What's the best way to rebut this argument, from Friday's NYTimes:
These days, the conventional way to look at taxes on investments is to think they should be low to stimulate investment and thus help the economy. It is a view that has much more support in economic theory than in economic history.
Correlation is not causation, of course, but the economy has tended to do the best when taxes on unearned income were high. Economic growth was great during the 1950s, when dividends were taxed at very high levels and capital gains rates were 25 percent, much higher than they are now. Since 2003, tax rates on unearned income have been at their lowest levels ever, and economic growth has been sluggish.
Tax rates are not the reason for that, at least not directly. But it could be argued that low tax receipts now are having a pernicious impact, particularly on state and local governments. Their layoffs have been a drag on the recovery, and the declining quality of infrastructure in many areas has hurt many businesses. If the federal government taxed unearned income anywhere close to historical averages, there could have been a lot more tax money available to help out when the credit crisis hit.
There is no question that tax policy has had a major impact on investment, but its impact probably has been less in the overall level than in the allocation of investments.
Taxing capital growth (aka gains) is counterproductive because it discourages investment. Bruce Bartlett explains it with a metaphor from Irving Fisher:
As the great economist Irving Fisher once explained, it confuses the fruit and the tree. Trees grow and they also produce fruit. The fruit is income and is justly taxed. But growth of the tree is an increase in capital. More capital will produce more income in the future, which will be taxed, but taxing the capital itself is counterproductive.
Not only does this have the effect of discouraging proper care of the tree (stock market investments), it discourages planting trees to begin with (venture capital), according to the Congressional Joint Economic Study Committee in 1997.
It also amounts to a tax on the simple ownership in the asset -- a property taking -- to the extent that capital gains are unindexed to inflation. From this Op-Ed in the Wall Street Journal:
Assume you purchased a common stock in a company in 1984 for $100 a share and sold it in 2007 for $200 a share. Have you received any "income" from the sale of the shares of stock? The IRS would say "yes," but this is clearly wrong. The IRS will claim that you had a $100 per share capital gain on the stock in the above example, yet actually the increase was solely a result of inflation. Because you cannot buy more goods and services with $200 now than you could have with $100 in 1984, you have had no "income" or wealth accretion.
In the early part of our country's history, we recognized that capital gains weren't income, much less "unearned" income. Three Supreme Court decisions said as much -- Gray v. Darlington, 1872; Lynch v. Turrish, 1918; Eisner v. Macomber, 1919). It wasn't until Merchants Loan and Trust v. Smietanka in 1921 that the Court reversed itself. [From Bruce Bartlett, "'Not Income at All'," Wall Street Journal, August 2, 2007]
Answer by Joseph Eagar
If you (painfully) read to the end, the author proposes simple tax reform, and an end to all tax loopholes. So, not higher taxes per se. I don't know very much about dividend taxes; I do know that the low rate for capital gains is supposed to reflect the implicit taxation of inflation on long-term investment.
The article (confused as it is) seems to object primarily to low dividend tax rates. The author seems to support low capital gains rates (compared to wage rates, at least) but opposes the carried interest deduction. The article is not very coherent. As for dividends, the right policy is probably to eliminate corporate taxes and bring dividend rates back up to wage rates, but I'm not sure if that's feasible in a geopolitical sense (look at how many nations hate and envy Ireland's low corporate tax rate--imagine the furor if we eliminated ours).