The Treasury Department’s recent tax proposals call for taxing capital gains at ordinary rates (although indexing such gains for inflation). Those who oppose preferential treatment for capital gains have traditionally based their arguments on grounds of equity. Preferential treatment, they argue, allows wealthy individuals to escape paying their fair share of taxes.
But taxing capital gains to investors, even at a low rate, while also taxing the return on capital, represents double taxation. Inasmuch as an increase in share price, for example, reflects the anticipation of higher future dividends, the increase in capital is not distinct from the increase in income. Taxing capital gains means taxing capital, and this discourages the formation and mobility of capital, thereby reducing the standard of living of all Americans.
Consider the economic consequences of the 1978 and 1981 reductions in capital gains tax rates. New issues of corporate common stock increased threefold between 1978 and 1982. New commitments to venture capital funds increased from just $39 million in 1977 to $11.5 billion by the end of 1983. The inflation-adjusted market value of corporate equities, which had fallen 24 per cent in the five years prior to 1978, rose 46 per cent in the five years following.
The real question is, why not eliminate capital gains taxation altogether?
