Seven Arguments for Eliminating the Capital Gains Tax Jude Wanniski February 5, 1992

1. IT WILL HELP LABOR. When you tax something you get less of that thing. When you reduce taxation on that thing, you get more of it. When you cut tax rates on labor (ordinary income), more people offer their labor in the market as work becomes more attractive. When this happens, capital becomes relatively scarce. In the 1980s, tax rates on labor were cut sharply and protected against inflation by indexation. Tax rates on capital were cut briefly, but increased again in 1987, and were not protected against inflation. Labor is now plentiful and capital is scarce (the "credit crunch"). Capital can pick and choose selectively from an army of unemployed, taking this worker here, that worker there, and sending the rest home. If capital were taxed at a lower rate, it would become plentiful, and labor would become relatively scarce. If capital were not taxed at all, it would become abundant. It would have to hire everyone in the unemployment lines in order to realize all profit opportunities, and then hire the homeless, derelicts, mentally retarded, etc. It would pay for capital to improve the quality of their lives and train them, in order to realize profits.

2. IT WOULD HELP MINORITIES. Consider the following hypothetical situation: Every tenth American born at random is marked on his or her forehead with an "X." Throughout their lives, they carry this sign, which makes it illegal for their fellow citizens to supply them with capital. They must be denied loans through banks, thrifts, credit unions, insurance companies, stock markets and all other sources of debt or equity. They would have only what they possess from birth, i.e., their labor. It should be no surprise that these "X" babies would develop their potential as best they could without capital, and become the best athletes and entertainers in the society. When Negro slaves were freed during the Civil War, they came into the market without a scrap of capital. Race prejudice, the equivalent of a bias against the "X", has kept black Americans starved for capital ever since. Eliminating the tax on capital would make it so abundant it would flow throughout society.

3. IT WOULD HELP LONGSHOTS. When capital is scarce, it is reserved for the "sure things." The "credit crunch" we speak of simply reflects the difficulty of enterprises that are not established in acquiring capital from the system. Imagine a horse race, where the favorite goes off at even money, the longshot at 40-to-1. If the longshot wins, but the bettors find their after-tax payoff is no better than if they had bet the favorite, they will henceforth only bet the favorites. The longshots will stop entering the races. Racetracks will find it unprofitable to stage races and will shut down. Capitalism, like a racetrack, must provide for large rewards for large risks. Eliminating the capital gains tax entirely will maximize the reward for risk-taking, innovation and enterprise, enabling capital to flow to 40-to-1 longshots, because only one need win in order to make the entire portfolio of bets worthwhile.

4. IT WOULD HELP SMALL TOWN AMERICA. Land, like labor, is a factor of production. When capital is scarce, it is reserved for established enterprises, the highest quality management and labor, and the choicest property. Throughout America's history, with capital taxed lightly or not at all, it spread from capital centers and found its way to profit opportunities throughout the grass roots. As capital becomes scarce through high taxation, it becomes concentrated at the metropoles, drying up opportunities in the country's small towns. Japan, which taxes capital lightly or not at all, has become a fountain of capital that spreads far beyond its own shores, seeking profit opportunities everywhere. Indeed, Japanese capital is even finding its way to America's small towns, which no longer find capital available from American sources. Ending the tax on capital gains would make American capital so plentiful it would push much of this Japanese capital in other directions, to Asia, Central and South America.

5. IT WOULD CREATE AN ECONOMIC BOOM WITHOUT INFLATION. As all economic growth beyond simple population growth is the result of risk-taking, innovation and enterprise, elimination of the tax on capital would maximize economic growth through productivity increases, which do not involve inflationary price increases of goods. The price of labor rises, of course, as capital abundance makes labor scarce, but as workers will have more capital available per man hour, they will be able to produce more with less effort. Real growth rates of five and six percent a year for many years on end are possible in this way, driving unemployment rates down as well as society's costs for welfare.

6. IT WOULD BALANCE FEDERAL, STATE AND LOCAL BUDGETS. Government is now experiencing fiscal crises at all levels, as the scarcity of capital has dried up new enterprise. Commercial office space built or planned prior to the changes in the tax laws remains empty. The longshot businesses that would have occupied them, employing longshot workers, did not come into existence. The housing the longshot workers would be buying is unaffordable and also remains vacant or unbuilt. Tax authorities that rely on businesses for business taxes and workers for income taxes find these sources drying up, and in order to offset the losses are forced to raise tax rates even higher and cut essential public spending. Eliminating the capital gains tax reverses the process, creating business activity as the rewards for risk-taking and enterprise are maximized. Tax revenues at every level of government throughout the nation would immediately rise following the end of the federal capital gains tax. Public works spending could rise to rebuild America's aging infrastructure.

7. IT WOULD AID THE ELDERLY. In several ways, the nation's senior citizens would benefit enormously from an end to the capital gains tax. As most capital assets are owned by people over 55 years, and as the price of these has been exaggerated through the last generation of monetary inflation, seniors are now unable to enjoy the fruits of their past investments without paying exorbitant taxes not on capital gains, but on capital. In the nation as a whole, taking account of inflation, there has been no net increase in the nation's capital this past quarter century. Eliminating the tax on capital gains would permit the seniors to unlock their past investments instead of being forced to pass them, at death, to their heirs. The second way seniors would benefit would be in the future, as rapid economic growth provides the resources enabling society to take care of the health and retirement needs of the aging population. The Japanese economy, with little or no tax on capital, has been doubling every eleven years. Were the U.S. economy to double between 1992 and 2003, the economy would be producing $10 trillion of goods and services instead of $5 trillion. Some portion of the extra $5 trillion would be available to both lower retirement ages and increase retirement benefits.

There are many other benefits that flow from elimination of the capital gains tax. Not the least of which is the revival of entrepreneurial capitalism in America, which holds out the promise for economic advancement and personal fulfillment to American citizens of every class and in every walk of life.