Rethinking How We Score Capital Gains Tax Reform
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We argue the revenue potential from increasing tax rates on capital gains may be substantially greater than previously understood. First, many prior studies focus primarily on short-run taxpayer responses, and so miss revenue from gains that are deferred when rates change. Second, the rise of pass-throughs and index funds has shifted the composition of capital gains in recent years, such that the share of gains that are highly elastic to the tax rate has likely declined. If some components are less elastic, then their elasticity should get more weight when scoring big changes because they will comprise more of the remaining tax base. Third, closer parity to income rates would provide a backstop to rest of tax system. Fourth, additional base-broadening reforms, like eliminating stepped-up basis, making charitable giving a realization event, reforming donor advised funds, and limiting opportunity zones to places with the highest poverty rates, will decrease the elasticity of the tax base to rate changes. Overall, we do not think the prevailing assumption of many in the scorekeeping community—that raising rates to top ordinary income levels would raise little revenue—is warranted. A crude calculation illustrates that raising capital gains rates to ordinary income levels could raise hundreds of billions more revenue over a decade than other leading estimates suggest.
This work does not necessarily reflect the views of the US Treasury. We thank Coly Elhai and Emily Bjorkman for outstanding research assistance. We also thank Tim Dowd, Howell Jackson, Robert McClelland, Rich Prisinzano, Jim Poterba, Joel Slemrod, and David Splinter for helpful comments. This work is supported by National Science Foundation under Grant Number 1752431. We declare that we have no relevant or material financial interests that relate to the research described in this paper other than owning some assets which have unrealized accrued capital gains. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.