Capital Gains Tax
Jude Wanniski
March 14, 1997


Supply-Side Economics Lesson No. 15

Memo To: Website students
From: Jude Wanniski
Re: Capital gains tax
The following questions come from a J. Shroeder, who just happened onto our website. He is skeptical enough about supply-side economics to ask some good questions. Thank you J.

Q: How is it that the market rose 300% (DJIA) over the past 6 years if the cap gains tax is such a detriment to investment? Or are you saying even 300% is not enough reward for an investor? Do we need to subsidize this with tax abatements?

A: The objective is to have as much capital available to the amount of labor available. Think of a pot of soup that has mixed in it labor and capital. If we add more capital, and stir it up, the soup becomes thicker, with a higher capital/labor ratio. Stirring, not targeting, is important. In that formulation, real wages will rise, unambiguously. Indeed, we can reduce the amount of labor in the mix, and still have more caloric content than we did with the thin soup with which we began. How do you increase the amount of capital in the soup? By reducing barriers to capital and opening avenues to capital. Capital is not money, remember, but the unutilized time, energy and talent of human beings who are satisfied with their daily needs and wants. Lowering risk and increasing rewards. The stock market rise of 300% has been good, because it reflects expectations of a better capital/labor ratio in the future in those enterprises that are traded publicly. The cream of the soup. Risks to capital additions are being reduced by a wiser monetary policy at the Fed and by discussions among our political leaders on how to increase rewards to capital, by cutting the capital gains tax, instead of raising tax rates on capital formation. Capital's prospects are much better now than they were six years ago, when President Bush was about to break his read-my-lips pledge and Treasury Secretary Brady was urging Greenspan to print more money.

Is a 300% reward enough for an investor? Of course it is. But that is not the objective. The objective of a capital gains tax cut is to induce investors to be willing to lose money on investments that are not now being financed at all. If you go to Las Vegas, you will find a roulette wheel that pays 300% if you place a successful bet on the numbers one through twelve. Isn't this enough? No, the roulette wheel will pay you 600% if you successfully bet on the numbers one through six. And 1200% on one through three. And 3600% on one. In our political economy, we would like capital to bet on the long shots as well as the sure things. We would like to find 36 people willing to come to the wheel and put a dollar down on each number, each knowing only one number will win, but that when it does, the after-tax payoff will be 36-to-1 after tax!!! This reasoning is why Alan Greenspan tries to get members of Congress to understand that the capital gains tax should be zero. If the system is not set up so that through the marketplace bettors can get bets down on the longest shots on the table, the longest shots will get no capital. They will have only the sweat of their brow, their labor, physical or intellectual.

Q: How is it that productivity in a heavily overtaxed country like Germany could show improvements over and above that of the U.S. for the last 25 years?

A: For one, Germany's monetary policy has been superior to ours over the last 25 years, in that the D-mark price of gold has risen less than the dollar price. This means there was a lower barrier to capital formation in Germany, more capital in their soup. Secondly, Germany has had a much lower capital gains tax, approaching zero, even while they have had higher rates on ordinary income. Your term "a heavily overtaxed country11 has very little real utility, after all. You cannot simply assert it is "overtaxed," but must tell me why you think so. I believe it is, but that is not the question you posed, and I will leave it for another time.

Q: If you indeed want further investment, why not tax speculation A:) All investment is speculation. All. All. All. The most speculative investment is on the long shot, at 36-to-1. Why would you say you can't cash the 36-to-l shot when it hits, but must require the winner to continue betting on it for Q:) Isn't a steady tax policy a much more conducive environment for business and taxpayers alike, rather than the instable continuous uncertainty created by bickering in several camps?

A: The history of civilization is largely a debate over public finance. Do you think we would be better off today if John Kennedy had left tax policy steady, at a top marginal rate of 90%, when he was inaugurated? Why do we have political leaders, if not to argue about the price of public goods and services? Tax policy should be changed as soon as possible when there are changes in the environment that require them. Would you have General Motors leave the price of a Chevrolet exactly the same year after year, on the grounds that stability is preferable?

Q: And last but not least, tell me of that person who has not made an investment or taken that $100,000 job because the tax is too high. 

A: A person does not make an investment when the likely return on that investment, after tax, is lower than can be had with a municipal bond or a Treasury bill. A person will not take a $100,000 job when the tax is so high that the job cannot be offered, because the enterprise finds that all the rewards to capital and labor entwined in their operation are being confiscated by the government.