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No serious economist thinks higher dividend and cap gains taxes are efficient ways to raise revenue. Why not limit deductions for high earners instead?

Friday's weak employment report reminds us anew of the flagging U.S. economic recovery. While the Obama administration discusses additional stimulus packages, Treasury Secretary Tim Geithner is arguing that we should roll back key elements of the Bush tax cuts passed in 2001 and 2003. The administration is particularly skeptical about the benefits of today's lower rates on dividends and capital gains.
The tax on dividends, for example, is currently 15%, but it could increase to as high as 39.6% if the 2001 and 2003 tax cuts expire. On top of this, a new 3.8% tax on investment incomes for high-income earners begins in 2013 to help pay for ObamaCare. The administration's arguments for higher taxes on capital center on fairness and the need for deficit reduction.
These arguments are seriously mistaken. The relationship between investment, capital and wages is such that workers are better off if capital is not taxed at all. […]
There are at least four channels through which Mr. Bush's tax reform (proposed and passed) raised the long-run productive capacity of the economy—that is, increased the size of the pie. First, since lower taxes mean higher returns to investors, those investors allocate more funds to corporate capital. Corporations can raise capital for investment more cheaply. As a result, the nation's capital stock and output increase.
Second, reducing or eliminating the differential tax treatment between corporate and noncorporate investments means that investment flows are not channeled artificially by tax considerations and the overall productivity of the economy increases.
Third, lowering or eliminating taxes on capital mitigates distortions in our financial structure. Prior to 2003, equity financing was disadvantaged relative to debt financing, with taxes levied twice, at the corporate level and again at the investor level. Because interest payments to debt holders are deductible at the corporate level, debt financing was taxed only once, at the investor level. This system contributed to over-reliance on debt financing. The 2003 tax cuts reduced this bias substantially. Nonfinancial companies went into the recent crisis with lower leverage as a result, a very good thing. […]
If the Obama administration's goal were truly fairness, it could propose an increase in the average tax rate on higher-income earners without raising marginal rates—for example, by limiting deductions. Does the Treasury really believe that raising dividend and capital gains taxes addresses its fairness concerns at the lowest cost in terms of reduced economic activity? […]
If President Obama is interested in promoting growth now and in the future, he should commit to retaining the low tax rates Congress passed in 2003.
Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush.
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2 Response to "Sarah Palin: Please Read WSJ - Higher Dividend & Cap Gains Taxes LOWER Revenue. Limit Deductions?"

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