going up, so when you sell your position in a stock, you realize a capital gain. That has been variously taxed at 28%, 20% and 15%.
• When the tax revenue is up, and more people are trading (in an up market everyone thinks they are a genius) it is easier for government to reduce that tax and look good without feeling any pain because even after the reduction, the revenue is still up. It looks good on paper, but a tax cut even here reduces revenue from what it would have been. 
• If the market is relatively flat, reducing taxes reduces revenues and increasing taxes increases revenues. 
• If the market is going down, people tend to trade less, and when  they do they are taking losses which results in a capital loss which reduces tax revenues. 
• When the market is down, taxes on capital gains goes down. Reducing taxes will reduce tax revenue. Increasing taxes will increase revenue.

The two moderators in Philadelphia directing questions to Obama and Clinton, besides demonstrating an abysmal lack of good sense in the questions they asked, had not done their homework.

Lowering taxes on capital gains does not increase capital spending or tax revenues. Taking away money does not magically produce more money.

Tax credits (which directly take the money you would otherwise be paying Uncle Same and apply it to the purchase of capital equipment) does have some effect. But even that does not have price elasticity if the prospective buyer of capital equipment knows in advance they won’t be putting the equipment to work. 

Business buys capital equipment, and funds it out of their own earnings or savings, borrowing from their bank or going to the capital markets. They do it for one reason ONLY, to wit: because they know that they will be filling orders, increasing revenues and making more profits.

Business does NOT incur the cost of capital equipment or expansion of their labor force because of a reduction in taxes, a tax deduction, or a tax credit, UNLESS the tax consequence makes an otherwise good business decision better and perhaps more timely. 

Filed under: bubble, inflation, Investor, Mortgage, politics | Tagged: capital equipment, capital gains, Debate, Gibson, Stephanopolous, tax |