Increase in long-term capital gain tax rate

Increasein long-term capital gain tax rate

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Increasein long-term capital gain tax rate

Capital gainsdenote the changes occurring in capital assets’ value such as realestate, corporate stock, or business interest. In simple terms,capital gain refers to the disparity in the price obtained fromselling a certain asset and the price that is paid for the asset.With this regard, there are various assets including farms, homes,and family businesses. It is worth noting that real capital gains aretaxed on a yearly basis as they accrue while the real capital lossesare deducted. The critics of increase in tax rates contend that lowcapital gain tax rate may not benefit the economy. According toAulerich &amp Molloy (2004), adecrease in long-term capital gains tax rate offers new strategies tothe investors to protect their investment gains and to minimizetaxes. Many policymakers assume that an increase in long-term capitalgain tax rate would have severe impacts on the economy. However,Huang (2012) argues that extensive research as well asanalysis has proved that raising the long-term capital gain tax ratehas no negative impact on the economy. In this regards, the discourseoffers a context for the support of an increase in capital gain rateto 28% thus, takes a critical analysis on the impacts of raising thelong-term capital gains to the economy.

Impacts of raising the long-term capital gains to the economy

The issue of increasing the long-term capital gains to the economyhas raised many concerns in the recent years. Critics of increasinglong-term capital gains tax rate contend that the move will havenegative impacts on the country’s long-term economic growth. On thecontrary, a reduction in long-term capital gain tax rate contributesto the increase in income inequality (Fieldhouse, 2013). This isbecause low tax rates will widen the gap between the low-incomeindividuals and high income in the country. Indeed, Fieldhouse (2013)argues that income inequality prevailing in the United States isabove that experienced in other developed economies. The primarydriver of this raising inequality is the tax policy in the country.This low tax rate on the long-term capital gain has aggravatedafter-tax income inequality in the country. Therefore, an increase inlong-term capital gain tax rate is necessary on high-incomeindividuals. This will lessen the existing gap between the low-incomeindividuals and high-income individuals apart from increasing thegovernment revenue.

Another argument in favor of increase in long-term capital gain taxrate is that it can result in business creation. Additionally,regarding work and labor supply, Huang(2012) claims that evidence reveals that increase inlong-term capital gain tax rate has little impact on the decisionsmade by high-income individuals “on how much to work”. Thisimplies that contrary to the opinion of the critics of increasing taxrate, this increase will not necessarily result in a decrease in workand labor supply. Note that the labor supply of high-incomeindividuals is insensitive to the changes in tax rates. As a result,a marginal increase in long-term capital gain tax rate may encouragesome of the taxpayers in the country to work less due to the declinein “after-tax return to work” (Huang,2012). However, some of the high-income individuals may decide towork more in order to maintain their income levels, which is similarto their earnings prior to the increase in tax rates. Consequently,this means that the will be an overall increase in productivity andthis will foster greater economic growth in the country.

In other words, the opposingresponses between those individuals who decide to work less and thosewho decide to work more because of the increase in tax rate willcancel each other. Therefore, an increase in long-term capital gaintax rate is necessary so that the government can obtain revenuenecessary for enhancing other development projects in the country. Inaddition, the critics of high long-term capital gain tax rate contendthat reduced tax rates will incentivize a higher labor supply.However, the advocates of the supply-side argue “increasedafter-tax income from lower top tax rates leads to a higher privatesavings rate” (Fieldhouse, 2013). In turn, the higher savings mightcan be directed to investment by using the process of financialintermediation as well as the larger capital stock and thus boostingproductivity growth. However, the responses of private savings to thetax increase are less important relative to the behavioral responsesof labor supply. This is so because, unlike personal savings, thenational savings are the ones that determine the existing interestrates. Furthermore, savings are important to the country’s economy.It results in higher investment levels, increased wages and workerproductivity, lager economic growth and rapid economic growth(Pomerleau, 2014).

There is also a debate on raising long-term capital gain tax rateregarding savings and investments. The critics of increase in taxrates claim that the tax increases on in long-term capital gains willdepress private investment as well as saving rates. On the contrary,Huang (2012) asserts thatthere is lack of evidence linking capital gain tax rates to thecumulative economic performance. On a similar note, most economistsbelieve that decreasing tax rates on long-term capital would havenegligible negative impact on investment and saving (Huang,2012). Moreover, economists argue that despite the fact that raisingthe long-term tax rate might reduce the savings amonghigh-income individuals, there will be an increase in the generalpublic savings if the revenue obtained from such taxes will bedevoted to the deficit reduction. This means that the governmentshould adopt the necessary strategies aimed at utilizing the revenueobtained from long-term capital gain tax rate in order to fosterpublic saving and investment. Thus, increase in long-term capitalgain tax rate seems to increase the public saving in the country andit has minimal or no impact on the private saving. Hence, increase inthe long-term capital gain tax rate will possibly have a positivelyinfluence on the national investment and saving. This emphasizes thefact that long-term capital gain tax increase is necessary for thecountry.

The economic theory postulates that a decrease in tax rates willprovide platform for firms to borrow more funds in order to enhancetheir investment in new equipment and property. However, increasingtax on long-term capital gains will increase the cost of such fundssince it “reduces the after-tax return to stockholders” (Meyer,2000). This implies that the potential stockholders will be able topay higher prices for new stock when they do not have t pay highertaxes because of the appreciation of the assets. It therefore followsthat a decrease in the long-term capital gain tax rate will result ina decrease in capital cost and increasing the growth of the economyand spurring investment. However, this behavioral effect istheoretically true but it is not applicable in practice. Researchershave found no real-world relevance of this theory for two majorreasons (Earnest &amp Young, 2013 Houston, &amp Eugene, 2014). The first reason is that any changes in long-term capital gain taxrates have minimal or no impact on the incentive of the potentialstakeholders to buying new stock and hence the general cost ofcapital. This means that the policymakers who wish to increaselong-term capital gain tax rate should go ahead and increase the taxrate by utilizing the investment tax credit. Secondly, since increasein long-term capital gain tax rate has minimal impact on theaggregate investment, the government will effectively generate morerevenue by using such tax policy. Apart from generating more revenue,this increase in tax rate will also spur the country’s economicgrowth and encourage more investment.

Increasing long-term capital gain tax rate can boost productivityas well as competitiveness in the country. This is because suchincrease in tax rate will encourage high-income individuals to workharder in order to cancel the effect of increased tax. However, thecritics on increased tax rate claim that high tax rate claim that“reductions in capital gains tax rates will simply provide anopportunity for more investments” (Green, 2010). However, areduction in tax rates on long-term capital gain will discourage newinvestments since firms will concentrate on the existing investmentsand thus raising the budget deficit on the long run. Therefore,raising the long-term capital gain taxes could help in shifting thetrend away from the financially oriented, short-term, andspeculative-type investment the long-term investments. In this case,Green (2010) asserts that this kind of investment can be achieved byimplementing a sliding-scale long-term capital gains tax ratestructure that incorporates an increase in the tax on the short-termgains with declining rates on the long-term. Additionally, these lowlong-term tax rates should only be applicable to the investments inthe productive assets and not to the art, vocational homes, and soon. By so doing, the tax policy can encourage long-term investmentsand hence enhancing productivity among firms in the country.Meanwhile, the government can also obtain higher revenues from thestart-up firms, which will be utilized in other critical developmentprojects in the country.

However, the critics of progressive tax rates on long-term capitalgain use the Neo-classical perception that there must be the creationof wealth prior to the consumption of such wealth. This means thattaxes on capital gain disrupts the process of wealth creation(McBride, 2012). This is because shareholder and corporate taxeslowers the incentive to build capital and to investment. This willultimately reduce the firms’ productivity. In this case, McBride(2012) asserts that less investment implies that there will be fewerproductive workers in the country and hence lower wages. In addition,the critics of high tax rates contend that raising long-term capitalgain will lower the incentive to work. Similarly, progressive taxeson long-term capital gain will reduce the education’s returns. Thisis because such taxes will correspondingly reduce the workers’income levels and consequently the incentive to building humancapital.

Another debate on increasing tax rates on long-term capital gain isfocused the income group benefits most from such increase in taxpolicy. In the light of this, critics argue that increasing long-termcapital gain tax rate is that the benefits accruing from such taxeswill be enjoyed by high-income. For instance, in the 1997 debateregarding capital gains tax, the opponents of rate increase held thatnearly all the benefits would go to the by high-income individuals(Moore, 2008). To some extent, this is true due to the direct impactof capital gains since high-income individual also earn most of suchgains. However, the benefits of increasing long-term capital gain taxrates will benefit the public because they spur economic growth inthe country.

Conclusion

There are twoopposing sides on the move to increase tax rates on long-term capitalgains. However, the benefits of increased tax rates outweigh thepotential adverse effects of such tax policy. Indeed, there is a needto raise the long-term capital rate due to the various benefits itwill bring to the economy. One of the benefits on long-term capitalrate increases is that it will reduce the prevailing incomeinequality. This will reduce the gap between high-income earners andlow-income earners. Secondly, it will also foster productivity andcompetitiveness among various firms in the country. This is becauseit will encourage more work among some of the taxpayers andconsequently higher productivity. Additionally, higher tax rates hasminimal or no impact on savings and investments. This is contrary tothe opponents’ opinion that increased tax rates will discouragesavings and investment. Similarly, increasing the tax rate on thelong-term capital gain will not have any significant effect on theshareholders’ incentive to purchase new stocks and hence theaggregate cost of capital. In general, higher tax rates on long-termcapital gains will spur economic growth and this will be beneficialto everybody. This calls for the relevant policymakers to make urgentand dedicated efforts towards enacting the tax policy.

References

Aulerich, J, R. &amp Molloy, J.(2004). Long-term Capital Gains Tax Strategies: Correlated ProtectivePut Strategy. Journal of Business &amp EconomicResearch (JBER), Vol. 2(8).

Earnest &amp Young. (2013).Earnest &amp Young Tax Guide. NewYork: John Wiley &amp Sons.

Fieldhouse, A. (2013). A review of the Economic Research on theEffects of Raising Ordinary Income Tax Rates. Retrieved onDecember 20, 2014 fromhttp://www.epi.org/publication/raising-income-taxes/

Fieldhouse, A. (2013). Rising Income Inequality and the Role ofShifting Market-Income Distribution, Tax Burdens, and Tax Rates.Economic Policy Institite. Retrieved on December 10, 2014 fromhttp://www.epi.org/publication/rising-income-inequality-role-shifting-market/

Green, M. J. (2010). Changing America: Blueprints for the NewAdministration. New York: Newmarket Press.

Houston, J. &amp Eugene, E. (2014). Fundamentals of FinancialManagement, Concise Edition. London: Cengage Learning.

Huang, C. (2012). Recent StudiesFind Raising Taxes on High-Income Households Would Not Harm theEconomy. Center on Budget and Policy Priorities.Retrieved on December 10,2014 from http://www.cbpp.org/cms/?fa=view&ampid=3756

McBride, W. (2012). What is the Evidence on Taxes and Growth? TaxFoundation. Retrieved on December 10, 2014 fromhttp://taxfoundation.org/article/what-evidence-taxes-and-growth

Meyer, A. (2000). Should We Axthe Capital Gains Tax? Federal Reserve Bank of St.Louis. Retrieved onDecember 10, 2014 fromhttps://www.stlouisfed.org/publications/re/articles/?id=1829&nbsp

Moore, S. (2008). Capital Gain Taxes. The Concise Encyclopedia onEconomics. Retrieved on December 10, 2014 fromhttp://www.econlib.org/library/Enc/CapitalGainsTaxes.html

Pomerleau, K. (2014). The High Burden of State and Federal CapitalGains Tax Rates. Tax Foundation. Retrieved on December 10,2014 fromhttp://taxfoundation.org/article/high-burden-state-and-federal-capital-gains-tax-rates