Congress Should Address Corporate and Capital Gains Taxes Differently

Tax policy is going to be a hot debate in Congress once President-Elect Obama’s term begins in January. Although Obama won the tax debate with McCain in the voter’s eyes (polls show voters preferred Obama’s plan, despite McCain’s continuous attacks on it), his administration will still have to work across party lines to pass tax reform next year.

Two areas getting a lot of attention are capital gains taxes and corporate income taxes. The argument for the former is that lower tax rates induce more investment capital into the system. For the latter it is that companies with extra cash flow will hire workers and buy new equipment. I actually don’t think either one of those arguments is true to any significant degree.

For instance, I don’t know anybody who has not invested in the stock market because of the 15% capital gains tax. The notion that if we lower that rate to 10% it would cause billions of dollars to rush into the market seems downright silly to me. Conversely, if Obama was to raise the rate to 20%, it should not result in excessive selling of financial assets because it is hard to argue 15% is fine but 20% is overkill given the small differential. Tax rates are simply not a core determinant of whether people invest or not, at least not when the rate changes we are talking about are so minimal (if tax rates were 50% and dropped to 10%, then my opinion might change).

On the corporate side, it is my belief that a tax cut alone does not directly result in additional hiring and capital expenditures. A corporate executive does not decide to hire more people or invest in new projects just because they have the money available to do so. There needs to be a business reason for the move, i.e. the demand for their products is growing, which makes the investment in new people and equipment worthwhile in return on the investment terms. I disagree with the idea that tax cuts cause job creation. Real increases in demand from a growing economy results in job creation because more people are needed to meet the demand.

All of that said, I think that given a choice between the two, a cut in the corporate tax rate would be far more beneficial than reducing the capital gains rate. Simply speaking, lower corporate taxes directly impact stock prices positively by increasing corporate earnings. Since a majority of Americans own stocks (I think the number is between 60 and 70 percent, I can’t recall the exact figure), lower corporate tax rates would benefit most Americans.

Many people make the same argument for reducing the capital gains tax rate, but it ignores a very crucial fact. While it is true that 60 to 70 percent of Americans own stocks, the vast majority of those people hold their investments in IRA and/or 401(k) plans, which of course are not subject to capital gains taxes. More often than not, those who own stocks in taxable accounts to any significant degree are the wealthiest Americans (entrepreneurs who retained large ownership stakes in the companies they founded, or executives who were granted stock options are part of their compensation plans).

Since our country has seen an acceleration in the recent trend of the rich getting richer while the poor get poorer, I would much prefer to help the majority of Americans through a corporate tax reduction, versus helping the top 5 or 10 percent of the country, who would see most of the benefit from a reduction in the capital gains tax rate.

Now, one can certainly make the case that personal income tax rate reductions would have a more positive impact on the economy (boosting incomes will increase end demand for products that corporations sell to consumers, thereby boosting job creation and new capital projects), but given the budget deficit problems we are facing, a corporate tax cut would be far less costly. The U.S. gets the bulk of its revenue from personal income taxes, whereas corporate tax collections are a much smaller fraction of overall federal revenues.