There are several issues people have with high capital gains taxes. The first is that many Americans are involved in the stock market and it could discourage investment, the second is that capital gains taxes do not generate substantial revenue, the third major reason is capital gains taxes hurt businesses and finally capital gains taxes are bad for senior citizens.

The amount of Americans who own stocks has exploded over the last century. In 1952 only 4.2% of the American population owned stocks. This smaller market can no doubt be attributed to post- depression angst, but the lack of communication technology and information technology were also a large factor. Furthermore the explosive growth of mutual funds would not occur until the 1970s. The combined changes in information access through technology as well as up and coming companies like Merrill Lynch and the advent of the Securities and Exchange Commission changed all of that.

David McPherson of Investopedia writes, “The median income of U.S. households that own mutual funds is $68,700, according to the Investment Company Institute, a trade association for the mutual fund industry. The median mutual fund holding among these households is $48,000, the group says. In 2005, according to ICI, about half of all U.S. households owning mutual funds in 2005 had incomes between $25,000 and $75,000.”

The overriding fact is that the stock market is no longer an exclusively rich man’s game. As McPherson’s statistics illustrate it is not uncommon for Americans below the poverty line to be actively engaged in the stock market. The stock market is seen as a great way to supplement income as well as save for retirement, as I addressed in earlier blogs and in “New Century, New Deal”, my book concerning the need to reform social security. Lower preferences for long term capital gains taxes have reportedly helped the stock markets over time, but this is more often correlation rather than causation. Joel Friedman and Katherine Richards of the Center on Budget and Policy Priorities write,

“There is little evidence, however, that these tax cuts have had a positive impact on the stock market.  A recent study by three Federal Reserve economists found that these tax cuts did not raise the value of U.S. stocks.[3] Similarly, an analysis by the Urban Institute-Brookings Institution Tax Policy Center found that capital gains tax rates and stock market values have been only weakly correlated over time.[4]

Capital gains are not consistent of amassing resources.  During an economic recession capital gains taxes are obviously less effective at generating revenue than during bull markets.

Stephen Moore of The Concise Encyclopedia of Economics, and a very good friend, stated, “For all the controversy surrounding the tax treatment of capital gains, that tax brings in surprisingly little revenue for the federal government. From 1990 to 1995, capital gains tax collections were between $25 billion and $40 billion a year, less than 3 percent of federal tax revenues. During the Internet boom, when stock gains were huge, capital gains tax collections peaked at $119 billion in 2000 before rapidly falling back below $50 billion (see Table 1 for a breakdown of the sources of federal revenue).”  It is the perceived opportunity to trade stocks and profit from trading, rather than capital gains taxation rates that appears to drive activity.

Part 3 of 3 will post on Friday the 30th