An evaluation of the Biden administration’s tax proposal to increase capital gains taxes finds that it could reduce wealth inequality without hurting economic growth.
of Studying at American University They examined Biden’s proposed budget, which would raise tax rates on dividends and capital gains from 20% to 39.6%, and concluded that the tax hike would reduce the wealth of only the wealthiest Americans.
On the other hand, the researchers concluded that higher taxes would increase gross domestic product (GDP) in the long run due to the indirect increase in investment associated with a lower return on equity.
“We know that capital gains have grown substantially over the past few decades, and we know that this has contributed significantly to wealth inequality,” Ignacio Gonzalez, lead author of the study, told The Hill.
Because stocks are primarily owned by the wealthy, the study argues that taxing stock market returns such as dividends would create a more equal economy.
Citing a University of Chicago study, the authors note that the wealthiest 1% of Americans own roughly half the stock market, while the bottom half of households own just 1% of stocks. Only about 20% of U.S. households earn their income from interest, dividends, and rental property income, according to Census Bureau data.
Wealth inequality has risen sharply in recent decades as a result of long-term changes in U.S. economic policy, a phenomenon that has been well documented in academic and government studies, as well as in the vast economic press.
“The gap between the wealth of the 90th percentile and the wealth of the median household widened from $532,000 to $861,000 during this period. [from 1989 to 2013]” researchers at the Congressional Budget Office wrote in 2016.
The study found that over the same period, the share of wealth held by the top 10% of households jumped from 67% to 76%, while the share held by the bottom half of households fell from 3% to 1%.
During the same period, industrial concentration also increased, with more sectors of the economy being controlled by a few large corporations. The economic model used in the American University study takes into account that this increased concentration gives the private sector greater market power, allowing companies to charge prices above their costs.
While income tax rates increase with income level, taxes on capital gains are treated separately, resulting in an overall tax structure that differs from the tax law presented by income taxes alone.
“Taken as a whole, today’s tax system resembles a flat tax and is regressive at the highest income levels,” Gonzalez and his co-authors wrote.
President Biden and Congress passed a bill to impose a 1% tax on stock buybacks as part of the Combating Inflation Act of 2022. The administration now seeks to quadruple that tax to encourage wealthy Americans to contribute more to the public purse.
The proposed dividend and capital gains tax rates “will primarily change stock market wealth valuations and will not affect the economy’s long-term productive capacity,” the study’s authors argue.
Not everyone is convinced by that argument.
“In their model, raising capital gains taxes reduces the cost of capital, but I think there’s good reason to be skeptical of that mechanism,” Tax Foundation economist Erica York told The Hill.
“The findings rely heavily on the unrealistic assumption that increases in tax rates do not change the amount of capital gains realized,” she added.
The relationship between capital gains taxes and economic growth is a common interest among politicians and economists, but it is not clearly defined, as periods of stronger growth have coincided with increases in capital gains tax rates.
“Traditionally, proposals to reduce corporate dividend taxes are based on the assumption that such reductions would stimulate corporate investment and promote economic growth. However, because corporate dividend taxes are levied on post-investment profits, in practice they have little impact on corporate investment decisions,” Gonzalez wrote.
In the debate over how to tax capital gains, what is more important than economic performance is the issue of perceptions of fairness in the economy, a topic that scholars have long focused on.
“Capital income accounts for only a quarter of all income, yet its taxation is at the center of one of the longest-running and most vigorous debates about federal income tax policy,” Congressional Research Service economist Jane Gravel wrote in a 1994 book on the subject.
“Capital income taxes are thought to have important fairness implications,” she writes.
