Empirically, it's a bit difficult to verify that variations in capital gains tax rates and the like really are making a material difference to investment levels. But then again the data is noisy. What's more the thing we have the most real-world experience with is measures like George W. Bush 2003 tax cut for investment income which was financed with government borrowing rather than higher wage taxes, consumption taxes, or spending cuts. It's not at all clear that the basic theoretical considerations in favor of low taxes on investment income apply to the case of a debt-financed tax cut. This is also separate from the question of whether hedge fund and private equity fund managers should be allowed to pretend their labor income is really investment income by calling it "carried interest" and paying at a low rate.Indeed we had another experiment with lowering tax rates on capital income that actually increased real interest rates and lowered investment – that being the original Reagan “supply-side” tax cut. Of course, Team Romney keeps wanted to pretend they have found some magic recipe for deficit neutral ways of reducing taxation on capital income. The problem, however, as Howard Gleckman notes is that when Team Romney member Kevin Hassett was forced to defend the revenue neutral proposition he had to basically admit you cannot do that without abandoning the reduction in tax rates for the well to do. But I think there is another fatal flaw in Matt’s defense of lower tax rates on capital income. Let me start with Matt’s example:
You imagine two prosperous but not outrageously so working people living somewhere—two doctors, say, living in nearby small towns. They're both pulling in incomes in the low six figures.OK – now let’s give the microphone to Dean Baker who was discussing a similar argument by Dylan Matthews:
Matthews rests his case on some arguments in the literature concerning scenarios in which we both look to an infinite future horizon and we have identically situated individuals, meaning that we all have the same wealth and the same opportunity to gain income. When these assumptions are relaxed, the case for preferential treatment of capital income becomes considerably weaker, as argued in a recent Journal of Economic Perspectives article by Peter Diamond and Emmanuel Saez … If we have some individuals who inherit immense wealth so that they can live entirely off their capital income and other individuals who must work for their income, a policy that subjects capital income tax to a lower rate of taxation than labor income means that we are taxing the rich at a lower rate than the middle class and poor. It is difficult to see how this is either efficient (we are giving disincentives to work for middle class people as a result of a higher than necessary tax rate) or fair. Furthermore, as a result of having a lower tax rate on capital income than labor income we are giving people an incentive to game the tax code by concealing labor income as capital income. While most workers may not have much opportunity to play such games, higher end workers, such as doctors or lawyers with their own practices would have ample opportunities for such gaming. This is both unfair and leads to a waste of resources as these people employ accountants to rig their books.Team Romney can pretend all they want that we all have similar endowments of initial resources and that any change in the tax code will somehow magically be paid for by offsetting fiscal restraint, but actual policy decisions must be made in the real world where things are not nearly as magical.