Working Paper: NBER ID: w3386
Authors: Patric Hendershott; Eric Toder; Yunhi Won
Abstract: This paper uses a general equilibrium model to simulate both the effects of a preferential capital-gains tax rate on total income tax revenues and the effects of a revenue-neutral substitution between a capital gains preference and marginal income tax rates on economic efficiency and the distribution of income. In the simulations, a capital gains preference increases efficiency by reducing tax distortions between untaxed assets (household and state and local capital) and taxable business sector assets and between realized and unrealized capital gains (the "lock-in" effect), but reduces efficiency by increasing tax distortions between corporate dividends and retained earnings and between financial assets that produce capital gain income and those that produce ordinary income. Because the model treats aggregate factor supplies as fixed, however, the simulations do not capture the efficiency gain from reducing the tax distortion between current and future consumption or the loss from increasing the tax distortion between current consumption and leisure (or untaxed labor). The net estimated welfare effects depend on two parameters: the elasticity of capital gains realizations with respect to a change in the capital gains tax rate and the elasticity of the dividend-payout ratio with respect to a change in the tax cost of dividends relative to retentions. With no payout response, the net welfare effect from a 15% maximum rate on capital gains is positive for a wide range of realizations elasticities. With a high payout elasticity, the net welfare effect is slightly positive for high estimates of the realizations elasticity and slightly negative for low estimates of the realizations elasticity. The welfare changes, both positive and negative, mainly affect taxpayers with income of $50,000 and over.
Keywords: Capital Gains Tax; Economic Efficiency; Welfare Effects; Tax Policy; General Equilibrium Model
JEL Codes: H24; H31; D58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital gains tax cut (H24) | economic efficiency (D61) |
| capital gains tax cut (H24) | total income tax revenues (H29) |
| capital gains tax cut (H24) | alleviation of lock-in effect (J65) |
| capital gains tax cut (H24) | distortions between corporate dividends and retained earnings (G35) |
| capital gains tax cut (H24) | distortions between financial assets that produce capital gains and those that generate ordinary income (G19) |
| high payout elasticity (G35) | positive net welfare effect (D69) |
| low realizations elasticities (H30) | slightly negative net welfare effect (D69) |
| capital gains tax cut (H24) | distributional impact on taxpayers with incomes of $50,000 and over (H22) |