Friday, February 03, 2006

Lies, Damned Lies, and Statistics (WSJ Edition)

Via TaxProf Blog, we have another fine example of the WSJ Editorial Board torturing statistics to prove an ideological point. The article, Tastes Great, More Filling (behind a paywall), purports to show the miracle of supply side economics because tax receipts from capital gains followed the reduction in capital gains rates. The evidence that the WSJ points to is found in a CBO study, The Budget and Economic Outlook: Fiscal Years 2007 to 2016. (The WSJ fails to note either the title of the study or the URL where it can be found. I have complained about this sort of omission before, but it appears to be typical of newspapers in general, not the WSJ in particular.)

As is frequently (always?) the case with WSJ editorials, the evidence does not support the conclusion.

The CBO report discusses capital gain realizations. That is, the amount collected by the government when capital gain assets are sold. There is no evidence that the total amount of capital gains or total tax revenues from capital gains will, in the long run, grow. In fact, the CBO report is quite explicit that:
The strong recovery in capital gains realizations since 2002 has pushed them to a level that, relative to the size of the economy, is above that implied by their past historical relationship. . . Consequently, CBO projects that, beyond 2005, capital gains will rise a bit more slowly than GDP. As it has tended to do in the past, the ratio of gains realizations to GDP is expected to gradually approach its long-run average level relative to the economy. Between 2007 and 2016, capital gains realizations are projected to grow by an average of 2.5 percent annually, lower than the 4.7 percent growth rate of both GDP and taxable personal income. Receipts from gains are expected to grow in step with gains realizations, except when tax rates increase in 2009.

The scheduled return to higher capital gains tax rates in 2009 is expected to alter the timing of realizations by encouraging taxpayers to speed up the sale of assets that will generate gains from that year to late 2008. In addition, realizations will be depressed after 2008 because the projected long-term equilibrium level of gains will be slightly lower as a result of the higher tax rates. Realizations are projected to rise by 17 percent in 2008 (boosted by the speedup in realizations), decline by 29 percent in 2009 (held down by the speedup and the adjustment to the lower equilibrium level), and rise by 21 percent in 2010 (when they rebound after the onetime speedup). After 2010, realizations are projected to rise by 3 percent to 4 percent annually through 2016.
In other words, the capital gain tax cut is much like retailers' price cutting before Christmas: Both activities raise revenue, but both also reduce profit margins. However, unlike retail purchases, sales of capital gain assets are not likely to be repeated. Think about it: you may be encouraged by price cutting to buy three instead of two shirts. But you can only realize the profit that is tied up in capital once. After you have sold the asset, there is no taxable gain left. Tax "price cutting" (i.e., the reduction in capital gain rates) only encourages a different timing of the events of realization. Thus, the net result of a decrease in capital gains taxes is that, over time, government revenues will decline. The jump in revenue that the WJS trumpets is merely an artifact of the timing of the receipt of income.

The WSJ also claims that that "stock values [increased] over that time, thanks in part to the higher after-tax return on capital induced by the tax cuts." Nothing in the report supports that conclusion. In fact, it would seem apparent that the rise in capital gain realizations in 2003 (20% over 2002) was due to the recovery from the collapse of the stock market bubble (capital gain realizations had fallen dramatically in the previous two years). If lower rates consistently caused an increase in capital gain realization, the trend would continue going forward. Yet the increase in capital gain realizations tailed off considerably after 2004 and the CBO's projections of capital gain realizations virtually fall off the table in 2006 and 2007 (2% increase in each year over the previous year). (Note: I am speaking here of capital gain realizations; any increase or decrease in capital gain tax receipts typically lags realizations by about a year.)

One positive of the WSJ's editorial positions: They're consistent. That is, they consistently mislead and in the same consistently wrong direction.

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