A review of the Biden administration's tax proposals on raising capital gains taxes found they would reduce wealth inequality without hurting economic growth.
The study from American University looked at Biden's budget plan to raise the tax rate on dividends and capital gains from 20 percent to 39.6 percent and concluded that only the richest Americans would see a drop in their wealth as a result of the bump.
Meanwhile, gross domestic product (GDP) would rise in the long run due to the tax increase due to indirectly increased investments linked to lower returns on equity, the researchers found.
“We know that capital gains have increased a lot in recent decades, and we know that this has contributed a lot to wealth inequality,” Ignacio González, the study's lead author, told The Hill.
Higher taxes on stock market returns, such as dividends, would create a more equal economy because stocks are largely owned by wealthy people, the study argued.
The top 1 percent of the U.S. wealth distribution owns about half of the stock market, while the bottom half of households owns just 1 percent of stocks, the authors said, citing research published by the University of Chicago. According to Census Bureau data, only about 20 percent of American households earn money from interest, dividends or rental income.
Wealth inequality has risen dramatically in recent decades due to longer-term changes in U.S. economic policy, a phenomenon well documented in academic and government research, along with copious economic reporting.
“The wealth gap between families in the 90th percentile and the wealth of those in the middle increased from $532,000 to $861,000 over the period. [from 1989 to 2013]” researchers at the Congressional Budget Office wrote in 2016.
The wealth shares of households in the top 10 percent of the distribution rose from 67 percent to 76 percent over that period, while the share of households in the bottom half of the distribution fell from 3 percent to 1 percent, they found.
Industries have also become more concentrated over that time frame, with an increasing number of economic sectors controlled by just a few giant companies. The economic model used by the American University study takes into account the increased market power of the private sector – the ability of companies to raise prices above costs – resulting from this higher degree of concentration.
While income tax rates rise as income levels rise, taxes on capital gains are treated separately, contributing to a different overall structure for the tax code than what is suggested by the income tax alone.
“Overall, the current tax system resembles a flat tax and even becomes regressive at the highest income levels,” González and his co-authors wrote.
Biden and Congress introduced a 1 percent tax on stock buybacks as part of the Inflation Reduction Act of 2022. The administration is currently seeking to quadruple that tax in an effort to get wealthier Americans to contribute more to the treasury .
The dividend and capital gains proposals “primarily change the valuation of wealth in the stock market, leaving the economy's long-term productive capacity unaffected,” the study's authors argue.
Not everyone is convinced of the argument.
“In their model, raising the capital gains tax lowers the cost of capital, and I think there are good reasons to be skeptical about that mechanism,” Erica York, an economist at the Tax Foundation, told The Hill.
“The study's findings rely heavily on the unrealistic assumption that the realization of capital gains does not change in response to a higher tax rate,” she added.
The relationship between capital gains taxes and growth of the economy is a common concern among politicians and economists, but is not clearly defined, because periods of much more robust growth have coincided with higher capital gains tax rates.
“Traditionally, proposals to cut taxes on corporate benefits have been based on the assumption that such cuts will stimulate business investment and promote economic growth. But since corporate benefit taxes are imposed on post-investment profits, they actually have little impact on companies' investment decisions,” González wrote.
More at stake in the debate over how to tax capital gains than economic performance is the issue of perceived fairness in economics, which researchers have long paid attention to.
“Capital income represents only a quarter of all income. Yet the taxation of capital income is at the center of some of the longest-standing and most spirited debates about federal income tax policy,” wrote economist Jane Gravelle of the Congressional Research Service in a 1994 book on the subject.
“Capital income taxes are … seen as having important fairness implications,” she wrote.
