John Edward, who teaches economics at Bentley and UMass Lowell, frequently contributes columns on economic issues
Actually, President Herbert Hoover was wrong about a lot. He was correct on one topic. When it came to tax policy and the business of America, Coolidge was wrong, but Hoover was right. The 2016 presidential candidates are choosing sides. We get to decide.
The federal government taxes capital gains at a lower rate than earned income. Hoover thought that policy was wrong. In his 1930 State of the Union Address he said:
It is urged by many thoughtful citizens that the peculiar economic effect of the income tax on so-called capital gains at the present rate is to enhance speculative inflation and likewise impede business recovery. I believe this to be the case and I recommend that a study be made of the economic effects of this tax and of its relation to the general structure of our income tax law.
To be clear, Hoover thought taxes on capital gains were too low. He wanted to rid the tax system of preferential treatment for capital gains. In some cases he wanted investment tax rates to be higher than earned income:
It is fundamentally wrong to charge at the same rate these two types of income, “earnings” and “property income,” because a person who possesses “property income” has already the capital protection of his dependents while a part of “earned” income must be put aside for such a purpose.
Hoover made that statement while serving as Secretary of Commerce under President Calvin Coolidge, a Republican. It was Hoover’s job to promote the business of America.
President Hoover, a Republican, did not stop the preferential treatment for capital gains. That did not happen until 1986. President Ronald Reagan, a Republican, set the maximum tax rate on capital gains to be the same as wages.
All this history is lost on the current parade of Republicans running for President. However, they are not what I want to talk about.
Democratic candidate Hillary Clinton recently put out her proposal for capital gains. Currently, the federal government taxes gains as ordinary income if investors sell in less than a year. The highest rate is 39.6%. Hold the investment for a year or more and the tax rate is only 20%.
Clinton wants to increase the holding period for “short term” gains to two years. Then she proposes a sliding scale where the tax rate decreases for every extra year the investment is held. The lowest rate, again 20%, would apply only if investors hold for six years.
Clinton’s intent is to provide an incentive for investors to think long term. It is a worthwhile goal. However, evidence and experience indicate her policy will not be very effective.
Every incentive is a disincentive. Clinton’s proposal will cause some investors to trade even quicker, as they would have to wait two years to benefit from a buy and hold strategy. She still gives preferential treatment to capital gains. Her policy will still, as Hoover warned, “enhance speculative inflation.”
Preferential tax treatment for capital gains is a disincentive to work. It gives those with the means an opportunity and incentive to invest, or speculate, rather than work.
It also provides an incentive and opportunity to avoid taxes. A Congressional Budget Office (CBO) study of options to reduce the budget deficit observed: “one advantage of raising taxes on long-term capital gains and dividends, rather than raising tax rates on ordinary income, is that it would reduce the incentive for taxpayers to try to mischaracterize labor compensation and profits as capital gains.”
Supporters of lower tax rates for capital gains argue the policy promotes economic growth. A CBO survey of analyses on that claim concluded: “the studies raise doubt about whether cutting taxes on capital gains can be counted on to significantly increase GNP.” Even the more optimistic studies estimate only a 0.1 percentage point or less increase in economic growth.
As we know in Massachusetts, a sliding scale makes filing more complex. We had a similar capital gains tax between 1994 and 2002. Beacon Hill eliminated the state’s sliding scale to raise revenue, but it was complicated and not very effective.
Preferential treatment for capital gains is a major expense. The Congressional Joint Committee on Taxation estimates that the current lower rate for capital gains will cost $633 billion between 2014 and 2018.
Thoughtful long-term investment is better for the economy than short-term trading and speculation. The government cannot make that happen. Manipulating tax rates is too much government intervention in the business of America.
Clinton, and the other candidates, would serve us better by focusing on the excessive inequality that has us heading toward The Social Cliff. As reported in The Washington Post “Over the past 20 years 80% of capital gains income went to the top 5% (of income earners).” About 50% goes to the 0.1% wealthiest.
Eliminating the preferential treatment of capital gains would be much fairer and much simpler. That is exactly what Senator Bernie Sanders proposed in 2013.
The New Hampshire primaries are in six months. Massachusetts holds primaries a few weeks later on March 1st.
An informed voter is our best citizen.