The 15 percent tax rate for individual capital gains has been a stunning policy success since it went into action in 2003, so why is the corporate capital-gains tax rate still a whopping 35 percent? The empirically proven arguments for low capital-gains tax rates apply at least as well for corporations as they do for individuals; it is time to slash the corporate cap-gains tax rate.
Every round of cuts in the cap-gains tax for individuals has been a triumph. In 1978, 1981, 1997, and 2003 the capital-gains rate for individuals was cut and the stock market rallied strongly, driving sizable increases in tax revenues. Cutting the cap-gains tax is the ultimate supply-side win-win. The most recent reduction, in 2003, breathed life back into the stock markets from the moment it was conceived, triggering a remarkable rally that is still underway.
Cap-gains tax revenues jump in response to rate cuts since these reductions boost the after-tax return on capital, making more economic endeavors profitable, while unlocking the longer-term gains that free up capital stocks for more efficient use. Revenue estimators consider the unlocking effect, but they ignore the growth effects — which is why they consistently fail to predict the revenue-increasing effects of rate reductions.
On the corporate side, where the cap-gains tax rate is still a relatively high 35 percent, there is a lot of room for improvement.
A recent paper by Harvard professor Mihir Desai powerfully makes the case for a rate cut. Because the tax comes in conjunction with the corporate income tax and individual tax-paid distributions, it discourages corporate investments. For dividends, the tax code provides relief from such triple-taxation by excluding 70 or 80 percent of corporate dividend income from taxation. But there is no relief from triple taxation for corporate capital gains.
Desai also pinpoints a significant lock-in effect since the tax discourages reallocating assets. He estimates unrealized corporate capital gains at over $800 million at book value. Market value could be more than double that.
The punitive triple taxation of corporate capital gains also puts America at a serious competitive disadvantage internationally. According to Desai, Hong Kong, Singapore, and New Zealand don’t tax corporate capital gains at all. France and Germany, traditional bastions of big government, recently passed laws that exclude 95 percent of corporate cap-gains from taxation. Canada has a 50 percent exclusion. Japan and the UK have exemptions for cap-gains that are reinvested.
Complete repeal of the corporate cap-gains tax would yield a huge economic payoff. Triple taxation makes for bad economic policy, and repeal would create annual efficiency gains in excess of $20 billion. A more politically attractive solution might be to reduce the rate to 15 percent, matching the individual rate.
A revenue projection run by Desai finds that a 15 percent rate would reduce federal revenue by $15 billion annually. His methodology considers the unlocking effect, but is otherwise static, mirroring the method used by the Joint Committee on Taxation and the Congressional Budget Office. But the relatively small revenue reduction means that such a policy could fit easily into the next major tax vehicle, perhaps this year’s reconciliation package (if there is one).
However, as we’ve learned time and again on the side of individual taxation, a reduction in the corporate cap-gains tax rate is unlikely to bring on a revenue decrease. It is far more likely that the investment boom created by reducing this triple tax, unlocking capital, and boosting U.S. international competitiveness will drive the stock market to new heights and create a windfall of federal revenues.
While the corporate cap-gains tax is idling, the individual cap-gains tax is headed in the wrong direction — under current law a hike is scheduled to occur in less than three years. Both of these situations amount to public-policy malpractice. Congress should act immediately to establish a permanent 15 percent cap-gains tax rate for both individuals and corporations, a win-win policy that will promote economic growth and prosperity while at the same increasing federal revenue.
– Phil Kerpen is policy director for the Free Enterprise Fund. A version of this article originally appeared in the New York Sun.