Gaining Capital
Some people continue to believe, or at least still assert, that tax rates don't influence taxpayer behavior all that much. We therefore direct their attention to the Treasury Department's latest historical data on revenues from taxes on capital gains.</br></br>The numbers look like a 25-year demonstration of the Laffer Curve in action. As the nearby chart shows, taxes paid on capital gains have been highly responsive to the maximum capital gains tax rate. (See accompanying table -- WSJ Jan. 24, 2005) Especially notable is how, over the years, capital gains realizations and the taxes paid on those gains have tended to increase in the years following a cut in the capital gains tax rate.</br></br>The reductions highlighted in the chart include the famous William Steiger tax rate cut that passed Congress in late 1978 over Jimmy Carter's objections, the Reagan tax cut passed in 1981, and the cut that was part of the Clinton-Gingrich balanced budget deal of 1997. All of those reductions caused taxpayers to cash in more of their gains and thus yielded revenue windfalls for the federal Treasury in succeeding years.</br></br>On the other hand, the capital gains tax increase of 1986 -- which moved the rate back up to 28% from 20% -- proved to be a revenue disaster. Taxes paid on long-term capital gains (those typically held longer than one year) fell off a cliff to $33.7 billion in 1987 from $52.9 billion a year earlier. And they stayed at close to that mediocre lower level for nearly another decade. In other words, higher rates didn't do anyone any good, not even the politicians who thought they'd be getting more tax revenue to spend.</br></br>We aren't asserting that tax-rate changes have been the only factors influencing revenue changes. The performance of the broader economy and the stock market have also mattered a great deal. Capital gains revenues boomed in the late 1990s after the 1997 rate cut, but they fell abruptly with the bursting of the dot-com and tech bubbles in 2001.