Rethinking How We Score Capital Gains Tax Reform
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 composition of capital gains has shifted in recent years, such that the share of gains that are highly elastic to the tax rate has likely declined. Third, focusing on capital gains tax collection may understate fiscal spillovers from decreasing the preferential tax treatment for capital gains. Fourth, additional base-broadening reforms, like eliminating stepped-up basis and making charitable giving a realization event, 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 $1 trillion more revenue over a decade than other estimates suggest. Given the magnitudes at stake, scorekeeping procedures employed in evaluating capital gains should be made more transparent and be the subject of external professional debate and review.
We thank Coly Elhai for outstanding research assistance. We received helpful comments from Tim Dowd, Robert McClelland, Rich Prisinzano, Jim Poterba, and others who wish to remain anonymous. These acknowledgments should not be interpreted as implying that these individuals are in agreement with this paper's conclusions. 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.