No Obvious Relationship between Capital Gains Tax Rates and Economic Growth

By :: March 19th, 2012

If you read the editorial page of financial newspapers, you might conclude that no aspect of tax policy is more important for economic growth than the way we tax capital gains.  You'd be wrong.

The chart displayed above shows top tax rates on long-term capital gains and economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, you'd expect to see a negative relationship--high gains rates, low growth, and vice versa--but there is no apparent relationship between the two time series.  The correlation is 0.12, the wrong sign and not statistically different from zero.  I've tried lags up to five years and also looking at moving averages of the tax rates and growth.  There is never a statistically significant relationship.

Does this prove that capital gains taxes are unrelated to economic growth? Of course not. Many other things have changed at the same time as gains rates and many other factors affect  economic growth. But the graph should dispel the silver bullet theory of capital gains taxes.  Cutting capital gains taxes will not turbocharge the economy and raising them would not usher in a depression.

Low capital gains tax rates do accomplish one thing: they create lots of work for lawyers, accountants, and financial geniuses because there is a huge reward to making ordinary income (taxed at rates up to 35%) look like capital gains (top rate of 15%).  The tax shelters that these geniuses invent are economically inefficient, and the geniuses themselves might do productive work were the tax shelter racket not so profitable.  And the revenue lost to the capital gains tax loophole adds to the deficit, which also hurts the economy.

Thus, it's no surprise that there's no obvious relationship between capital gains tax rates and economic growth. Indeed, the low rates on gains might do more harm than good.

PS, The data in the chart above are available upon request. Email me and I'll send you the spreadsheet. (And if you find something that I missed, tell me and I'll post an update.)

 

This first appeared on my Forbes blog. If you'd like to receive my Forbes blog posts by email, click this link.

29Comments

  1. Michael Bindner  ::  3:42 pm on March 19th, 2012:

    More interesting is the possibility of a relationship between the top dividend tax rate and various measures of worker well-being (wages, unemployment, plant closings, demand pull inflation, union membership, attempted adverse labor actions – i.e. union busting).

  2. Adam Boatsman  ::  8:38 am on March 20th, 2012:

    Thanks for the post Len. While one of those profiting from deferring / minimizing taxes I do find it facinating that pundits trying to figure out a way to spur growth through tax policy ignore this, and much other statistically valid research that contradicts their points.

  3. Flat Tax  ::  2:57 pm on March 20th, 2012:

    Might you also conclude from your statements that anything other than a flat tax creates inefficiencies and distortions as individuals (i) seek counsel on how to lower their tax burden and (ii) invest in policy-favored industries (housing, oil, ag, alternative energy, etc.) creating bubbles and unnecessary goods?

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    please you should add the current account deficit, inflation, and unemployment
    the correlation will give a different result

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