The Tax Elasticity of Capital Gains and Revenue-Maximizing Rates
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Research by @OleAgersnap finds that the revenue-maximizing federal capital gains tax rate is btw 38-47%. A 5 percentage point increase in capital gains tax rates could generate $18-30bn in annual federal revenue.
“…Our data, which range from 1980 to 2016, allow us to characterize responsiveness in a more recent period than most of the literature, and our event-study approach enables us to estimate effects over different time horizons and test for dynamic effects. We then build a simple framework to relate these state-level effects to a policy-relevant elasticity at the national level, which is the state-level realization response after removing migration effects and accounting for average state taxes and a minor aggregation adjustment term. We find that this policy-relevant elasticity of realizations with respect to capital gains tax rates over a ten year period is approximately -0.3 to -0.5 depending on the specification, and that the estimates are larger in absolute value in the short and medium run than in the long run….This paper uses an event study approach to estimate the effect of capital gains taxation on realizations at the state level, and then develops a framework for determining revenue-maximizing rates at the federal level. We find that the elasticity of revenues with respect to the tax rate over a ten-year period is -0.5 to -0.3,indicating that capital gains tax cuts do not pay for themselves, and that a 5 percentage point rate increase would yield $18 to $30 billion in annual federal tax revenue. Our long-run estimates yield revenue-maximizing capital gains tax rates of 38 to 47 percent….”
Their takeaway, “….We highlight three implications of these elasticity estimates. First, these estimates are well below an elasticity of one in absolute value, which indicates that capital gains tax cuts do not pay for themselves. We formallytest and reject the null of an elasticity of -1.0. Second, these estimates suggest thatraising capital gains tax rates by 5 percentage points (in the current regime with unlimited deferral and step-up-basis at death) would yield 18 to 30 billion in annual tax revenue, which is roughly twice the amount suggested based on recent estimates from the Joint Committee on Taxation (JCT), which according to Gravelle (2020) currently uses an elasticity of -0.7 to score proposals.1 Third, ourlong-run elasticity estimates correspond to point estimates for the revenue-maximizing capital gains tax rates of 38 to 47 percent….”
Ole Agersnap and Owen Zidar, "The Tax Elasticity of Capital Gains and Revenue-Maximizing Rates," National Bureau of Economic Research, August 2020, https://www.nber.org/papers/w27705
Current state of capital gains taxes, “…Table 1 provides summary statistics. On average, state capital gains tax rates are 4 percent, but they range from 0 to 15 percent in our sample. Figure 1 plots the maximum federal tax rate over time. The current maximum capital gains tax rate is 23.8 percent. Combining both tax rates and accounting for interactions and phase-outs results in an effective keep rate of 75 percent on average, indicating that a dollar of realized capital gains amounts to 75 cents after taxes….”
Worth noting from Owen Zidar (Capitalists in the Twenty-First Century) looks at the impact of changes in treatment of capital gains on the state level to estimate a the revenue-maximizing rates for federal level. They estimate a Federal “…revenue-maximizing capital gains tax rates of 38 to 47 percent…”
Ed Comment: I’m amazed people publish this stuff. It’s embarrassing. As if anyone has a clue. First, I find it hard to believe that they can make any credible measure of the slow and gradual long-term effects of taxes rather than just conflating intermediate-term effects, which are lesser became things change slowly, with long-term effects. Second, I don’t see how cross-state tax rate differences reveals much. If the inherent payoffs are higher in California despite higher taxes then there will gradually be relatively more risk-taking there than elsewhere. but if you apply that rate to Kansas, which has inherently lower payoffs, there will be gradually less. In large part, the rates are different because inherent payoffs allow them to be. Do they consider that? And lastly, is the purpose/definition of optimal taxation to maximize tax revenues? No. Obviously, it should be to maximize welfare. So what have they proven other than that they are fools? But I liked “Capitalists in the Twenty-First Century.”