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    Capital Gains Tax Rates Versus Ordinary Income Tax Rates – Differing Viewpoints and Does it Matter?
    The Vault

    Capital Gains Tax Rates Versus Ordinary Income Tax Rates – Differing Viewpoints and Does it Matter?

    May 2012

    Recently I came across three great blog posts regarding capital gains tax rates versus ordinary income tax rates.  While there has always been some debate about tax rates on the super wealthy – especially those that derive income primarily from investments, the political commentary on this issue has become more 'vocal' as national elections loom this fall, based on Warren Buffett's calls for taxes on the super rich and from the disclosure of Republican Candidate Mitt Romney's tax returns.

    The first two posts are respectively an explanation of the differences and a counterpoint that the differences are unfair. However, the third post nails the coffin and asks 'why even have a debate' as statistically there is no correlation between capital gains tax rates and economic growth. While somewhat derogatory on my profession (D'oh!) the author is using statistical correlations to make a point – just remember that I am not lobbying one way or the other!

    The first post by Gregory Mankiw, an economist at Harvard University appeared in the New York Times. While seemingly not advocating a position one way or the other, Mankiw simply describes a very common scenario we can all understand. He uses rehabbing a dilapidated house and selling the house for a gain, to explain carried interest and capital gains rates associated with private equity firms such as Bain Capital.

    The second post also appeared in the New York Times as a counterpoint to the first post. Authored by Ewe Reinhardt, professor of economics and public affairs at Princeton University, the second post makes the argument that capital gains rates for effectively doing the 'work' of making an investment more profitable are inherently unfair, as isn't the ordinary wage earner also bolstering investment in the economy in the same manner (e.g. the doctor that makes a patient productive and gets them back to work – isn't that an investment – the attorney that saves a company from a disastrous lawsuit?).

    While fascinating reading on social justice and the tax code, those of you that know me know that I really care about the data itself. Here's where the third post comes into play. In the post, Len Burman, a professor of public policy at Syracuse University, presents a dataset that shows that despite best efforts to prove a correlation between capital gains tax rates and economic growth (including changing the time horizon to show lags between rate changes and corresponding growth) no correlation can be found – which is very similar to studies that show that there is not a strong correlation between lower tax rates than those we enjoy now and economic growth.

    There will always be political commentary on both sides of the debate when it comes to tax policy and its effect on the economy – it's a complicated topic – if it weren't complicated we'd have solved our issues, right?


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