A couple of posts back, I referred to earlier work debunking the link between low capital gains tax rates and real investment (and please don’t give me “what, you don’t think taxes matter?!” I do, but the actual elasticities—in this case, investors’ responses to tax changes–are far, far lower than the claims).
Here, I’d like to tackle something else that came up in that post: the idea that what really gets investors going is not the cap gains rate itself…it’s the difference between it and the rate on ordinary income. The figure below shows the differential between the top rates on cap gains and ordinary income.
Now, in this case I’m the first to say that this tax difference affects behavior, but it’s not real economic behavior—the stuff that generates investment, jobs and good stuff like that. It’s tax lawyer fun-and-games designed to label everything a cap gain so you can take advantage of the rate differential.
First, if you plot real business investment against the gap between the cap gains and the ordinary rate, you certainly don’t see much of a correlation between the tax gap and real investment. In fact, the correlation between the tax gap and investment growth is .04 and that between the change in the tax gap and investment growth is 0.12, neither of which are statistically significant.
Source: BEA, TPC
What’s that? I’m not capturing the dynamics of the relationship? A handy statistical way to do that is to throw the taxgap and investment growth (and unemployment, to control for the business cycle) into a VAR (a statistical procedure that just lets you see how different variables affect each other’s growth over time). You can then ask: what would happen to investment if you “shock” the tax gap grew (e.g., the ordinary income rate is made higher than the cap gains rate)? The trickle downers, and this represents the views of all the R candidates for president, argue that this is precisely the way to generate more investment, jobs, and incomes for the middle class.
But, alas, it fails to do so, at least in this simple exercise. The figure shows the reaction of real investment to such a boost in the tax gap (the x-axis represents years, the y-axis shows percent change–0.01=1%–in real investment in response to a larger tax gap), and investment responds not at all (the confidence intervals are wide and cover zero, meaning these impacts are again statistically insignificant). If you substitute the change in the tax gap instead of the level, you get the same result.
Caveats abound—these are all simple correlations, and micro-investor behavior is a lot more complex than I’m capturing in these macro variables. But I can tell you from decades of experience in crunching such numbers that if it’s this clearly not showing up in the simple correlations, it’s probably not going on in the real world.
And thus once again, we conclude the trickle down is BS, serving only to exacerbate economic inequality, which in turn stifles mobility, while starving the federal government of revenues it needs to achieve budget sustainability and to fulfill the roles we need it to both now and in coming years.