What’s "Courageous" When It Comes to Taxing Investment Income? - International Center for Law & Economics

What’s "Courageous" When It Comes to Taxing Investment Income?

Today’s New York Times accuses President Bush of getting things “exactly backwards” by exhorting Congress to demonstrate political courage by resisting the urge to raise taxes. The politically courageous move, the Times says, would be to raise taxes (i.e., to refuse to extend the 2003 cuts beyond their expiration date). In particular, the Times calls for brave lawmakers to eliminate the “special low tax rates for investment income,” which “overwhelmingly enrich the rich and will be even harder to justify in the years to come, when, by all reasonable estimates, the country’s financial outlook will have deteriorated further.” It was, the Times says, “Orwellian” for President Bush to suggest that courage would be required to extend the tax cuts on investment income.

No it wasn’t.

As any politician knows, it takes a good bit of political courage to resist popular — but wrong — ideas. One such idea, held by even the smart folks who write editorials for the Times, is that those “special low tax rates for investment income” cause the country’s financial outlook to deteriorate. Most folks think this simply must be the case. After all, if tax rates are lowered, won’t receipts necessarily fall?

Counterintuitively (to most people), the answer is no. As yesterday’s W$J observed, capital gains tax receipts have gone way up — by 45%, to be exact — since President Bush’s 2003 investment tax cut package lowered the rate from 20% to 15%.

How can this be? Well, the reduction in tax penalty on capital asset sales contributed to a doubling of gain realizations, from $269 billion in 2002 to $539 billion in 2005. Tax receipts on these gains rose from $49 billion in 2002 (at a 20% rate) to $80 billion in 2005 (at a lower 15% rate). In addition, the lowering of tax rates on dividends has been followed by a tripling of dividend payouts.

Most voters, busy with their own lives (i.e., doing the various things that create all this wealth!), are rationally ignorant of the revenue effects of tax cuts on investment income. Repeatedly told by media outlets like the Times that tax cuts inevitably enhance deficits, they rationally form opinions that all tax cuts reduce revenues.

Our elected officials, however, are charged with knowing the real effects of different types of tax cuts. In our republican democracy, we expect them to make the wisest choices — even when those choices contradict populist sentiment. That sometimes takes political courage.