WASHINGTON, July 27, 2015 − Last week, 2016 Democratic Presidential candidate Hillary Clinton proposed raising the tax on capital gains upward from its historical rate of 15 percent to a maximum of 43.4 percent. The rate would decline as the time the investment is held increases,so that, if the investment is held for a total of six years, the rate would drop to 23.8 percent, where it is currently under President Obama’s policy. This action would prove to be disastrous for the economy.
The worst-performing sector of the economy during the current tepid six-year economic recovery has been the business investment sector. This includes current businesses expanding operations and new business start-ups. This is the sector where growth should be encouraged since that’s where most jobs are created. Clinton’s proposal will significantly reduce business investment activity.
Suppose an investor earns a $1,000 gain on the sale of an asset. If the capital gain tax rate is 15 percent, the investor would pay $150 in taxes and have $850 of new capital to invest into the economy. At a tax rate of 43.4 percent, he or she would have to pay $434 in taxes and would have only $566, instead of $850, to re-invest.
Hillary’s proposal would significantly reduce capital formation and thus lead to less economic growth at a time when the economy has seen minimal growth since the recovery began in 2009.
Economists will note that there are two basic inputs into the economy: labor and capital. A third (interaction) input, which includes a number of things like human capital, entrepreneurship and technology, affects how much increases in the two basic inputs affect total output.
Today we have less than 63 percent of the adult population participating in the American labor force. Recent history suggests this figure should be about 67 percent. The result is that we have about 8 million fewer adults contributing to economic growth.
While the returns to capital have been significant during the recovery, increased government regulation, overly protective lending rules implemented under the Dodd-Frank law (which reduces the leveraging effect of capital investment) and increasing tax rates on investment earnings have kept the economic input derived from capital very low. With less labor and less capital, it is very difficult for the economy to grow.
Investments in human capital have been mostly stagnant, primarily because people have been convinced by the tepid recovery that college degrees may not be economically justified. Considering that during the current recovery there have been more businesses shutting down than starting up, the input from entrepreneurship is noticeably decreasing. Fortunately, technology has been improving, which has contributed in some respects to economic growth.
Almost all economists agree that economic growth is needed to solve America’s economic problems. Instead of the less than 2½ percent annual growth experienced during the current recovery, the U.S. needs the 4½ percent annual growth we saw even after the much-deeper 1981 recession.
The non-partisan Tax Foundation says that the top three influences on economic growth are the capital gains tax, determining when capital expenditures can be expensed and the corporate tax rate. The Obama/Clinton policies have had a negative impact on all three.
Investments must still be expensed over a number of years, sometimes as many as 25 years. Some economists have suggested that allowing all capital expenditures to be fully expensed in the year they are made would lead to an investment boom and contribute to rapid economic growth. Neither Obama nor Clinton is interested in this, however.
Obama has already raised the capital gains tax rate from 15 percent to 23.8 percent, and now Hillary wants to raise it to 43.4 percent on some investments. Obama raised the corporate tax rate from 36 percent to 39.6 percent, and Clinton wants to keep it there.
All of those actions lead to poor economic growth. Clinton’s proposals will continue the stagnant economy of the past six years and likely will slow growth even further.
In 2008, then-candidate Barack Obama said he wanted to raise the capital gains tax from 15 percent to 28 percent. It was pointed out to him that the last time that happened tax revenue decreased because the higher tax was levied on a smaller tax base. After all 28 percent of $1,000 is $280, while 15 percent of $2,000 is $300.
Obama said that didn’t matter because he wanted to be “fair.” Are Hillary’s economic policies geared toward creating her own unique perception of “fairness”? Shouldn’t America’s primary economic goals be growth, full employment and price stability?
* Cartoon by A.F. Branco ©2015. Reprinted by permission and arrangement, via Comically Incorrect.