The gold medal in the capital gains tax rate event will be shared by nine countries. Belgium, Czech Republic, South Korea, Luxembourg, Netherlands, New Zealand, Slovenia, Switzerland, and Turkey all do not tax capital gains.
Five of these countries have received medals in previous e21 Olympics events. South Korea won a bronze in yesterday’s Balanced Budget event. Turkey received a silver in GDP Growth. The Netherlands won a bronze for Higher Education. Slovenia earned a silver and the Czech Republic won a bronze in Corporate Tax Rates.
A new report from the non-partisan Tax Foundation, authored by Kyle Pomerleau, highlights the high capital gains tax burden in the United States. Our average combined state and federal top marginal rate for long-term capital gains is 28.7 percent, the sixth highest rate among Organisation for Economic Co-operation and Development countries. The OECD average is only 18.2 percent—a full 10 percentage points lower than the U.S. combined state and federal average.
Many U.S. states have even higher rates. Six out of the top ten highest OECD capital gains rates are found in U.S. states. California has the highest rate, 33 percent.
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Even in states such as Florida, Texas, and South Dakota, that have no state capital gains taxes, residents are paying up to 23.8 percent of their capital gains in taxes because of the federal rate, ignoring deductions. To offset some of the costs of the Affordable Care Act, a 3.8 percent tax on unearned income was added to the 20 percent statutory capital gains rate. This rate applies to all individuals earning over $200,000 a year in adjusted gross income ($250,000 for married filing jointly).
The White House argues that no households earning more than $1 million in a year should pay lower tax rates than middle class families. However, high capital gains rates have negative effects on the economy since they reduce U.S. investment or drive it overseas. When firms pay more in capital gains taxes, they make fewer investments, especially in the businesses or projects that most need capital, and they hire fewer workers.
High capital gains taxes reduce economic activity, especially financing for private companies, innovators, and small firms getting off the ground. Taxes on U.S. investment are higher than taxes abroad, so some investment capital moves to lower tax jurisdictions, such as today’s gold medal-winning countries.
There are good reasons for taxing capital gains at lower rates than earned income. First, capital gains have a lower tax rate to encourage the risk-taking involved in investment. Investors supply the financial capital essential for investments that spur innovation, improve productivity, and expand capacity.
Second, capital gains have already been subjected to many layers of taxation by the time they are realized. Before money can be invested, it must be earned—so it is subject to individual income taxes. The company the investment was made in has to pay corporate income tax, which lowers its revenue and the value of the investment.
Finally, a portion of the gain comes from inflation. Many people hold on to capital for years before selling it, and some of the price increases are due to inflation. Rather than calculating the inflationary gain from each stock holding, Congress decided to tax such gains at a lower rate.
Sales taxes, another form of double taxation when incomes are taxed, are far lower than capital gains rates. The highest combined state and local sales tax rate in the United States is in Tuba City, Arizona. There, the sales tax rate is just under 14 percent. It is much more common for sales taxes to be between five and seven percent.
People often assume that spending is superior to saving in creating economic growth. However, when money is saved it is not simply hidden under a mattress. Rather, investing allows money to be transferred from people who have little use for it now to those who do. Taxes should not punish this type of behavior. A dollar saved is a dollar spent, just more effectively.
High capital gains rates decrease investment efficiency. Instead of evaluating investments purely on merits, individuals have to plan the timing of their purchases and sales based on tax implications. Individuals also invest less because know part of their gains will be lost to taxation.
Raising taxes has a populist ring. But capital is mobile in a global economy, and can easily move to lower-tax environments. It is especially important to ensure that America's environment is hospitable to investment, so that jobs are created here. Populist rhetoric might make Americans feel fiscally responsible, but high taxes on capital gains slow economic growth and harm those who want to get back to work.
For these reason, it would be wise for the United States to follow the examples of today’s gold medal-winners and eliminate its capital gains tax. The e21 Olympics will continue next Tuesday with the Employment event.
*The e21 Olympics are in no way affiliated with the International Olympic Committee
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