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)| false , Ross, D.and R. Pearlman 1989, Testimony of Acting Assistant Secretary (Tax Policy) Dennis E. Ross and Joint Committee on Taxation Chief of Staff Director Ronald A. Pearlman before the Senate Finance Committee, March 14, 1989, Tax Notes, July 10, 1989, p. 145.
The author would like to thank colleagues in the North American Division, Lans Bovenberg, and David Coe for helpful comments. The usual disclaimer applies.
A capital gains tax rate which increases by the holding period would reduce the gains of deferral.
Reducing or eliminating the benefits from deferral with a deferral charge based on holding period would reduce the lock-in effects. For a description of a possible construction of such a charge, see Pechman (1977), p. 152.
In the United States, realized long-term capital gains were originally taxed as ordinary income, but following the Revenue Act of 1921 they were subject to preferentially low rates. However, the provisions applying to such gains have changed substantially. The increase of the capital gains tax rate in the Tax Reform Act of 1986 was considered part of the deal for obtaining lower marginal tax rates, especially for high income earners.
In 1985, individual taxpayers reported total long-term gains of $168.7 billion (after deduction of long-term losses and loss carryovers) while only $6.1 billion was reported in short-term gains. Source: Statistics of Income for 1985: Individual Income Tax Returns, table 1.4, U.S. Internal Revenue Service.
The purpose of this legislation is to bar taxpayers other than corporations from selling stock or securities and promptly repurchasing substantially identical property. The time limit is 30 days.
An IMF working paper concluded that in the 1980s a U.S. saver faced a heavier tax burden than a Japanese saver while the tax burden on investments in Japan exceeded that in the United States. See Bovenberg, et al. (1989).
Pechman (1989a) argued that a capital gains tax cut would be a bonanza for the rich and would undermine the tax reform achieved in 1986.
As pointed out earlier, neither is the tax treatment of capital gains arising from different sources.
Auerbach (1988). A series is stationary if its stochastic properties are invariant with respect to time. Many time series are nonstationary. For example, GNP is nonstationary because of its growth trend.
Auerbach, op. cit.
An elasticity above 1 in absolute value would lead to an increase in revenues when the tax rate is lowered.
Office of the Secretary of the Treasury (September 1985), op. cit.
Thus, there would be a sample selectivity bias on the estimated regression parameters. They correct for this by using weights that reflect the probability to be put into the data set based on income level.
To avoid the problem of endogeneity of the last dollar marginal tax rate, this study uses an instrumental variables approach. It entails deriving an exogenous measure of annual income, then calculating marginal tax rates and virtual income corresponding to the alternative income level. These are used as instruments for the observed values in the behavioral equation.
A simple calculation demonstrates how much the frequency of realizing capital gains has to increase in order for the revenues to increase (see Auerbach, 1989). Assume that assets appreciate annually at a rate of 10 percent, one fourth of all assets are held until death and therefore never sold and that the remaining assets are sold once every ten years. Under these conditions the annual ratio of realized gains to assets would be 4.7 percent. Doubling this ratio, as suggested by the Treasury Department's estimates, would require that all assets be sold and all capital gains be realized every year. The calculation may be unrealistic but it suggests that some of the revenue impact is likely to be transitory rather than permanent.
This specific provision could be eliminated either by requiring realization at death or by assuming the heirs acquired the relevant assets at the same cost basis as the original owner.
An alternative would be to continue to base the tax on realizations, but to have the tax rate increase over time reflecting the value of the deferral. However, under that scheme the problem of the tax being based on nominal gains would remain since the inflationary component varies across assets and over time.
It should be noted that the choice of index would likely prove controversial.
This argument presumes that entrepreneurial activity deserves preferential treatment.
Instead of paying out dividends, a firm could pay out its retained earnings by acquiring another company. When another company buys the stocks in a cash transaction, the capital gains are realized and capital gains taxes may have to be paid. However, with a lower capital gains tax rate, the stock owners may be more inclined to accept an offer leading to corporate restructuring.
A temporary revenue effect could also be achieved by announcing an increase in the capital gains tax rate to take place some time in the future.