Capital Gains Tax Debate

Here is an interesting article from the Washington Post concerning debate on capital gains tax.  While the authors discuss some interesting points, they fail to touch on a few key issues:

1.  As far as tax revenue goes, the S&P 500 is down about 12% over the last 5 years and up only about 2% over the past 10 years, so raising the capital gains tax will generate little additional revenue in the short-term (assuming the S&P 500 is a good proxy).  Furthermore, the authors imply that capital gains is responsible for the widening wealth gap over the past 10 years but this evidence suggests there’s more to it than that.

2.  Equity prices are a function of after-tax expected future returns (based on perceived levels of risk).  All else equal, if the tax rate is raised, equity prices must adjust downward to maintain the same level of expected return.  In other words, raising cap gains taxes should send the market down.  Even those with tax-exempt accounts would experience these effects due to those with taxable assets who own the same stocks/investments.

3.  Private equity managers that only pay capital gains tax do so because they are not paid a salary.  Instead, they risk their own capital by investing alongside the limited partners in the fund.  In other words, these managers have significant capital at risk, just like other investors that pay capital gains taxes.

-Bill Ray Valentine

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