Cherry-picking economics: Tax cut myths & realities
Ron Ennis, Lehigh Valley Postal Workers
Editor, Lehigh Valley Labor Council
If a rooster crows in the morning and the sun comes up, did the rooster cause the sun to rise?
Of course not.
But that kind of economic thinking has gripped the minds of some in recent decades. Hand out tax cuts and if the stock market goes up, or the employment picture brightens, or the federal deficit shrinks, well then, it was the tax cuts that caused it.
In cherry-picking economics, facts are selectively juxtaposed and edited to infer a cause and effect relationship when, in reality, there is no supporting evidence for it.
Witness the chorus of “cherry-pickers” responding to Senator Barack Obama’s suggestion that he would raise taxes on capital gains income should he become president.
“Bill Clinton, in 1997, signed legislation that dropped the capital gains tax to 20 percent….And George Bush has taken it down to 15 percent. And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected..”
Charles Gibson, ABC News moderator, to Sen.Barack Obama at the Philadelphia Democratic presidential debate, April 16, 2008.
“There is strong evidence that the investment tax relief enacted in recent years – both the lower tax rates on capital gains and dividends – has played an important role in spurring economic growth. Any talk of raising these rates is, at best, irresponsible and, at worse, a serious threat to our country’s economy. NAM members believe it is critical that Congress make these investment tax cuts permanent.”
National Association of Manufacturers, March 13, 2008.
“…when the (capital gains) tax rate has risen over the past half century, capital gains realizations have fallen and along with them tax revenue.”
Wall Street Journal editorial April 18, 2008.
In each example, cutting taxes on investment income is seen as an elixir for all economic ills: a tax revenue booster, a stock market stimulant, or a recession vaccine. Republican presidential nominee Sen. John McCain has also embraced this notion. “I think it’s very important that we make the Bush tax cuts permanent,” he said earlier this year.
What has sparked the echo chamber against Obama is the fear that an economic era is coming to an end. The Illinois senator has signaled that, should he become president, he will reverse a near 30-year trend of deregulation and tax cuts aimed primarily at the wealthy.
Nowhere has the downward direction on tax rates been more pronounced than on stock ownership. When Ronald Reagan took office in 1981, the rate on capital gains stood at 28 percent and dividends were taxed the same as wage income – up to 50 percent. Soon afterward, he dropped the capital gains rate to 20 percent.
As a Reaganomics disciple, George Bush promoted a tax bill in 2003 that further lowered levies on both capital gains and dividends to 15 percent. But the measure, the Jobs & Growth Tax Relief Reconciliation Act (JGTRR), came under immediate criticism from Democrats and, curiously, in hindsight, Sen. McCain.
In joining the Democrats, McCain rightly pointed out that slashing taxes during war was unprecedented. Undeterred, Bush rolled over the GOP-controlled Congress to win passage of his bill as American troops stormed Baghdad. The following year, McCain said to Tim Russert on Meet the Press, “I voted against the tax cuts because of the disproportional amount that went to the wealthiest Americans. I would clearly support not extending those tax cuts in order to help address the deficit.”
The comments by the four-term Arizona senator took note that Congress omitted making Bush’s tax cut permanent and should the next Administration fail to act, a most likely scenario under Obama, the rates will rise in January 2011. Inexplicably, McCain now wants to reverse course and “make the Bush tax cuts permanent,” including those on investment income.
So, what are capital gains and dividends? And why such a fuss over a widely misunderstood part of the tax code? The answers could set the stage for a tax debate showdown between the party’s presidential nominees.
Tax brackets and rates for 2008
Single-filer Marginal* Capital gain/dividend
Income Tax rates Tax rates
$0 - $8,025 10% 0%
$8,026 - $32,550 15% 0%
$32,551 - $78,850 25% 15%
$78,851 - $164,550 28% 15%
$164,551 - $357,700 33% 15%
$357,701+ 35% 15%
* Wages, salaries, interest income, non-qualifying dividends, etc.
Capital gains relate to stocks, real estate and collectibles. If you purchase 100 shares of XYZ Inc. for $50 each and over a year later you sell the stock when it climbs to $60 per share, your one thousand dollar return is a capital gain. You must report that gain to the Internal Revenue Service.
In addition, if XYZ Inc. pays an annual dividend, say $1.50 for each share you own, you’ll receive $150 twelve months later. This, too, will have to be reported to the IRS.
In each case, the capital gain and dividend you collect will trigger a tax.
What’s at the center of this year’s tax controversy between Obama and McCain is that the tax rate on investment income is lower than wage income. Owning and trading stocks on Wall Street is not taxed as harshly as working for a living. (See Figure #1)
Obviously, affluent tax filers have larger taxable stock portfolios and, consequently, will report a higher share of their income as capital gains and dividends. Therefore, a substantial portion of their income will be taxed at a rate – 15 percent – that is as low, if not lower, than the levy applied to the wages of most Americans.
“When governments set tax rates, they are making decisions about who will prosper and by how much,” wrote David Cay Johnston, a Pulitzer Prize winner, in his book Perfectly Legal: the covert campaign to rig our tax system to benefit the super rich – and cheat everybody else. The declining tax trend on investment income over the last three decades starkly demonstrates Washington’s longstanding generosity to the nation’s wealthiest individuals.
Putting aside the questionable morality of a tax code that favors trading equities on a stock exchange over sweat equity in the workplace, there are sound economic arguments to debunk the myths supporting cherry-picking economics.
Myth #1: The reductions in dividend and capital gains taxes benefit all taxpayers, even those in the lowest income brackets as claimed by Gibson.
Fact: While it’s true that a majority of Americans own stock, they do so in an employer-sponsored or individual retirement account. In fact, Americans have squirreled away $6.2 trillion in 401(k) plans alone.
But IRAs and 401(k) plans are already tax-advantaged and would receive little, if any, gain from a cut in taxes on investment income. Any benefit from an investment tax cut an ordinary American would receive in a taxable account would be miniscule.
That’s because the average American holding stocks has just a handful of shares in a company or mutual fund. According to the IRS, of the 92 million tax returns for individuals earning less than $50,000 in 2003 – representing 70 percent of all returns – only 15 percent filed a return with dividend income. Their average tax cut was $14. Further-more, only eight percent filed a return with capital gain income and their average tax cut was $5.
Myth #2: Capital gains and dividend tax cuts lead to long-term economic growth.
Fact: President Bush, John McCain and other tax-cut proponents argue that cutting taxes on stock gains fuels economic growth. “But they have produced no evidence,” concluded the Center on Budget & Policy Priorities last month, “to support their leap from correlation –the tax cuts coincided with improvement in the economy – to causation – the claim that the tax cuts caused the improvements.”
In fact, all evidence appears to point in the opposite direction. The Tax Policy Center found that “capital gains tax rates display no contemporaneous correlation with real GDP growth during the past 50 years.” And the Joint Committee on Taxation (JCT), after it conducted a macroeconomic analysis of the JGTRR Act shortly after its enactment, concurred that any short-term benefit was “eventually likely to be outweighed by the reduction in national savings due to increasing Federal government deficits.”
Enacting tax cut legislation without paying for it would be more likely to reduce economic growth over the long term than to increase it. Former Treasury Secretary Robert Rubin argues that capital gain tax changes have little effect on business investments and that a bigger concern for the economy is the lack of a realistic plan for reducing the growing federal deficit. Without that, investors cannot have certainty in the market or the economy.
Myth #3: When the tax is cut on capital gains and dividends, the revenue from the tax to the IRS increases.
Fact: “You cut taxes and the tax revenues increase,” said President Bush in February 2006. But this is another distortion of facts. In testimony before the House Budget Committee in 2004, then-Federal Reserve Chairman Alan Greenspan said, “It is very rare and very few economists believe that you can cut taxes and you will get the same amount of revenues” to the IRS.
Just because a cut in the capital gains tax precedes a rise in capital gains revenues doesn’t mean the tax cut caused the gain in revenues. In reality, the tax cut stimulates, at best, a short-lived increase in tax receipts by inducing stockholders to sell their shares. Dean Baker, co-director of the Center for Economic and Policy Research, recently stated that, “most of the apparent increase is likely due to timing: investors delay selling stock when they know a tax cut is imminent. After the cut takes effect,” they sell their holdings, “declare their gains and pay taxes at the lower rates.”
The Congressional Budget Office (CBO) wrote, in a letter to then-Chairman of the Senate Finance Committee Charles Grassley, “After examining the historical record, we cannot conclude that the unexplained increase (in gains realizations) is attributable to the change in the capital gains tax rates.”
If you lower the tax rate on capital gains without lowering the levies on ordinary wage income, you encourage people to express their income through capital gains. Many tax shelters are designed to do exactly this. Capital gains tax revenue may rise, temporarily, in part because people are shifting their income from a high-tax category into a low-tax one, resulting in a net revenue loss for the government.
According to the CBO, the JCT and even Bush’s own Office of Management and Budget, the revenue loss is substantial. All project that making the JGTRR provisions permanent would cost about $100 billion over the next ten years.
With Senators Obama and McCain on opposite sides of the tax issue, voters will do more than elect the next Oval Office occupant. They will also pronounce their verdict on the economic myths that have prevailed for the last 30 years.