Friday, February 24, 2006

Hobby Horse Destroyed

Supporters of the Bush Administration's tax cuts on capital gains, particularly the WSJ, have contended that the cuts have contributed to an increase in tax revenues. A CBO letter to Senator Charles E. Grassley, out today, smashes that hobby horse.

The letter acknowledges that:
[P]rojections of a revenue source characterized by high volatility are bound to be uncertain. Moreover, much of that volatility seems unrelated to changes in capital gains tax rates.
The letter then goes on to describe in meticulous detail the methodology the CBO uses to predict revenue realizations. In essence, capital gains realizations do tie to changes in capital gains tax rates, but only with respect to timing, not total increases in governmental revenues. Thus:
In analyzing the relationship between capital gains tax rates and capital gains realizations, it is important to distinguish between the temporary and permanent effects of tax rate changes. Investors can generally choose when to realize their gains; if they believe that tax rates will change in the future, they may try to time their realizations to occur during a period with lower tax rates. As a result of such timing decisions, capital gains realizations may increase shortly before scheduled tax increases or after tax reductions. Similarly, realizations may temporarily decline before scheduled tax reductions and after tax increases. Such timing effects are, by their nature, temporary. Over longer periods, the pace of capital gains realizations is also influenced by capital gains tax rates; realizations are higher when tax rates are lower.
(Emphasis mine.)

In other words, the government can speed up its receipt of tax revenues, but over the long term, the total revenue is roughly the same.

In concluding, the letter states that:
CBO has updated its latest models with available data through 2004. Those models, which incorporate changes in the tax rate, fall well short of explaining the surge in realizations that occurred in 2004. Roughly half of the growth in realizations between 2003 and 2004 remains unexplained. After examining the historical record, including that for 2004, we cannot conclude that the unexplained increase is attributable to the change in capital gains tax rates. Volatility in gains can stem from other factors, such as changes in asset values, investor decisions, or broader economic trends.
(Emphasis mine.)

I'm waiting for the WSJ to spin this.


Anonymous said...

In my opinion, if Congress permits the favorable capital gains and dividends tax rate of 15% to expire, there will be a sharp sell - off. The sell - off will take place if it only looks like expiration is likely.

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