Capital
Gains Taxes
and the
Economy
Authored by Allen Sinai
Decision Economics, Inc.
Prepared for the American Council for Capital Formation: Center for Policy Research by Decision Economics, Inc. (DE), September 2010.
Capital Gains Taxes and the Economy
Allen Sinai*
Executive Summary
In 2011, capital gains tax rates for taxpayers in the top four income brackets are set to move
higher.1 At yearend, the current 15% tax rate on capital gains for assets held one-year-or-more
will rise to 20% for individuals earning approximately $34,000-or-more and married couples
earning $68,000 or higher.
This paper assesses the macroeconomic effects of changes in capital gains tax rates for
individuals, with estimates from simulations with the Sinai-Boston (SB) large-scale
macroeconometric model of the U.S. economy. The Model is used in simulating reductions, and
increases, in capital gains taxation starting in 2011 and extending to 2016, relative to the current
15% rate paid by many taxpayers. The capital gains tax rates considered ranged from 0% to 50%
with gradations at 5%, 10%, 20% and 28%.
Several conclusions are suggested by the results:
x
Very high, or very low, individual capital gains tax rates relative to the current level can
do significant damage, or provide significant help, to the economy.
x
Raising the capital gains tax rate from 15% to 20%, 28% or 50%, reduces growth in real
GDP, lowers employment and productivity and, ex-post, or after feedback, negatively
affects the federal budget deficit.
For example, at a 20% capital gains rate compared with the current 15%, real economic
growth falls by 0.05 % per annum and jobs decline 231,000 a year. At a 28% rate,
economic growth declines by 0.10 % and the economy loses 602,000 jobs yearly . When
the capital gains tax rate is increased to 50%, real GDP growth declines by 0.3% per year
and there are 1,628,000 fewer jobs per annum.
x
Despite an “ex-ante” or “static” increase in tax revenues from a rise in the capital gains
tax—after the negative effects on the economy and feedback effects on tax receipts from
*
Chief Global Economist and President, Decision Economics, Inc. (DE); New York, London, Boston, Chicago.
Financial support was provided by the American Council for Capital Formation (ACCF).
1
These tax increases will result from the expiration of reductions legislated in the Economic Growth and Tax
Reconciliation Act of 2001 and Jobs and Growth Tax Relief Reconciliation Act of 2003, where the maximum longterm individual capital gains tax rate was reduced to 15% from 20% across all income levels. Marginal personal
income tax rates also were reduced; originally (2001) to be in stages and then in 2003 the previously legislated
reductions were accelerated. A 15% tax on qualifying dividends also expires at yearend and all dividends will be
taxed at ordinary income tax rates in all tax brackets. The Obama Administration has proposed leaving the existing
tax rates on capital gains and dividends for families with joint incomes less than $250,000 and individuals who earn
less than $200,000; also a zero capital gains tax rate for small business. None of these proposals have yet been
enacted.
The proposals of the Obama Administration in the FY2011 budget were not examined in this study, only responses
to various changes in capital gains tax rates compared with the current level.
-2a worsened economy and a weaker stock market, the federal budget deficit actually ends
up larger, by over $1 billion per year with a 20% capital gains rate and almost $10 billion
per year if the tax rate is 28%. And, at 50%, despite the ex-ante, or planned, increase in
tax revenues, $191.5 billion per annum, the actual, or ex-post, federal budget deficit
actually ends up lower, by $67 billion per year.
x
Reducing the capital gains tax rate to 0% increases growth in real GDP by a little over
0.23 percentage points per year.
Jobs increase by 1,322,000 per annum.
The
unemployment rate drops 0.7 percentage points at its lowest point. And, productivity
growth improves 0.5 percentage points a year.
x
The net impact on the federal budget of a reduction to 0% is a decline in tax receipts of
$23 billion per year, ex-post, far less than the ex-ante revenue loss of the tax change.
This tax cut produces new jobs at a cost of only $18,000 per worker.
x
When the capital gains tax rate is decreased to 5% from the current 15%, growth in real
GDP rises 0.2 percentage points per annum, the unemployment rate falls 0.2 percentage
points per year, and nonfarm payroll jobs increases 711,000 a year. At this capital gains
rate, productivity growth improves 0.3 percentage points per year.
x
Lower and higher capital gains tax rates also affect the financial positions of households
and corporations. When capital gains taxes are reduced, the aftertax return on equity
rises, stock prices increase, household wealth is higher, some capital gains are realized,
consumption increases, output and production rise, capital spending increases, household
financial assets tend to rise, liabilities decline, debt service burdens are reduced, and
household financial conditions improve. These financial effects from the lower capital
gains taxes are supportive to additional spending out of disposable income and tend to
sustain and raise and for a longer time the multiplier effects from the reduction in the
capital gains tax.
Corporations benefit as equity prices rise and profits improve from the better economy.
This provides additional cash flow that can reduce growth in borrowing or add to
financial assets, improving measures of financial well-being for the nonfinancial
corporate sector. Higher capital gains taxes would have opposite effects.
Enhanced financial positions for households and businesses provide resiliency to the
economy in the face of negative shocks reduce the cost of financing and financial risks taken by
those who provide funds for new businesses, entrepreneurship, and innovation.
-3While a small increase in capital gains taxes does not have a large negative impact on the
economy, much higher capital gains taxes are very punitive.
For example, a 20% capital gains tax rate is not much higher than the current 15%. But, any
capital gains tax hike is counterproductive because it brings weaker real economic growth,
reduces consumption and real consumption per capita, causes losses in jobs, a higher
unemployment rate, less productivity growth, and lower potential output. There is little “bangfor-a-buck” for the economy per dollar of tax revenue on any capital gains tax hike; indeed, the
revenues gained ex-post are hardly worth the loss in economic growth, in jobs, in productivity
and potential output.
Similarly, or conversely, significant reductions in the capital gains tax rate, e.g., to 5% or
even 0%, bring strong gains in real economic growth, in new jobs, and likely will increase
entrepreneurship and new businesses, increase capital formation, raise productivity growth, bring
higher potential output, and greater efficiency.
The challenge for macroeconomic policymaking and Washington will be how to devise
macroeconomic policies that can increase real economic growth and jobs with minimal
increases in the federal budget deficit; or, if possible, reductions. Capital gains tax reduction
scores well on these grounds. Capital gains tax reductions, not increases, on what activities, and
on whom, perhaps in the context of full tax reform and whether to tax consumption, income, or
capital, are more general issues to be considered.
-4Capital Gains Taxes and the Economy
Allen Sinai*
Introduction
This study employs a large-scale structural macroeconometric model with considerable detail
relating to capital gains taxation and its potential effects on the overall economy. Analysis of
allocative efficiency and equity, normal dimensions for assessing any tax, its incidence and
effectiveness, is not part of the research. The conclusions are based strictly on an assessment of
the macroeconomic impacts of changes in capital gains tax rates.
In 2011, individual capital gains tax rates in the top four income brackets are set to move
higher. At yearend, the current 15% tax rate on capital gains for assets held one-year-or-more
will rise to 20% for individuals earning approximately $34,000-or-more and married couples
earning $68,000 or higher. These tax increases will result from the expiration of reductions
legislated in the Economic Growth and Tax Reconciliation Act of 2001 and Jobs and Growth
Tax Relief Reconciliation Act of 2003, where the maximum long-term individual capital gains
tax rate was reduced to 15% from 20% across all income levels.2 The main purpose was to
stimulate the U.S. economy.
Throughout U.S. history, numerous changes in capital gains tax rates have been legislated as
risky investments alternatively have been viewed as needing special incentives or not, capital
formation has been an objective, growth of the economy a concern, revenues needed, or issues
relating to fairness or the distribution of income central. Capital gains taxation is controversial;
in part, because those perceived to benefit most, many think unfairly so, are “rich” as opposed to
“poor,” and because of questions about whether a tax subsidy to “risky” investments, i.e., a lower
capital gains tax relative to the ordinary income tax rate, really adds to real economic
performance or just supports and encourages speculative and unproductive activities.
What are the pluses and minuses of this controversial tax? Will the coming increase in
capital gains taxes hurt the U.S. economy? How do changes in capital gains taxes affect the
*
Chief Global Economist and President, Decision Economics, Inc. (DE); New York, London, Boston, Chicago.
Financial support was provided by the American Council for Capital Formation (ACCF). Robert “Chip” Curran
performed the simulations with the Sinai-Boston (SB) Model as well as collaborating on other aspects of the
research. The comments and suggestions of Margo Thorning and Pinar Cebi Wilber are gratefully acknowledged.
2
Marginal personal income tax rates also were reduced; originally (2001) to be in stages and then in 2003 the
previously legislated reductions were accelerated. A 15% tax on qualifying dividends also expires at yearend and all
dividends will be taxed at ordinary income tax rates in all tax brackets. The Obama Administration has proposed
leaving the existing tax rates on capital gains and dividends for families with joint incomes less than $250,000 and
individuals less than $200,000; also a zero capital gains tax rate for small business. None of these proposals have
yet been enacted.
Tax proposals in the proposed FY2011 budget were not examined in this study, only responses to changes in capital
gains tax rates compared with the current level.
-5economy, inflation, jobs and unemployment, productivity, potential economic growth, and
federal government budget deficits? What are the transmission mechanisms from changes in
individual capital gains taxes to the economy? Would a much lower or much higher capital
gains tax rate make a significant difference to economic performance and to jobs?
These questions, and others, are dealt with in this paper, where the macroeconomic effects
from a wide range of changes in capital gains tax rates are assessed. Estimates are obtained in
simulations with the Sinai-Boston (SB) large-scale macroeconometric model of the U.S.
economy. The Model is used in simulating the effects of reductions, and increases, of individual
capital gains tax rates starting in 2011 and extending to 2016, relative to the 15% paid now by
many taxpayers. The capital gains tax rates considered ranged from 0% to 50% with gradations
at 5%, 10%, 20% and 28%.3
In this study, capital gains tax changes, up-or-down, if small, show relatively little, but still
noticeable, effects on economic growth, jobs, capital formation, productivity growth and federal
budget deficits.
Much higher capital gains taxes, e.g., 28% or 50%, are associated with
significant damage to the economy, production, capital spending, employment and
unemployment. Much lower capital gains tax rates are noticeably stimulative.
Changes in the maximum capital gains tax rate from 15% to a higher rate for families and
individuals, while raising tax revenues and reducing federal budget deficits initially, do not
produce such a result ex-post, or after feedback, taking account of the direct and indirect effects
on the economy of the changes in taxes.
A higher capital gains tax rate, e.g., 50% or 28%, or even 20%, compared with the current
15%, leads to reductions in real economic growth, losses in household wealth, less business
profits and incomes, fewer capital gains realizations, lost jobs, a higher unemployment rate and
reductions in tax receipts, ex-post, across-the-board except for capital gains. There is little
“efficiency” from this kind of tax increase; indeed, ex-post the net revenues gained are hardly
worth the losses in economic growth, wealth, real consumption per capita, jobs, productivity, and
potential output.
3
Although not examined in this paper, which looks at “what if” hypothetical changes to the capital gains tax rate,
current policies are set to take the maximum capital gains tax rate to 20% from 15% for all taxable gains and for
families with high incomes ($250,000-and-more; individuals, $200,000-and-up) to 23.8% because of an additional
3.8% tax on unearned income contained in 2010 health care legislation.
The federal tax on ordinary income at the highest income bracket will rise to 39.6% from 35%, so that the
differential between the tax rate on ordinary income and long-term capital gains realizations will be 15.8% in 2011
compared with the previous 20%.
-6Conversely, significant reductions in the capital gains tax rate, e.g., to 5% or even 0%, will
bring significant gains in real economic growth, new jobs, entrepreneurship and new businesses,
an increase in capital formation, increased productivity growth, and higher potential output.
Why these results?
An essential element has to do with the role of the equity market in a mixed capitalistic free
market system such as exists in the United States, where there are multiple and flexible capital
markets, robust financial intermediation, and a diverse set of financial intermediaries to transfer
the savings and investible funds of households, businesses, and the rest-of-the-world into taxadvantaged uses for saving and investment, new business development, entrepreneurship and
capital formation.
A lower/higher capital gains tax relative to ordinary income tax rates increases/decreases the
aftertax return on equities and raises/lowers the demand for equities relative to the supply. On
average, stock prices rise/fall as a result.
Gains/losses in household wealth, higher/lower
incomes, rising/falling consumption, higher/lower business profits, increased/decreased jobs and
incomes, and greater/less capital spending take place.
With lags, if the tax is lower and permanent, capital gains can be realized, providing an
additional source of funds besides earned income to households for spending, saving, and to pay
higher taxes, net, in the aggregate from all categories of tax receipts except capital gains.
With robust capital markets and a diverse set of financial intermediaries, including
investment banking/brokerage, private equity, venture capital and other such firms, the additional
funds, aftertax, realized on a reduction in the capital gains tax can be used for consumption, debt
reduction, or additions to household financial assets. Because the capital gains realized are not
counted in disposable income but can be spent on consumption, there is a decline in the
“savings” rate as conventionally measured in the National Income and Product Accounts
(NIPA). But, from a household balance sheet and flow-of-funds perspective, savings actually
increase and can find an outlet via financial intermediation into investments that promote new
businesses, innovations, research and development, mergers and acquisitions, and business
expansion.
Housing activity and residential real estate prices should rise with a reduction in the capital
gains tax, since the long-term aftertax return on real estate, and the demand for it, will increase.
In such a situation, modern mortgage finance and mortgage-related financial instruments that tap
or draw on equity in residential real estate, e.g., gross cashout financing, can provide additional
spendable funds for household consumption or savings. Since these funds are not counted in
-7disposable income the NIPA personal saving rate would decline but savings increase in the
flows-of-funds and the stocks of assets and liabilities in the household balance sheet change.
The outline of the paper is as follows. Some pluses and minuses of capital gains taxes are
indicated. How capital gains tax changes affect the economy is discussed. The channels in the
SB Model connecting changes in capital gains taxes to the economy are indicated. Results for
the economy from simulating changes in the capital gains tax rate are reported and discussed. A
final section offers some perspectives on capital gains taxation in the current difficult
macroeconomic and political environment of the United States.
Capital Gains Taxation—Pluses and Minuses
Table 1 summarizes some history of changes in statutory individual capital gains tax rates
since 1942.4 There have been a number of changes, with the statutory rate over the period
ranging from 15% to 45%. Changes in the holding period for purposes of calculating the capital
gains subject to tax are not indicated but have been numerous. Figure 1 shows the history of
capital gains realizations, seen to be significantly up-or-down at times of major equity bull or
bear markets and after changes in capital gains tax rates. Strong rises/declines in capital gains
realizations often have occurred not long after the tax rate has been changed.
Table 2 shows that over time, capital gains tax receipts have been rising as a percent of
individual and total tax receipts. In boom periods and times of rising asset prices, for example
2003 to 2007, capital gains tax receipts moved up sharply, providing a significant source of
revenues to the federal government.
Part of the surprising strength of tax receipts in business expansions comes from capital gains
taxes and similarly some of the surprising weakness during economic downturns from declines
in capital gains tax receipts. The role of the stock market in the ups-and-downs of the business
cycle should be noted, affecting economic activity in a significant way and thus tax receipts
across all categories. Particularly in a business cycle upturn, realizations of capital gains can be
nonlinear and thus so can capital gains tax receipts. This was particularly so in the last decade
when huge capital gains were realized on sales of businesses, from the residential real estate and
stock market booms, and because the total compensation of many corporate executives was tied
to the performance of the company’s stock price.
4
The average effective capital gains tax rate, i.e., capital gains taxes paid as a percent of income, depends not only
on the statutory capital gains tax rate but also the income tax bracket of a family, the holding period for capital
gains, possible unlocking of previously unrealized gains, and other itemized deductions that affect adjusted gross
income. The average effective rate is exogenous in the SB Model. But, changes in the statutory rate provide a
“lever” that changes the average effective rate which initiates the model simulations.
-8Why should there be a capital gains tax? And, why a differential between capital gains and
ordinary income tax rates, that is preferential tax treatment for capital gains income? What are
some pluses and minuses of the tax?
A capital gain, or increase in the price of an asset realized upon its sale, is income to the
holder and as a result subject to tax. Otherwise, a preponderance of investments in capital gains
Table 1
Capital Gains Tax Rates: Some History (1942 to 2011)
Date
Statutory
Capital Gains
Tax Rate
(Percent)
2011*
20
2003-10
15
1997-02
20
1987-96
28
1981-86
20
1979-80
1978
28
33.8
1972-77
1971
1970
35
32.5
30.2
1969
1968
27.5
26.9
1954-67
1952-53
1942-51
25
26
25
Comments
Expiration of 2001/03 capital gains tax reductions to 2001 levels for
individuals and couples in the top four income tax brackets. The recently
passed health care bill adds a further 3.8 % increase on capital gains for
individual taxpayers above $200,000($250,000 married, filing jointly).
Lower capital gains tax rates from the 2001/03 programs of tax reductions to
stimulate the economy.
Tax reductions from 1997-2002 included as part of budget reconciliation
legislation to help spur capital formation.
Tax reform legislation to reduce income tax rates and broaden the tax base.
The exclusion for capital gains was eliminated so that the tax rate on capital
gains was increased to be the same as for ordinary income.
Part of major Reagan Administration income tax reductions as stimulus to the
economy and to provide tax relief.
Full impact of 1978 tax law changes.
Transitional tax rate as a minimum and alternative tax repealed as part of a
1978 Act late in the year to help keep the expansion on track and to spur
capital formation.
Alternative and minimum tax effects.
Alternative and minimum tax effects.
New minimum tax, higher alternative tax rate on capital gains and earned
income tax rate—part of the 1969 Tax Reform Act and from the effects of the
Vietnam War surtax. The 1969 Act was the culmination of efforts by the
Kennedy-Johnson Administrations to reform the tax system.
10% Vietnam War surtax.
The Vietnam War surtax increased the rate for part of the year and was
designed to help pay for the Vietnam War.
Back to 1942 alternative tax rate.
Small change from the 1951 Tax Act.
25% alternative tax on capital gains introduced as part of 1942 tax legislation
to pay for WWII.
*Under current law.
vehicles might occur and perhaps too heavy an allocation of resources into what might be less
productive activities from an economic point-of-view.5 Although varying degrees of risk are
5
This point is arguable. Some would suggest that there should be no taxes on income from capital so as to
encourage saving, investment and growth; instead, only a consumption tax with exemptions to mitigate regressivity.
-9associated with investments in assets whose prices may appreciate, the expected gains on such
investments, in aftertax terms, could outweigh the perceived risks and lead to a sizeable
misallocation of resources compared to a situation where there is capital gains taxation.
Figure 1
Capital Gains Realizations
(Bils. of $s)
1000
900
800
700
600
500
400
300
200
100
0
1954
1959
1964
1969
1974
1979
1984
1989
1994
1999
2004
Shaded areas denote Equity Bear Markets.
Arrows denote direction of capital gains tax rate change. Data for 2008-09 are DE estimates.
Sources: Capital gains realizations, U.S. Treasury; Bear Markets, Standard & Poor; and Decision Economics, Inc..
2009
In addition, those individuals, or families, in a position to invest in capital gains vehicles may
already be high in the distribution of income and wealth. Successful investing by them might
lead to further disparities in wealth and income, justifying some sort of capital gains tax on
grounds of fairness.
A final reason is that the taxation of realized capital gains is a source of government
revenues.
A criticism of capital gains taxation, at whatever the rate and conditions for holding, is that
capital is taxed more than once—capital available for investment originally savings taxed as
income or profits and then again on the realization of capital gains from the investments made
with the saving.
Taxing income twice, or perhaps more, e.g., also at the state level, or even more times if
dividend income is included, can be argued to be a distortion on allocative grounds, discouraging
risk-taking, entrepreneurial activity, and innovations that might lead to new businesses and new
jobs. How capital gains as a kind of saving in all its forms and channels affect the real economy,
For capital formation, increased potential economic growth and economic growth itself, this is a view of the author.
Inequality of income or wealth, or “excessive” executive pay, if societal issues, are better dealt with through higher
marginal tax rates for the superrich, e.g., on incomes of $1 million-or-more, or perhaps a $5 million threshold, or
one-time excess income taxes.
-10along with the role that financial intermediaries play in mediating savings from the private
sector to productive investments, has been little analyzed, analytically or empirically.
A higher capital gains tax also raises the cost-of-capital and can reduce capital formation.
Table 2
Taxes Paid on Capital Gains
(Bils. of $s)
Years
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008E
2009E
Tax
Receipts
5.943
5.275
3.161
4.350
5.708
5.366
4.253
4.534
6.621
8.232
9.104
11.753
12.459
12.852
12.900
18.700
21.453
26.460
52.914
33.714
38.866
35.258
27.829
24.903
28.983
36.112
36.243
44.254
66.396
79.305
89.069
111.821
127.297
65.668
49.122
51.340
73.213
102.174
117.793
137.042
118.866
85.748
Percent of Individual
Tax Payments
Percent of Total
Tax Receipts
7.7
5.7
3.6
5.0
5.6
4.9
3.3
3.8
4.7
5.1
4.8
5.2
4.9
4.4
4.4
6.4
7.1
7.8
15.0
8.5
9.5
7.8
5.9
5.3
6.0
7.0
6.6
7.4
9.9
10.5
10.6
12.3
12.6
6.6
5.9
6.5
8.9
10.8
11.1
11.6
10.5
9.9
3.5
2.7
1.7
2.2
2.6
2.1
1.5
1.6
2.1
2.3
2.2
2.4
2.3
2.1
2.1
3.1
3.1
3.6
6.8
3.9
4.2
3.5
2.6
2.4
2.6
3.1
2.8
3.2
4.5
4.9
5.1
6.0
6.2
3.3
2.7
2.9
3.8
4.7
4.8
5.3
4.8
4.2
-11Sources:
Dept. of the Treasury, Monthly Treasury Statement; Office of Tax Analysis;
Decision Economics, Inc. (DE).
-12Yet another issue, or question, has to do with how capital gains are realized and whether the
activities that give rise to capital gains are “productive,” that is increase productivity, potential
economic growth, real economic activity, and jobs.
Capital gains realized from the price
appreciation of residential real estate in the housing boom of 2001 to 2006 led to considerable
spendable funds for households and higher real consumption per capita, but may not have
engendered much capital formation and the kind of investment that raises potential output and
sustainable economic growth. Why shouldn’t one kind of capital gains be taxed differently from
another, e.g., gains on stock versus gains on the sale of a business where jobs have been created
in the process? Isn’t the latter more productive than the former, deserving of a greater incentive
through a lower capital gains tax?
There is a possible minus, relating to fairness, because of the unequal ability of households,
depending upon the levels of income and wealth, to invest in capital gains vehicles and the
advantage, or subsidy, that capital gains taxation provides from a capital gains tax rate that is
lower than the ordinary income tax rate. This differential can provide a powerful signal for the
allocation of effort to work or investments and typically has been responded to more by high
income and high wealth families than middle- to lower-income families. Questions of equity, or
fairness, arise every time capital gains taxation, higher-or-lower, is being considered.
In the research here, the major concern is with the performance of the U.S. economy in
response to changes in capital gains taxes compared with current law. Issues relating to the
pluses and minuses of the tax, fairness and equity, income inequality, and the distribution of
income or wealth, are not a focus—only how capital gains tax rates affect the economy and its
performance.
Capital Gains Tax Rates and the Economy—The Process
How do changes in individual capital gains tax rates affect the economy?
Consider a reduction in the capital gains tax rate for individuals.
The aftertax return on equity will rise. This suggests an increase in the demand for new
equity issues and in secondary equity markets for the stocks of all companies in different risk
categories. For companies issuing stock, there is a reduction in the cost of equity which should
lead to increased financing or a shift in the mix of financing from debt to equity.
But although these are obvious points of direct impact, they are not the only ones since there
are complex transmission mechanisms which, directly or indirectly, respond to changes in
individual capital gains tax rates and the reactions of financial markets, in asset prices, then
affect the activities of financial intermediaries, the consumer, business activity and financing.
-13Increased demand for equities should raise stock prices, increase equity asset values, increase
household wealth and consumption, lead to more production, higher real GDP, new jobs, affect
the balance sheet and financial activities of financial intermediaries, and other areas of business
and economic activity. Capital gains realizations can be expected as some investors take profits,
both short-term and long-run. Existing mortgage finance instruments, or because of financial
innovation or financial engineering, new ones that permit an increase in equity extraction from
rising values of asset collateral, e.g., margin borrowing on stocks, home equity lines of credit,
interest-only mortgage refinancing or structured derivative financial products, generate funds for
increased spending, financial intermediation, and savings.
An associated improvement in
household financial conditions should increase the borrowing capacity of households and make
credit easier. Financial markets, public and private, some of them auction markets, can absorb
the increased supply of debt as investors and lenders diversify assets. This is a relatively new
channel from the stock market to the economy which has grown immensely in the last decade.
In addition, a larger differential between capital gains and personal income tax rates suggests
a shift away from ordinary income-generating work effort and an increase in the flows of funds
to activities, or investments, in new enterprises, R&D, technology and innovations to take
advantage of expected capital gains in estimated returns. A reduction in the cost-of-capital and
increase in potential aftertax returns suggest an increased availability of finance through
contemporary financial intermediaries such as venture capital or private equity firms. The
formation of new businesses and development of innovations with the prospect of long-term
capital gains would be favored.
These areas of activity—entrepreneurship, innovation, and the funding of startups or new
businesses by financial intermediaries—in response to a reduction in capital gains tax rates have
not been explored much in economic and financial research.6 Empirical evidence is scant. But
there is considerable anecdotal evidence to suggest a significant response by businesspeople, in
financial markets, and in the supply of funds from nonbank financial intermediaries to the real
economy because of lower capital gains taxes.
For the overall macroeconomy, the reductions in the cost-of-capital and increased stock
prices lead to an increase in household net worth, or wealth, which, if the capital gains tax
reduction is expected to be permanent, will bring increased consumption. Decision Economics,
Inc. (DE) estimates that the propensity to consume a permanent increase in household net worth
is approximately $0.06 per dollar, the combined total from both stocks and real estate, with lags
6
See Poterba (1988) for an attempt to examine the effect of capital gains on venture capital firms.
-14of one-to-two years. While nowhere near so strong as the short- and long-term effects of
changes in real disposable income on aggregate consumption, it nonetheless is quite significant.
In addition, a reduction in the aftertax cost-of-capital, essentially tantamount to a reduction in
“the interest rate” or “rental price of capital” in standard macroeconomic paradigms, will bring
an increase in business capital spending. In the SB Model, there is also a derived effect on
capital spending from increases in aggregate demand, if expected to be permanent, through
expectations by business of “permanent” increases in sales and earnings.
The propensity to save out of increased household wealth is sizeable and leads to more
“savings” by the household sector, although not necessarily on the NIPA basis, and improved
household sector financial conditions. With lags, an improved household balance sheet should
eventually permit more consumption out of real disposable income, which will positively affect
the macroeconomy. Propensities-to-consume disposable income are distributed over time, and
cumulative.
A significant way that a reduction in the capital gains tax rate can affect the economy is the
effect on capital gains realizations and the use of those funds in household spending and savings.
This transmission channel is virtually unexplored in standard macroeconomic analysis.
The improved stock market that results from a reduction in the capital gains tax will lead to
some capital gains realizations as investors, businesspeople, and sellers of other assets such as
residential real estate, or businesses, realize gains.
Figure 1 showed how capital gains realizations have tended to grow over time (1954 to
2009). Table 3 indicated that capital gains realizations, at times, have been quite sizeable
relative to disposable income and are tending higher in the overall economy. Some of the largest
increases appear to have followed changes in the capital gains tax rate.
In the SB Model, capital gains realizations respond to the overall performance of the stock
market and to changes in the capital gains tax and its level relative to the tax rate on ordinary
income. Significant effects on consumption and saving from the realization of capital gains have
been found, with the marginal propensity to consume capital gains realizations approximately
$0.25 per dollar within a year. This is in addition to the propensities to spend out of real
disposable income and real wealth. Furthermore, since realized capital gains are not directly
counted in national income, upon spending some of the realizations the personal savings rate
notionally goes down but the actual volume of savings goes up.
-15Table 3
Capital Gains Realizations as a Percentage of
Disposable Income and Gross Domestic Product
Date
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986*
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008E
2009E
Disposable Income
2.7
3.5
3.2
2.5
2.9
3.8
3.2
4.2
3.3
3.4
3.8
4.3
4.0
4.8
5.7
4.7
2.8
3.5
4.1
3.7
2.8
2.6
3.0
3.2
3.1
4.1
3.7
3.6
3.7
4.7
4.9
5.6
10.1
4.3
4.4
3.9
2.9
2.5
2.7
3.1
2.9
3.3
4.5
6.0
7.0
8.1
8.8
4.6
3.4
3.9
5.6
7.4
8.0
8.9
7.3
5.2
GDP
1.9
2.4
2.2
1.8
2.0
2.6
2.2
2.9
2.3
2.4
2.6
3.0
2.7
3.3
3.9
3.2
2.0
2.5
2.9
2.6
2.0
1.9
2.2
2.2
2.2
2.9
2.7
2.6
2.8
3.5
3.6
4.1
7.3
3.1
3.2
2.8
2.1
1.9
2.0
2.3
2.2
2.4
3.3
4.4
5.2
5.9
6.5
3.4
2.5
2.9
4.2
5.5
6.0
6.6
5.5
4.0
* In 1986, change in law raised the tax rate on capital gains realizations effective in 1987,
prompting investors to liquidate holdings and to take gains in 1986.
E-Estimate by Decision Economics, Inc. (DE).
Sources: U.S. Department of the Treasury, Office of Tax Analysis; U.S. Dept. of Commerce,
Bureau of Economic Analysis; Decision Economics, Inc. (DE).
-16In the household sector balance sheet, or household flows-of-funds, the additional funds from
realized capital gains result in some investments and reductions in liabilities, along with an
increase of expenditures. Left to “spend” or “save” are the gains, aftertax, resulting from the
realizations. Taxes are paid to the federal government and states, another effect of the increased
stock prices that comes from a reduction in the capital gains tax rate. The additional tax receipts
to federal and state governments offset, to some extent, the original cost of the tax reduction.
If, in addition, there is “unlocking” of unrealized capital gains, then the tax receipts of the
federal and state government sectors will rise further and provide additional payback, ex-post, as
an offset to the ex-ante cost of the capital gains tax reduction. Federal budget deficits can do
surprisingly well on capital gains tax reductions, depending on the stock market response,
economy effects, and whether unlocking occurs.
The mechanisms through which changes in capital gains tax rates, capital gains realizations,
and an unlocking of unrealized capital gains affect the economy and the federal government
budget are little-known and hardly explored. The uses of funds from these sources in both
consumption and saving, the effects on the macroeconomy as the funds flow through the
household sector into spending and saving, and the investment of those savings through financial
intermediation in a financial system with robust capital markets need to be researched.
In the SB Model, some of the effects are captured roughly in the regression coefficients of
equations and through model simulation, enlarging and elucidating the transmission effects on
the economy from changes in capital gains tax rates.
Effects of Changes in Capital Gains Tax Rates on the Economy—Results of Model
Simulations
What effects would changes in the individual capital gains tax rate have on U.S. economic
performance?
In light of coming changes to the existing capital gains tax rate, a need for policies to
stimulate the economy and jobs and the likelihood of a public discussion on comprehensive tax
reform, assessing the potential effects on the macroeconomy of changes in the capital gains tax
rate seems appropriate.
In order to obtain estimates, the SB Large-Scale Quarterly Macroeconometric Model of the
U.S. was utilized. Simulations were performed for changes in capital gains tax rates ranging
from 0% to as high as 50%, including rates at 20%, 28%, 10% and 5%.
The time horizon was 2011 to 2016—enough to observe short-, intermediate-term, and
longer-run effects. Existing law for marginal personal income tax rates was assumed, which
-17includes the yearend expiration of the current lower capital gains and dividend tax rates for the
top four income tax brackets. The Appendix provides a summary and schematic of the SB
Model (2007 Version) used for the simulations. There is also a short section describing the
mechanics of the simulations.
Table 4 provides a summary of the results. The average of the changes in simulated values
across all years compared with the Baseline is presented for each capital gains tax rate. The
results may be taken as the overall effects on U.S. economic performance, over six years, for
each rate. The variables reported are only a small subset from the hundreds in the SB Model for
which results could be shown. More detail can be found in Tables 6 to 10.
In Table 4, results are reported for real GDP growth, inflation, unemployment and jobs,
productivity growth, and the federal government budget. Table 4 also reports the ex-ante (static)
cost of the change in the capital gains tax rate and the ex-post (dynamic) cost after simulation
and economic feedback.
Table 4
Macroeconomic Effects of Changes in the Capital Gains Tax Rate
(Diffs. from Baseline, Avg. Per Year, 2011-16)*
Variables
Real GDP Growth (Pct.)
Inflation (Pctg. Pts.)
GDP Chain Price
CPI-U
PCE Chain Price
Unemployment Rate (Pct.)
Nonfarm Payrolls (Mils. Jobs)
Productivity Growth (Pctg. Pts.)
Federal Budget Deficit, Unified
Avg. per Year (Bils. $s)
Budget Chg., % of Baseline GDP
Receipts, Unified (Bils. $s)
Ex-Ante Cost (Static) (Bils. $s)
(Avg. per Year)
% of GDP
Ex-Post Cost (Dynamic) (Bils. $s)
(Avg. per Year)
% of GDP
Raised
to 50 Pct.
Raised
to 28 Pct.
Raised
to 20 Pct.
Lowered
to 10 Pct.
Lowered
to 5 Pct.
Lowered
to 0 Pct.
-0.3
-0.1
-0.05
0.10
0.16
0.23
-0.36
-0.72
-0.33
0.4
-1.628
-0.6
-401.8
-67.0
-2.4
-49.6
1148.9
191.5
1.1
-401.8
-67.0
-2.4
-0.13
-0.26
-0.12
0.2
-0.602
-0.2
-174.5
-9.8
-1.0
-6.2
551.6
91.9
0.5
-37.2
-6.2
-0.2
-0.04
-0.09
-0.04
0.1
-0.231
-0.1
-8.0
-1.3
-0.0
-1.0
272.0
45.3
0.3
-6.2
-1.0
0.0
0.08
0.16
0.07
-0.1
0.381
0.1
-33.5
-5.6
-0.2
-7.7
-268.9
-44.8
-0.3
-46.4
-7.7
0.0
0.15
0.29
0.13
-0.2
0.711
0.3
-118.2
-19.7
-0.7
-21.6
-435.6
-72.6
-0.4
-129.6
-21.6
-0.1
0.30
0.61
0.26
-0.5
1.323
0.5
-143.4
-23.9
-0.8
-32.8
-451.5
-75.2
-0.4
-196.7
-32.8
-0.2
*Simulations using the Sinai-Boston (SB) Model of the U.S. Economy. Monetary policy unchanged.
The important role of the equity market in the U.S. economy should be noted, since it is a
center for transmitting the effects from capital gains tax reductions to the macroeconomy.
The SB Model has a large amount of structural detail on expectations and asset prices as they
affect financial markets, the financial system and the economy. This includes expected federal
government budget deficits (impacts current long-term interest rates, the dollar, and the stock
-18market); expected earnings (impacts the stock market currently); the expected weighted average
aftertax cost-of-capital (affects the stock market currently), sector balance sheets, flows-of-funds
and household wealth; asset prices; household, business and financial sector behavior as affects
the economy; and the detail of tax receipts, by category, including individual and business capital
gains tax receipts.
Several conclusions are suggested.
First, that very high, or very low, individual capital gains tax rates relative to the current level
can do significant damage, or provide significant stimulus, to the economy.
Raising the capital gains tax from 15% to 28% leads to a loss in real economic growth of 0.1
percentage points per annum over 2011-16 and 602,000 fewer jobs annually. When the rate is
increased to 50%, real GDP growth is decreased by 0.3% per year and there are 1,628,000 fewer
jobs per annum.7
The mechanisms are through declines in the stock market, negative effects on household
wealth and consumption, a higher cost-of-capital, and reduced capital spending. Household
financial conditions worsen on a rising ratio of debt-to-assets, lost jobs, and reductions in
household financial assets. On an increased cost of equity capital, the weighted average cost-ofcapital, debt and equity, used to discount future earnings rises somewhat—a negative for the
stock market—and through reduced household wealth, capital gains realizations, and the cost-ofcapital become sources of slower growth in consumption and for capital spending.
The inflation rate, no matter how measured, moves lower from the weaker economy, some
0.4 percentage points per year on the GDP Fixed Weight Price Deflator and 0.7 percentage
points per annum in the CPI-U. The unemployment rate is higher by 0.4 percentage points per
year and lost jobs, on the nonfarm payroll basis, average 1.6 million per annum. Productivity
growth slides 0.6 percentage points per year. Potential economic growth falls from a reduction
in productivity growth, declines in persons working and in average hours worked. Household
financial conditions worsen to reduce consumption further.
The declines in aggregate
consumption, in turn, reverberate through the rest of the economy, internationally, then back to
the U.S. economy through reductions in exports.
7
The nonfarm payroll jobs response probably is overstated, given a sample period heavily influenced by the
experience of the 1990s. Nonfarm payroll employment is disaggregated by sector and related to components of
GDP, not GDP itself which is econometrically less significant. Structural changes in the labor market, in the use of
capital in production, and in the organization of production suggest less employment per unit of output than in the
past. This is not yet fully captured by the Model’s regression coefficients because the sample period for the newer
phenomena is too short.
-19Despite the tax revenues raised by the increase in the capital gains tax—about $1.15 trillion
cumulatively or $191.5 billion per annum—after the negative effects on the economy and
feedback effects on tax receipts from a worse, by economy and weaker stock market, the budget
deficit actually ends up worse, some $67 billion per year.
Thus, a large hike in the capital gains tax rate proves counterproductive by weakening
economic growth, reducing consumption and real consumption per capita, causing losses in jobs,
a higher unemployment rate, less productivity growth, lower potential output, and an increase in
the federal budget deficit. The only positive is a lower inflation rate, which may not help much
if already low.
Conversely, a reduction in the capital gains tax rate to zero from the current 15% increases
growth in real GDP by over 0.2 percentage points per annum, lowers the unemployment rate by
one-half percentage point, increases nonfarm payroll jobs 1.3 million a year, and ends up, net,
ex-post, costing the federal government less than the initial ex-ante, or static, cost of the tax
reductions. The economy is considerably improved, household financial conditions improve,
and the U.S. standard-of-living rises.
The Baseline includes changes in law set for 2011 that take ordinary income tax rates higher
for families with incomes of $250,000-or-more and individual taxpayers $200,000-and-up, as
well as down the income ladder to households with joint incomes as low as $68,000. The threeto-five percentage point increase in marginal income tax rates for high income families against a
five percentage point rise in the capital gains tax rate preserves much of the differential between
ordinary income tax rates and the capital gains tax rate for upper income families and individuals
and limits the negative impact. The higher capital gains tax rate does reduce the differential of
the capital gains tax rate with income tax rates for families and individuals and thus is negative
for the stock market. This increases the cost-of-capital, lowers household wealth, reduces capital
spending, and takes down incentives for entrepreneurship and new businesses.
For small changes in the capital gains tax rate compared with current law, to 20% or 10%,
the effects are relatively small but noticeable. Growth in real GDP is down 0.1% per annum on a
capital gains tax rate of 20% and up 0.1% per annum on a lower 10% rate.
A third result of the simulations underscores the effect of capital gains taxes on productivity
and potential output. In the SB Model, there are certain variables that reflect entrepreneurship
and innovative activity, e.g., R&D spending, the number of new businesses, and patents.
Generally, the lower is the individual capital gains tax rate, the higher is productivity growth
and growth in potential output. Some of this arises from an increased labor stock and higher
-20potential output, calculated as the sum of growth in the labor force and manhours worked. The
improvement in productivity growth from a zero capital gains tax rate is quite noticeable, 0.5%
per annum. Conversely, with a 28% capital gains tax rate, the decline in productivity growth is
0.2 percent per year. At a 50% capital gains tax rate, the decline is 0.6% per year. These results
indicate the negative effect of higher capital gains taxes on the capacity of the U.S. economy.
A final empirical result worth noting has to do with the federal budget deficit and the ex-ante
cost of capital gains tax reductions, or ex-ante increase in revenues on a hike in the capital gains
tax, versus the results, ex-post.
After feedback—a stronger economy, improved stock market, more jobs and increased
income—higher bases for taxes on personal income, profits, social security and excise taxes with
given tax rates and the new capital gains rate raise total tax receipts. The stronger economy leads
to reductions in some federal government outlays. These effects reduce the federal budget
deficit.
In the simulations, no special assumptions were made with respect to “unlocking,” i.e., the
realizing of unrealized capital gains as a consequence of the change in the capital gains tax rate.
At times, unlocking has raised capital gains tax receipts and the total tax receipts of the federal
government. In the SB Model, the capital gains realization function will capture some unlocking
reflected in the historical data, but not necessarily all.
Table 5 shows the effects of changes in capital gains tax rates on capital gains realizations.
Realizations can be significant for government tax receipts and funding that the household sector
can spend or save; therefore, need to be taken into account in any analysis that involves capital
gains taxation. The responses shown undoubtedly reflect some historic “unlocking” and the
effects on realizations, since in some of the history unlocking must have occurred.8 No separate
estimate of unlocking is identifiable from these quantitative estimates, however.
Tables 6 to 10 show some additional results from changes in capital gains tax rates—on
macroeconomic activity, financial markets, the financial position of nonfinancial corporations,
and the federal government budget. The simulations used 50%, 28%, 20%, 10% and 0% as the
various capital gains tax rates.
8
For an example of an attempt to determine the extent of capital gains realizations and its elasticity of response, see
Matthew Eichner and Todd Sinai, “Capital Gains Tax Realizations and Tax Rates: New Evidence from Time
Series,” National Tax Journal, September 2000, pp. 663-681. Although the 1986 Tax Reform Act is found to have
disproportionate effects, the historical elasticities of response for capital gains realizations are sizeable and
consistent with the results reported here.
-21Table 5
Capital Gains Realizations in Response to a Change in the Capital Gains Tax Rate*
(Bils. $s)
Capital Gains
Tax Rate
50%
28%
20%
10%
5%
0%
2011
-74.8
-30.2
-12.0
12.5
25.4
39.0
2012
-325.2
-152.9
-64.5
73.0
155.2
248.0
2013
-439.0
-228.0
-100.2
120.9
265.1
437.2
2014
-443.2
-236.0
-105.0
129.9
287.5
477.5
2015
-415.2
-220.7
-98.4
122.0
270.8
446.9
2016
-361.6
-191.7
-86.2
106.2
236.5
382.4
Average
-343.2
-176.6
-77.7
94.1
206.8
338.5
*Estimates using capital gains realizations functions in the SB Model of the U.S. Economy.
The responses of inflation-adjusted consumption and business capital spending are presented
for each year, 2011-16, and for the averages of those years.
The effects on Research &
Development expenditures also are shown. Changes in the financial position of nonfinancial
corporations are indicated for some key parameters such as cash flow, “debt burden,” “leverage,”
and the ratio of investment outlays to cash flow as a need for external financing. In almost no
other macroeconometric model is there structure to assess nonfinancial corporate responses, real
and financial, to changes in taxation.
Generally, in simulations of hikes in the capital gains tax rate compared with current law the
economy does worse, losing more in growth the higher is the capital gains tax rate and gaining
when the rate is reduced to lower levels. Large changes occur in the stock market, mostly on
reductions of earnings from a weaker economy and no offsetting reductions in interest rates. In
the simulations, Federal Reserve policy was assumed to be unchanged. In actuality, the Federal
Reserve might alter policy in response to changes in the economy and inflation.
On an increase in the capital gains tax rate to 50%, the unemployment rate rises sharply, at its
peak 0.7 percentage points above the Baseline. Nonfarm payroll jobs peak at negative 2 million
three years after the tax increase and average approximately 1.6 million less jobs per annum.
Quite the opposite can be seen when the capital gains tax rate is reduced to 0%. A significant
decline in the unemployment rate occurs, at most falling 0.7 percentage points below the
Baseline. Strong increases occur in jobs, 1.854 million at the peak, and 1.323 million per annum.
With higher capital gains tax rates, business profits fall and the cash flow of nonfinancial
corporations diminishes.
The ratio of capital expenditures to cash flow rises, indicating
increased demand for external financing by nonfinancial corporations. But, as the higher capital
gains tax rates negatively impact on the economy, nonfinancial corporations work to improve
financial positions by cutting borrowing and reducing leverage (the debt/equity ratio).
The federal government budget deficit actually worsens when capital gains tax rates are
raised. The only gains come from the capital gains tax rate increase itself. Tax receipts from the
-22-
Item
Table 6
Macroeconomic Effects of Changes in the Capital Gains Tax Rate
Capital Gains Tax Rate Increase to 50%*
(Changes Relative to Baseline, Unless Otherwise Indicated)
Years
2011
2012
2013
2014
2015
Economy
Real GDP Growth (Pct. Chg.)
Real GDP ($ 00’ Bils.)
Consumption ($ 00’ Bils.)
Business Capital Spending ($ 00’ Bils.)
Net Exports ($ 00’ Bils.)
R&D ($ 00’ Bils.)
Inflation
Consumer Price Index (%)
Consumption Deflator Ex-Food & Energy (%)
Jobs and Unemployment
Nonfarm Payroll (Mils. of Jobs)
Unemployment Rate (%)
Financial
Interest Rates (%)
3 Mo. CP.
3 Mo. Treas.
AAA-Equiv. Corp.
10-Yr. U.S. Treas.
Stock Market
S&P500 EPS ($/Share)
S&P500 Index (Pct. Chg. from Baseline)
Dollar vs.
Yen
Euro
Financial Position (Nonfin. Corps.)
Cash Flow ($ Bils.)
Capex/Cash Flow (Ratio, Pctg. Pts.)
“Quick” Ratio (Pctg. Pts.)
Interest Charges/Cash Flow (Ratio, Pctg. Pts.)
Borrowing ($ Bils.)
Debt/Equity (Ratio)
Fed’l. Govt. Budget
Unified Budge Deficit (-)/Surplus (+)
Tax Receipts ($ Bils., NIPA)
Corporate
Personal
Cap. Gains
Other
2016
Avg.
2011-16
-1.3
-149.5
-1.1
-289.4
-0.1
-305.9
0.4
-267.1
0.3
-236.2
0.1
-229.4
-0.3
-246.2
-156.4
-8.0
-365.5
-41.3
-428.2
-71.3
-420.2
-86.5
-391.4
-91.7
-364.3
-97.6
-354.3
-66.1
46.7
-4.5
177.4
-11.1
248.0
-12.0
272.4
-10.1
255.0
-8.0
222.8
-7.2
203.7
-8.8
-0.1
0.0
-0.7
-0.2
-1.1
-0.4
-1.0
-0.5
-0.8
-0.4
-0.6
-0.3
-0.7
-0.3
-0.845
0.2
-1.815
0.6
-2.042
0.7
-1.860
0.5
-1.634
0.3
-1.572
0.1
-1.628
0.4
-0.08
-0.05
-0.12
-0.04
-0.09
-0.02
-0.02
-0.01
0.05
-0.01
0.12
-0.02
-0.02
-0.03
0.00
0.02
0.10
0.15
0.16
0.15
0.17
0.15
0.15
0.22
0.15
0.23
0.12
0.15
-2.8
-27.5
-5.0
-43.4
-5.4
-48.1
-5.3
-50.2
-5.7
-51.2
-6.0
-51.7
-5.0
-45.3
-1.1
4.7
-2.4
14.8
-1.1
19.8
1.2
17.3
2.9
10.6
3.6
4.4
0.5
11.9
-16.6
1.0
0.0
0.5
-10.1
-11.5
-42.7
1.5
0.0
1.7
-60.5
-68.7
-51.3
0.3
-0.4
2.4
-124.2
-141.1
-51.9
-0.7
-0.8
2.7
-163.9
-186.2
-54.3
-1.8
-1.2
2.4
-175.8
-199.7
-58.9
-1.4
-1.7
3.2
-166.1
-188.6
-45.9
-0.2
-0.7
2.2
-116.8
-132.6
103.6
123.4
-8.3
139.7
146.1
-8.0
-9.7
-15.2
-23.9
29.2
45.2
-20.5
-112.8
-80.1
-24.1
-26.0
-3.0
-29.9
-132.6
-97.5
-21.1
-40.2
-11.8
-36.2
-126.1
-103.2
-18.0
-44.4
-9.8
-40.9
-124.3
-110.2
-15.2
-50.1
-7.2
-44.9
-67.0
-47.1
-18.4
1.4
26.6
-30.1
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy. Monetary policy
unchanged; federal funds rate unchanged from the Baseline.
-23Table 7
Macroeconomic Effects of Changes in the Capital Gains Tax Rate
Capital Gains Tax Rate Increase to 28%*
(Changes Relative to Baseline, Unless Otherwise Indicated)
Years
2013 2014
2015
2016
Avg.
2011-16
0.2
-96.2
0.1
-84.2
0.0
-82.4
-0.1
-89.8
-158.8
-25.6
-151.8
-30.5
-138.6
-31.5
-128.0
-33.0
-128.9
-23.1
67.4
-4.2
91.5
-4.5
98.5
-3.7
89.7
-2.8
76.6
-2.5
73.6
-3.2
0.0
0.0
-0.3
-0.1
-0.4
-0.1
-0.4
-0.2
-0.3
-0.1
-0.2
-0.1
-0.3
-0.1
-0.313
0.1
-0.684
0.2
-0.764
0.3
-0.682
0.2
-0.594
0.1
-0.576
0.0
-0.602
0.2
-0.03
-0.02
-0.05
-0.02
-0.03
-0.01
-0.01
-0.01
0.01
-0.01
0.03
-0.01
-0.01
-0.01
-0.01
-0.01
0.02
0.03
0.04
0.03
0.05
0.04
0.04
0.07
0.04
0.07
0.03
0.04
-1.03
-11.62
-1.88
-18.90
-2.01
-21.44
-1.94
-22.67
-2.06
-23.23
-2.16
-23.50
-1.85
-20.23
-0.4
1.7
-0.9
5.4
-0.5
7.1
0.4
6.2
1.0
3.8
1.3
1.5
0.1
4.3
-6.0
0.4
0.0
0.2
-4.4
-5.0
-15.9
0.6
0.0
0.6
-25.5
-28.9
-19.1
0.2
-0.1
0.8
-51.3
-58.3
-18.8
-0.2
-0.2
0.9
-67.3
-76.5
-19.3
-0.5
-0.3
0.8
-73.7
-83.7
-20.8
-0.4
-0.5
1.0
-74.7
-84.8
-16.7
0.0
-0.2
0.7
-49.5
-56.2
41.3
51.0
-3.1
57.1
59.6
-3.0
12.4
10.0
-9.7
27.4
34.0
-7.7
-23.4
-14.6
-9.6
6.2
16.2
-11.1
-31.3
-22.8
-8.2
-1.3
11.5
-13.3
-28.7
-26.3
-6.8
-4.6
11.4
-14.9
-29.1
-31.3
-5.6
-9.4
10.5
-16.3
-9.8
-5.6
-7.2
12.5
23.9
-11.0
Item
2011
2012
Economy
Real GDP Growth (Pct. Chg.)
Real GDP ($ 00’ Bils.)
-0.5
-54.7
-0.4
-108.0
0.0
-113.1
-58.1
-2.8
-138.0
-14.9
17.7
-1.7
Consumption ($ 00’ Bils.)
Business Capital Spending ($ 00’ Bils.)
Net Exports ($ 00’ Bils.)
R&D ($ 00’ Bils.)
Inflation
Consumer Price Index (%)
Consumption Deflator Ex-Food & Energy (%)
Jobs and Unemployment
Nonfarm Payroll (Mils. of Jobs)
Unemployment Rate (%)
Financial
Interest Rates (%)
3 Mo. CP.
3 Mo. Treas.
AAA-Equiv. Corp.
10-Yr. U.S. Treas.
Stock Market
S&P500 EPS ($/Share)
S&P500 Index (Pct. Chg. from Baseline)
Dollar vs.
Yen
Euro
Financial Position (Nonfin. Corps.)
Cash Flow ($ Bils.)
Capex/Cash Flow (Ratio, Pctg. Pts.)
“Quick” Ratio (Pctg. Pts.)
Interest Charges/Cash Flow (Ratio, Pctg. Pts.)
Borrowing ($ Bils.)
Debt/Equity (Ratio, Pctg. Pts.)
Fed’l. Govt. Budget
Unified Budge Deficit (-)/Surplus (+)
Tax Receipts ($ Bils., NIPA)
Corporate
Personal
Cap. Gains
Other
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy.
Monetary policy unchanged; federal funds rate unchanged from the Baseline.
-24Table 8
Macroeconomic Effects of Changes in the Capital Gains Tax Rate
Capital Gains Tax Rate Increase to 20%*
(Changes Relative to Baseline, Unless Otherwise Indicated)
Item
2011
2012
Years
2013 2014
2015
2016
Avg.
2011-16
Economy
Real GDP Growth (Pct. Chg.)
Real GDP ($ 00’ Bils.)
-0.18
-20.9
-0.14
-38.7
0.02
-37.2
0.06
-30.5
0.01
-30.1
-0.05
-37.7
-0.05
-32.5
-22.3
-1.1
-49.0
-5.5
-49.9
-9.1
-42.6
-10.4
-38.1
-10.6
-40.6
-11.9
-40.4
-8.1
6.9
-1.4
24.3
-1.5
28.8
-1.5
26.9
-1.2
20.9
-1.0
16.7
-1.2
20.7
-1.2
0.0
0.0
-0.1
0.0
-0.1
0.0
-0.1
-0.1
-0.1
0.0
-0.1
0.0
-0.1
0.0
-0.120
0.0
-0.250
0.1
-0.263
0.1
-0.233
0.1
-0.233
0.0
-0.287
0.0
-0.231
0.1
-0.01
-0.01
-0.02
-0.01
-0.01
0.00
0.00
0.00
0.00
0.00
0.01
0.00
0.00
0.00
-0.01
-0.01
0.00
0.00
0.01
0.01
0.02
0.01
0.02
0.03
0.02
0.03
0.01
0.01
-0.39
-4.69
-0.66
-7.70
-0.65
-8.80
-0.61
-9.37
-0.70
-9.64
-0.85
-9.78
-0.65
-8.33
-0.2
0.7
-0.3
2.0
-0.1
2.4
0.2
1.9
0.3
1.1
0.3
0.7
0.0
1.5
-2.3
0.2
0.0
0.1
-1.8
-2.0
-5.8
0.2
0.0
0.2
-10.3
-11.7
-6.3
0.0
0.0
0.3
-20.5
-23.3
-5.8
-1.1
-0.1
0.3
-26.6
-30.2
-6.1
-0.2
-0.1
0.2
-28.7
-32.6
-7.3
-0.2
-0.2
0.3
-28.9
-32.9
-5.6
0.0
-0.1
0.2
-19.5
-22.1
16.3
20.4
-1.2
22.8
23.8
-1.1
8.1
7.0
-3.7
13.5
16.6
-2.8
-3.6
-1.9
-3.4
5.5
10.7
-3.9
-6.7
-6.2
-2.7
1.1
8.8
-4.5
-8.3
-10.3
-2.3
-2.7
8.4
-5.3
-13.8
-16.7
-2.2
-8.2
7.4
-6.3
-1.3
-1.3
-2.6
5.3
12.6
-4.0
Consumption ($ 00’ Bils.)
Business Capital Spending ($ 00’ Bils.)
Net Exports ($ 00’ Bils.)
R&D ($ 00’ Bils.)
Inflation
Consumer Price Index (%)
Consumption Deflator Ex-Food & Energy (%)
Jobs and Unemployment
Nonfarm Payroll (Mils. of Jobs)
Unemployment Rate (%)
Financial
Interest Rates (%)
3 Mo. CP.
3 Mo. Treas.
AAA-Equiv. Corp.
10-Yr. U.S. Treas.
Stock Market
S&P500 EPS ($/Share)
S&P500 Index (Pct. Chg. from Baseline)
Dollar vs.
Yen
Euro
Financial Position (Nonfin. Corps.)
Cash Flow ($ Bils.)
Capex/Cash Flow (Ratio, Pctg. Pts.)
“Quick” Ratio (Pctg. Pts.)
Interest Charges/Cash Flow (Ratio, Pctg. Pts.)
Borrowing ($ Bils.)
Debt/Equity (Ratio, Pctg. Pts.)
Fed’l. Govt. Budget
Unified Budge Deficit (-)/Surplus (+)
Tax Receipts ($ Bils., NIPA)
Corporate
Personal
Cap. Gains
Other
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy.
Monetary policy unchanged; federal funds rate unchanged from the Baseline.
-25Table 9
Macroeconomic Effects of Changes in the Capital Gains Tax Rate
Capital Gains Tax Rate Decrease to 10%*
(Changes Relative to Baseline, Unless Otherwise Indicated)
2015
2016
Avg.
2011-16
0.0
69.3
-0.1
59.4
0.1
73.9
0.1
58.9
108.4
12.7
122.3
17.0
123.2
17.9
143.4
19.4
99.1
12.4
-34.7
2.1
-59.9
2.9
-79.2
2.8
-85.6
2.1
-93.9
2.6
-60.1
2.2
0.0
0.0
0.1
0.0
0.2
0.1
0.2
0.1
0.2
0.1
0.2
0.1
0.2
0.1
0.129
0.0
0.344
-0.1
0.472
-0.2
0.459
-0.2
0.380
-0.1
0.504
-0.1
0.381
-0.1
0.01
0.01
0.02
0.01
0.02
0.01
0.02
0.01
0.01
0.01
0.01
0.01
0.01
0.01
0.01
0.01
0.00
0.00
-0.01
0.00
-0.01
0.00
-0.01
0.00
0.00
-0.01
0.00
0.00
Stock Market
S&P500 EPS ($/Share)
S&P500 Index (Pct. Chg. from Baseline)
0.42
4.99
0.99
8.32
1.34
9.63
1.39
10.30
1.45
10.59
1.85
10.68
1.24
9.09
Dollar vs.
Yen
Euro
0.2
-0.7
0.5
-2.5
0.4
-4.0
0.0
-4.3
-0.5
-3.4
-0.6
-2.7
0.0
-2.9
2.4
-0.2
0.0
-0.1
1.9
2.2
7.8
-0.3
0.0
-0.3
10.9
12.3
11.8
-0.4
0.0
-0.5
21.9
24.9
13.0
-0.2
0.1
-0.6
30.0
34.1
13.0
0.1
0.1
-0.5
36.0
40.9
14.3
0.0
0.1
-0.6
42.4
48.2
10.4
-0.2
0.1
-0.4
23.9
27.1
-16.7
-21.4
1.3
-23.9
-24.9
1.2
-10.9
-11.7
4.7
-20.1
-22.1
3.8
1.2
-4.6
5.6
-16.6
-18.4
6.4
4.3
-3.2
5.5
-16.8
-16.6
8.2
-2.3
-6.2
4.8
-20.2
-15.7
9.2
-9.0
-7.2
4.9
-23.7
-13.9
11.5
-5.6
-9.1
4.5
-20.2
-18.6
6.7
Item
Economy
Real GDP Growth (Pct. Chg.)
Real GDP ($ 00’ Bils.)
Consumption ($ 00’ Bils.)
Business Capital Spending ($ 00’ Bils.)
Net Exports ($ 00’ Bils.)
R&D ($ 00’ Bils.)
Inflation
Consumer Price Index (%)
Consumption Deflator Ex-Food & Energy (%)
Jobs and Unemployment
Nonfarm Payroll (Mils. of Jobs)
Unemployment Rate (%)
Financial
Interest Rates (%)
3 Mo. CP.
3 Mo. Treas.
AAA-Equiv. Corp.
10-Yr. U.S. Treas.
Financial Position (Nonfin. Corps.)
Cash Flow ($ Bils.)
Capex/Cash Flow (Ratio, Pctg. Pts.)
“Quick” Ratio (Pctg. Pts.)
Interest Charges/Cash Flow (Ratio, Pctg. Pts.)
Borrowing ($ Bils.)
Debt/Equity (Ratio, Pctg. Pts.)
Fed’l. Govt. Budget
Unified Budge Deficit (-)/Surplus (+)
Tax Receipts ($ Bils., NIPA)
Corporate
Personal
Cap. Gains
Other
Years
2013 2014
2011
2012
0.2
22.3
0.3
55.3
0.1
73.2
24.1
1.1
73.1
6.4
-7.4
0.7
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy.
Monetary policy unchanged; federal funds rate unchanged from the Baseline.
-26Table 10
Macroeconomic Effects of Changes in the Capital Gains Tax Rate
Capital Gains Tax Rate Decrease to 0%*
(Changes Relative to Baseline, Unless Otherwise Indicated)
Item
Economy
Real GDP Growth (Pct. Chg.)
Real GDP ($ 00’ Bils.)
Consumption ($ 00’ Bils.)
Business Capital Spending ($ 00’ Bils.)
Net Exports ($ 00’ Bils.)
R&D ($ 00’ Bils.)
Inflation
Consumer Price Index (%)
Consumption Deflator Ex-Food & Energy (%)
Jobs and Unemployment
Nonfarm Payroll (Mils. of Jobs)
Unemployment Rate (%)
Financial
Interest Rates (%)
3 Mo. CP.
3 Mo. Treas.
AAA-Equiv. Corp.
10-Yr. U.S. Treas.
Stock Market
S&P500 EPS ($/Share)
S&P500 Index (Pct. Chg. from Baseline)
Dollar vs.
Yen
Euro
2011
2012
Years
2013 2014
2015
2016
Avg.
2011-16
0.6
73.7
1.1
210.1
0.5
274.8
0.0
285.3
-0.3
254.0
-0.6
177.5
0.2
212.6
73.3
3.3
214.9
23.1
298.8
47.7
326.9
64.1
302.3
68.3
221.6
64.0
239.6
45.1
-16.8
2.1
-61.7
8.6
-111.2
11.8
-150.8
11.4
-157.8
8.6
-122.0
5.1
-103.3
7.9
0.1
0.0
0.4
0.1
0.8
0.3
0.9
0.4
0.8
0.4
0.7
0.3
0.6
0.2
0.430
-0.1
1.368
-0.4
1.841
-0.6
1.854
-0.7
1.500
-0.5
0.945
-0.3
1.323
-0.4
0.03
0.03
0.08
0.04
0.09
0.04
0.13
0.04
0.18
0.03
0.15
0.02
0.11
0.03
0.04
0.05
0.01
0.02
-0.03
0.02
-0.02
0.02
0.03
-0.01
0.05
-0.02
0.02
0.01
1.40
15.95
3.77
26.99
4.87
31.67
5.53
34.00
5.87
34.74
5.22
34.82
4.44
29.70
0.5
-2.2
1.8
-8.9
1.6
-14.4
0.3
-16.2
-1.4
-13.9
-3.0
-8.1
0.0
-10.6
Financial Position (Nonfin. Corps.)
Cash Flow ($ Bils.)
7.7
27.7
42.2
50.6
54.4
53.2
Capex/Cash Flow (Ratio, Pctg. Pts.)
-0.5
-1.2
-1.1
-0.9
-0.1
-0.6
“Quick” Ratio (Pctg. Pts.)
0.0
0.0
0.1
0.2
0.2
0.2
Interest Charges/Cash Flow (Ratio, Pctg. Pts.)
-0.2
-1.0
-1.7
-2.1
-1.8
-2.0
Borrowing ($ Bils.)
6.1
35.4
74.1 106.3
133.8
161.4
Debt/Equity (Ratio, Pctg. Pts.)
6.9
40.2
84.1 120.7
152.0
183.4
Fed’l. Govt. Budget
Unified Budge Deficit (-)/Surplus (+)
-51.7
-41.0
-11.4
1.2
-7.2
-33.3
Tax Receipts ($ Bils., NIPA)
-66.8
-46.0
-31.6
-19.9
-17.9
-30.0
Corporate
4.2
16.9
20.3
21.4
20.1
16.0
Personal
-75.0
-77.5
-76.1
-72.8
-73.5
-81.8
Cap. Gains
-78.3
-87.6
-90.9
-88.0
-83.0
-72.8
Other
4.1
14.5
24.2
31.4
35.5
35.7
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy.
Monetary policy unchanged; federal funds rate unchanged from the Baseline.
39.3
-0.7
0.1
-1.5
86.2
97.9
-23.9
-35.4
16.5
-76.1
-83.4
24.2
-27aggregate of personal, corporate and other sources decline, ex-post, so that the taxes gained on
the capital gains tax increase, ex-ante, are more than offset by the lost tax receipts induced by a
weaker economy. The reverse occurs on reductions in the capital gains tax rate to 10% and 0%,
as shown in Tables 9 and 10.
These results demonstrate that the cost of a capital gains tax cut, ex-post, is significantly less
than the lost tax revenues from the original reduction in federal tax revenues. For an increase in
the capital gains tax rate to 28%, for example, ex–post the federal budget deficit worsens by $6.2
billion per year. An increase to a 50% capital gains tax rate worsens federal budget deficits, expost, by $67 billion per year, despite an initial “score” of positive $191.5 billion a year. At a
zero percent capital gains tax rate, the ex-post cost of the tax reduction in terms of the net budget
deficit is -$32.8 billion per year versus -$75.2 billion per year, ex-ante.
This result, which directionally should characterize all complete economy large-scale
macroeconometric models, reflects the induced tax receipts across all tax categories as a
consequence of a stronger economy.
How to “score” tax changes, either reductions or increases, remains controversial. Current
scoring of the cost, or the gain, is done on a “static” or “ex-ante” basis. It is arguable as to
whether this is the appropriate way to score the costs of macroeconomic policies designed to
stimulate the economy.9
Tables 11 and 12 look at the responses of the nonfinancial corporate sector and the federal
government budget in more detail, in response to changes in capital gains taxes. Both the
nonfinancial corporate sector and federal government financial position improve with lower
capital gains tax rates and are worse with higher capital gains tax rates.
Tables 13 and 14 show the effects of changes in capital gains tax rates on the financial
position of households and on household “savings,” calculated on a flow-of-funds basis. The
asset and liability position of the household sector and other effects on household finances of
changes in capital gains tax rates to levels other than the current one are shown as averages over
the six years of the simulations.
Household financial positions are significantly damaged by higher capital gains tax rates and
improve on lower capital gains tax rates.
9
The author is on record favoring “dynamic” scoring rather than “static;” one reason being that reality is ex-post not
ex-ante. Another is that policy stimulus, ex-ante, could be too little without taking account of the induced tax
receipts that arise from the stimulus itself. Yet another reason is that different tax policies have different induced
effects on taxes. By not scoring dynamically, judgments on the efficacy of alternative tax policies could be flawed.
Capital gains tax reduction is one of those because of its effects on the stock market, capital gains realizations,
capital gains tax receipts and a possible unlocking of gains, demonstrated at various times in history to be of real
consequence.
-28Table 11
Nonfinancial Corporate Balance Sheet Effects of a Change in the Capital Gains Tax Rate*
(Changes Relative to Baseline, Unless Otherwise Indicated)
50%
28%
20%
10%
5%
0%
Item
Sources of Funds
Total Funds Raised ($ Bils.)
Domestic Cash Flow ($ Bils.)
Physical Assets
Plant & Equipment
Financial Assets ($ Bils.)
Liabilities
Debt
Total External Funds ($ Bils.)
Short-Term Liabilities ($ Bils.)
Long-Term Liabilities ($ Bils.)
Financial Position of Nonfinancial Corporations
Cash Flow % of Funds Raised (Ratio, Pctg. Pts.)
Plt. Equip. & Inven./Dom. Cash Flow
(Ratio, Pctg. Pts)
“Quick” Ratio (Pctg. Pts.)
ST Debt/Liabilities (Ratio, Pctg. Pts.)
LTD/Liabilities (Ratio, Pctg. Pts.)
Interest Charges/Cash Flow (Ratio, Pctg. Pts.)
Liabilities/Net Worth (Ratio, Pctg. Pts.)
-152.5
-61.6
-23.2
31.6
61.9
115.8
-45.9
-16.7
-5.6
10.4
19.2
39.3
-106.5
-94.8
-37.7
-27.3
-13.3
-9.0
19.2
10.3
36.3
18.6
71.2
24.4
-106.6
-44.9
-17.7
21.3
42.8
76.5
32.8
-139.4
9.5
-54.4
3.0
-20.7
-3.8
25.1
-7.1
49.8
-9.9
86.4
-0.2
-0.2
-0.1
0.0
0.0
0.0
0.1
-0.2
0.1
-0.3
0.2
-0.7
-0.7
-0.2
-0.1
0.1
0.1
0.1
0.7
0.2
0.1
-0.1
-0.2
-0.4
-0.7
-0.2
-0.1
0.1
0.2
0.4
2.2
0.7
0.2
-04
-0.7
-1.5
-3.2
-0.4
-0.2
-0.7
-1.3
-3.2
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy. Monetary policy
unchanged, with the federal funds rate at Baseline levels.
Table 12
Federal Budgetary Effects of Changes in the Capital Gains Tax Rate*
(Changes Relative to Baseline, Unless Otherwise Indicated)
Item
Unified Budget (+) Deficit/(-) Surplus
($ Bils.)
Total Receipts-Unified Budget
($ Bils.)
NIPA Budget Deficit (-) Surplus ($ Bils.)
Tax Receipts ($ Bils., NIPA)
Corporate
Personal
Cap. Gains (Pers. & Corp.)
Other (Soc. Sec. & Excise)
Government Outlays ($ Bils., NIPA)
Federal ($ Bils., NIPA)
Govt. Transfer ($ Bils, NIPA)
State & Local ($ 00’ Bils.)
Ex-Ante Revenue Cost or Gain ($ Bils.)
Ex-Post Tax Receipts ($ Bils.)
50%
28%
20%
10%
5%
0%
-18.1
-2.8
-0.5
-1.5
-5.3
-6.7
-12.4
-1.5
-0.3
-1.9
-5.4
-8.2
-2.4
-7.4
-23.0
-29.4
-69.9
-10.6
-18.4
1.4
-7.2
12.5
-2.6
5.3
4.5
-20.2
8.4
-44.4
16.5
-76.1
-30.1
-11.0
-4.0
6.7
12.6
24.2
22.7
16.8
-53.9
4.9
6.4
-20.1
1.1
2.2
-7.6
-1.7
-5.1
10.2
-0.6
-9.3
19.8
-6.0
-19.8
36.1
1148.9
551.6
272.0
-268.9
-435.6
-451.5
-12.4
-1.5
-0.3
-1.9
-5.4
-8.2
*Decision Economics, Inc. (DE) and simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model
of the U.S. Economy. Monetary policy is unchanged with the federal funds rate at Baseline levels.
In all circumstances, household financial assets decline relative to the Baseline. With higher
capital gains tax rates the economy is weaker, job losses greater, income falls and households run
down financial assets ex-stocks.
With reductions in capital gains tax rates, the value of
household equity goes up significantly. This generates additional funds that can be used in
spending, reducing short-term liabilities, and increasing household financial assets. The flow-of-
-29Table 13
Household Balance Sheet and Household Sector Savings in Response
to Changes in Capital Gains Taxation*
(Changes Relative to Baseline)
Assets/Liabilities/Net Worth
Financial Assets Ex-Stocks ($ Bils.)
Cash & Equivalent
Bonds
Household Equity (Stocks)
Liability/Debt ($ Bils.)
Consumer Credit
Mortgage Debt
Flow-of-Funds Saving ($ Bils.)
Flow-of-Funds Saving Rate (Pctg. Pts.)
Household Debt Service ($ Bils.)
Other Financial Risk Variables:
Financial Assets/Liabilities (Pctg. Pts.)
Debt/Income (%)
Debt/Wealth (%)
DE Household Financial Conditions Index
50%
28%
20%
10%
5%
-223.0
-33.4
-189.6
-3,437.0
-249.2
-94.8
-154.4
-364.4
-322.2
-140.5
-181.7
1,022.5
-455.2
-216.1
-239.1
2,964.9
-538.1
-262.7
-275.4
4,022.8
-632.9
-317.9
-315.1
5,217.5
0%
-421.5
149.7
-169.5
-1.5
-4.8
-158.7
47.5
-8.5
-0.1
-3.9
-56.1
5.8
69.6
0.5
-2.1
91.0
-51.3
184.3
1.5
2.2
173.3
-83.0
248.9
2.0
6.0
253.3
-116.3
331.7
2.6
8.9
-0.2
0.4
2.5
80.3
0.0
0.5
0.4
50.6
0.0
0.6
-0.4
39.6
0.1
0.5
-1.3
26.3
0.2
0.2
-1.8
20.2
0.2
0.0
-2.4
12.2
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy. Monetary policy is unchanged; federal funds rate
unchanged from the Baseline.
funds savings rate is higher compared with the Baseline when capital gains taxes are reduced and
falls on significantly higher capital gains tax rates. Various measures of household financial risk,
such as the ratio of financial assets to financial liabilities, debt as a proportion of wealth, and the
DE Household Financial Conditions Index improve with capital gains taxes that are lower than
currently. The financial risk variables worsen on higher capital gains tax rates.
In Table 14 are estimates of “savings” based on household flows-of-funds and the household
balance sheet under the various capital gains tax rate scenarios.
Savings, defined as the changes in financial assets less liabilities plus physical assets plus net
earnings are higher, relative to the Baseline, the lower is the capital gains tax rate and decline
sharply if the capital gains tax rate is raised to 50%. The “savings rate” rises the lower is the
capital gains tax rate compared with current law and even when the capital gains tax rate is
raised to 20%. The savings rate, as defined here, is not the same as the NIPA savings rate nor
that calculated in the Federal Reserve’s flow-of-funds.
Concluding Perspectives
Capital gains taxes for many individuals and families will be going up at the end of this year.
The maximum statutory marginal capital gains tax rate will rise to 20% from the current 15%. In
addition, the recently passed Patient Protection and Affordable Care Act will raise capital gains
taxes by an additional 3.8% for individuals with incomes above $200,000 (married filing jointly
$250,000 and up). The current 15% tax rate on capital gains and on qualifying dividends for
families with incomes as low as $63,000 also will expire unless the Obama Administration
-30FY2011 budget, which proposes to hold them at current levels, gets enacted. The capital gains
tax rates for individuals in the two lowest income brackets will remain the same.
Table 14
Household Sector “Savings” in Response to Changes in Capital Gains Taxes*
(Changes Relative to Baseline)
“Savings” Flows ($ Bils.)
Financial Assets
Money & Deposits
Misc. Assets
Bonds
Stocks (1)
Life Insurance
Pensions (Including Annuitized Assets)
Financial Liabilities (Debt)
Physical Assets (2)
Consumer Durables
Real Estate
Net “Earnings” ($ Bils.) (3)
Interest and Dividends
Borrowing Costs
“Savings—Total” (Finan. Assets less Liabs.
plus Phys. Assets plus Net “Earnings”)
“Savings” Rate (Pctg. Pts.) (4)
50%
28%
20%
10%
5%
0%
-33.4
-6.5
-189.6
-3,437.0
9.6
-1,555.1
-318.7
-377.5
-36.6
-340.8
41.5
44.9
-3.4
-94.8
-2.5
-154.4
-364.4
4.4
-581.0
-125.4
-143.4
-21.5
-121.9
53.6
57.4
-3.8
-140.5
-0.9
-181.7
1,022.5
1.0
-218.5
-52.0
-50.3
-15.2
-35.1
55.8
58.0
-2.2
-216.1
1.5
-239.1
2,964.9
-4.4
240.5
54.9
87.1
-3.5
90.6
58.4
55.8
2.6
-262.7
2.8
-275.4
4,022.8
-7.6
469.9
114.1
164.3
4.4
160.0
61.4
54.3
7.1
-317.9
5.3
-315.1
5,217.5
-10.4
707.3
170.4
290.8
31.1
259.7
66.0
54.7
11.3
-5229.4
-32.8
-1157.1
-4.9
549.4
6.8
2837.9
21.8
4061.4
29.5
5473.1
37.1
*Simulations with the Sinai-Boston (SB) Large-Scale Macroeconometric Model of the U.S. Economy. Monetary policy unchanged; federal
funds rate unchanged from the Baseline.
(1) Market value-based.
(2) Principally residential real estate and automobiles, light trucks—all at market value.
(3) Interest and dividends earned on the additional financial assets and stock plus reductions in borrowing costs.
(4) Defined as “Savings—Total” divided by disposable income.
How do changes in capital gains taxes affect the economy? Will the legislated increase in
capital gains taxes hurt the economy? What are the mechanisms by which capital gains taxes
affect the economy? And, in the context of the current need for faster economic growth and
increased jobs creation, what is the role, if any, for capital gains taxation?
These are some of the issues raised and examined in this paper, where changes in capital
gains tax rates across a wide range were simulated in the SB Quarterly Macroeconometric Model
of the United States to determine the effects on real economic growth, inflation, jobs and the
unemployment rate, productivity growth, potential output, and the federal budget deficit.
Capital gains taxation is controversial.
Much of the controversy revolves around issues of fairness or equity, often a “rich” or “poor”
debate since the bulk of preferential treatment on capital gains goes to individuals and families at
the upper end of the distribution of income or wealth. Fairness often becomes a highly-weighted
dimension of the discussion on the pluses and minuses of changes in the capital gains tax.
Here, the research was limited to the macroeconomic effects of changes in capital gains tax
rates compared with the current level. Even on this dimension, where macroeconomic research
has been performed there is considerable disagreement.
However, most research on the
-31macroeconomic effects of capital gains tax rate changes have been based on partial segments of
the economy rather than the full economy-wide empirical analysis conducted here.
The SB Model of the U.S. economy contains considerable structure relating to capital gains
and its potential macroeconomic effects that are not found in most other research. Analysis of
allocative efficiency and equity, normal dimensions for assessing any tax and its effectiveness,
was not part of the research and the conclusions are based strictly on the macroeconomic impacts
of changes in capital gains tax rates.
In the context of the current policy challenges facing the United States, on macroeconomic
grounds, maintaining the same or reducing capital gains taxes is one implication.
Changes in the capital gains tax rate from 15% to a higher rate, while initially raising tax
revenues and reducing the federal budget deficit, do not sustain this result in economy-wide full
system analysis.
Higher capital gains tax rates, e.g., hikes to 50% or 28%, or even 20%, compared with the
current 15%, lead to reductions in real economic growth, in aggregate spending, to lost jobs, a
higher unemployment rate, and reductions in aggregate tax receipts, except for capital gains,
because of the weaker economy. There is little “bang-for-a-buck” for the economy per dollar of
tax revenue; indeed, the revenues gained ex-post are hardly worth the loss in economic growth,
in jobs, in productivity, and in potential output.
Similarly, or conversely, significant reductions in the capital gains tax rate, e.g., to 5% or
even 0%, bring gains in real economic growth, new jobs, entrepreneurship and new businesses,
an increase in capital formation, increased productivity growth, higher potential output, and
greater efficiency.
The budgetary cost of the increased growth and gains in jobs is offset to an extent by
increased tax receipts, net, ex-post, from the tax cut stimulus to the economy. And, should
unlocking of unrealized capital gains occur and get taxed at a new lower capital gains tax rate,
the resulting increase in tax receipts can reduce the ex-post cost of the stimulus even further,
making the “bang-for-a-buck” of real economic growth per dollar of lost tax revenues relatively
high.
Central to the impact of capital gains tax reductions on the economy is the stock market and
cost-of-capital. Reductions in capital gains taxation lead to an increased aftertax return on equity
and demand for equities as an asset class, relative to supply. Stock prices rise, leading to an
increase in household wealth, increases in consumer spending, and derived positive effects on
the rest of the economy through multiplier-accelerator interactions in the economy.
The
-32reduction in the aftertax weighted cost-of-capital (debt and equity) for business raises capital
spending as does the induced effects on capital formation from increases in sales and profits.
Capital gains realizations rise as investors and businesspersons cash-in long-term capital
gains.
Consumer spending increases as capital gains realizations, aftertax, are “spent” or
“saved.” Rises in asset prices, both in the values of equity and residential real estate, are
reflected in a stronger household balance sheet and reductions in debt because of increased
income and capital gains realizations. Household financial conditions improve; in turn, reducing
the risk of lending to households and increasing the availability of credit.
The prospect of longer-term capital gains at a reduced rate relative to the ordinary income tax
induces some entrepreneurship, new businesses, innovation, inventions, and startups using riskbased financing from a range of nonbank financial institutions whose objective is to produce
high long-term aftertax returns for investors.
This channel of financial intermediation is
supported by the funds released from capital gains realizations as gains develop and the
channeling of them by investors into investments through various kinds of financial
intermediation.
The central nature of asset prices and their effects on economic activity through investments,
globalized financial markets, and financial intermediation is partially captured in the empirical
results of the simulations with the SB Model, but probably not fully so, given a lack of data, and
a full and elaborated structure on the way modern finance and global capital markets interact
with the U.S. economy. The SB Model probably captures more of these phenomena than most,
particularly in the full-economy context, but still not fully so.
Federal government budget effects from changes in capital gains taxes can be significant.
Most importantly, the increase in costs, ex-ante, from capital gains tax reductions can be
significantly offset after the economic responses, adjustments, and full economy feedback that
occurs. On a significantly lower capital gains tax, for example, the economy is stimulated
enough to increase the tax bases for ordinary income, social security, corporate, excise and estate
taxes so that at given tax rates induced increases in tax receipts offset some, or even all, of the
ex-ante costs of the capital gains tax reduction. The reverse is true on significant increases in
capital gains taxes. The economy weakens enough so as to bring down the bases subject to tax—
reducing tax receipts across-the-board except for the increased capital gains tax receipts. The
federal budget deficit can actually worsen as a result. Increased federal government outlays for
income and job support also serve to worsen the federal budget in a weaker economy.
-33All things considered, in the context of stimulating increased economic growth, new jobs,
capital formation, productivity and potential output at a relatively low cost to the federal budget
deficit, reductions in capital gains, on macroeconomic considerations, should be an important
part of any program of comprehensive tax reform that is growth and jobs-oriented.
Will the coming capital gains tax increase hurt the economy?
The evidence presented here is in the affirmative, although not by much, since the rate is set
to rise only to 20%. Nevertheless, this may not be the most important question to be answered.
The challenge for macroeconomic policymaking and Washington will be how to devise
macroeconomic policy combinations that will increase real economic growth and jobs with
minimal increases in the federal budget deficit; or, if possible, actual reductions. Capital gains
tax reduction scores well on these grounds. Capital gains tax reduction, not increases, on what
activities, and on whom in the context of full tax reform, and whether to tax consumption,
income, or capital, is the more general set of issues to be considered.
-34References
Arena, John J., “Capital Gains and the ‘Life Cycle’ Hypothesis of Saving,” American Economic
Review, March 1964, pp. 107-111.
Auerbach, Alan J., and Jonathan M. Siegel, “Capital Gains Realizations of the Rich and
Sophisticated,” American Economic Review, May 2000, pp. 276-82.
Auten, Gerald E., Leonard E. Burman and William C. Randolph, “Estimation and Interpretation
of Capital Gains Realization Behavior: Evidence from Panel Data,” National Tax Journal,
September 1989, pp. 353-74.
Auten, Gerald, and Robert Carroll, “The Effect of Income Taxes on Household Behavior,”
Review of Economics and Statistics, November 1999, pp. 681-93.
Bailey, Martin J., “Capital Gains and Income Taxation,” Brookings, October 29, 1963.
Break, George F., “Income Taxes and Incentives to Work,” American Economic Review,
September 1957, pp. 529-49.
Brown, S.A., “The Locked-In Problem,” Federal Tax Policy Economic Growth and Stability,
Joint Committee on the Economic Report, 84th Cong., 1st Sess., November 1955, p. 367.
Burman, Leonard, and William Randolph, “Measuring Permanent Responses to Capital-Gains
Taxes in Panel Data, “American Economic Review, September 1994, pp. 794-809.
Carroll, Robert, “The 2001 and 2003 Tax Relief: The Benefit of Lower Tax Rates,” Tax
Foundation Fiscal Fact No. 141, August 23, 2008.
David, Martin, “Economic Effects of the Capital Gains Tax,” American Economic Review,
Papers and Proceedings, May 1964, pp. 288-299.
Eichner, Matthew, and Todd Sinai, “Capital Gains Tax Realizations and Tax Rates: New
Evidence from Time Series,” National Tax Journal, September 2000, pp. 663-82.
Feldstein, Martin, “Behavioral Responses to Tax Rates: Evidence from TRA 86,” American
Economic Review, May 1995, pp. 170-174.
Feldstein, Martin, Joel Slemrod and Shlomo Yitzhaki, “The Effects of Taxation on the Selling of
Corporate Stock and the Realization of Capital Gains,” Quarterly Journal of Economics, June
1980, pp. 777-791.
Gravelle, Jane G., “Can a Capital Gains Tax Cut Pay for Itself?” CRS Report 90-254,
Congressional Research Service, March 1990.
Gravelle, Jane G., The Economic Effects of Taxing Capital Income, Chapter 6 “Capital Gains
Taxes,” pp. 123-59, MIT Press, Cambridge and London, 1994.
Gravelle, Jane G., “Estimating Long-Run Revenue Effects of Tax Law Changes,” Eastern
Economic Journal, Fall 1993, pp. 481-494.
Holtz, Charles C. and John B. Shelton, “The ‘Locked-In’ Effect of the Capital Gains Tax,”
National Tax Journal, Summer, 1962, pp. 337-52.
Musgrave, Richard A., John Lintner and E. Cary Brown. “Discussion,” American Economic
Review, May 1964, pp. 300-08.
Poterba, James, “Venture Capital and Capital Gains Taxation,” Tax Policy and the Economy,
Vol. 3 , 1989, pp. 47-67.
Slemrod, Joel. “Do Taxes Matter? Lessons from the 1980’s,” American Economic Review, May
1992, pp. 250-56.
Sprinkel, Beryl W. and Kenneth B. West, “Effects of the Capital Gains Tax on Investment
Decisions,” Journal of Business, April 1962, pp. 122-34.
-35-
Appendix
The Sinai-Boston (SB) Model of The U.S. Economy (2007 Version)—A Brief Summary
The Sinai-Boston (SB) Model of the United States Economy (2007 Version) is a large-scale
quarterly macroeconometric model that includes considerable detail on:
x aggregate demands—consumption; residential construction; business fixed investment and
inventories; government—federal, state and local; net exports; the balance of payments and
aggregate capital account.
x financial markets and asset prices
- interest rates, stock prices, and currency exchange rates;
- sector flows-of-funds for households, nonfinancial corporations, bank and nonbank
financial intermediaries, government—federal, state and local, the external sector and the
rest-of-the-world;
- balance sheet stocks of assets, liabilities and net worth, and the financial risks of various
sectors based on the configuration of its balance sheet;
- real estate prices of new and existing homes, generally and the market values of this asset
class.
x transmission channels and interactions of the financial system with the real economy
including from monetary policy and financial markets to the economy
- interest rates and exchange rates;
- household balance sheets; household sources and uses of funds including income, capital
gains realizations, and cashout mortgage financing; flows-of-funds; household and
nonfinancial corporate business financial risk effects on spending;
- stock market prices, residential real estate prices, and household wealth effects on
consumption;
- housing prices, the value of residential real estate as collateral, cashout mortgage
financing, rental price of real estate, affordability of residential real estate, and real estate
wealth effects on consumption, home sales, housing starts, and residential construction;
- the rental price of capital, weighted average cost of debt and equity, and business capital
spending, business sector “financial risk” and business spending on capital goods,
inventories and employment;
- capital gains realizations on stock and real estate and effects on consumption spending,
savings, household and business balance sheets, and the tax receipts of federal
government, states and localities;
- aftertax real interest rates as returns on saving and costs of borrowing and spending;
- aftertax expected real rates of interest and other asset prices;
- aftertax weighted average cost-of-capital to business and discount rate for expected
earnings and stock valuation.
x price and wage inflation modeled in a stages-of-processing approach—producer prices,
consumer prices, GDP price deflators, and inflation expectations with the effects of expected
inflation feeding back to wages and then into prices, and through unit labor costs to prices.
x expectations
- “antidotal” evidence;
- forward-looking and model-consistent, particularly for financial markets;
- extrapolative, backward-looking, particularly for the real economy and inflation,
reflecting expectations and adjustment lags;
- consumer and business sentiment surveys, directly on consumption and some categories
of business fixed investment.
x trade, international activity and international financial flows, including the current account;
trade and current account endogeneity to economic growth and interest rates; exchange rates,
exports and imports.
x potential output and its growth based on productivity; labor force participation rates; capital
stocks; R&D; real money balances; employment and unemployment; technology.
-36x
global economy interactions and responses—endogenous with major G-7 countries through
economic growth and exchange rate effects on U.S. exports, imports, and the current account.
The SB Model (2007 Version) has approximately 950 equations containing nearly 1500
variables, 950 endogenous (including identities), and over 500 exogenous variables. The
“financial system” and its channels to the real economy are extensively covered, with about onethird of the behavioral equations, including sector sources and uses of funds, sectoral balance
sheets, equity market wealth, real estate wealth, mortgage and housing finance, and measures of
financial risk comprising the “financial system” (Table A.1).
Aggregate Demands
The aggregate demands of the model include 31 categories of behavioral equations for real final
demands—16 for consumption; 8 for business capital spending and inventories; 11 for exports
and imports; and 2 for federal and state and local government purchases.
Computer spending is separately identified in all relevant final demands, minimizing distortions
caused by rapid declines in computer prices.
For simulation purposes, this richness of detail allows the model to yield differentiated impacts
among the various demand categories, improving the linkages to downstream systems used in
disaggregated industry models. The latter provide a “bottom-up” check on aggregate profits in
the model such as the S&P500 Operating EPS, a principal measure of corporate profits.
Markets
There is a “goods” market, “money” market, “loans” markets, “financial intermediaries”
markets, numerous “fixed income” securities markets, the “equity” market, and “currency
exchange” market. There is a “labor” market, which helps determine aggregate supply and the
potential output of the economy. There is an “international” market where trade, capital flows
and the current account are modeled. The “financial intermediaries” sector is comprised of
commercial banks, thrift institutions, and nonbank financial intermediaries. There is a
government sector—federal, state and local—and its financing.
Financial System
The “financial system” is an elaborate and detailed portion of the SB Model, consisting of 479
equations, 317 behavioral and 162 exogenous. The richness of detail extends to 59 fixed income
markets, where a wide array of nominal and real aftertax interest rates have significant effects on
portfolio adjustments, flows-of-funds, balance sheet states, sector financial risks, and as
transmission channels from the financial system to the real economy.
Flows-of-funds (uses and sources of funds) by sector and sectoral balance sheet stocks of assets
and liabilities are represented for households, nonfinancial corporations, the federal government,
state and local government, commercial banks, thrift institutions, nonbank financial
intermediaries and the rest-of-the-world, another distinguishing feature of the Model.
Spending and financing are jointly determined with financial flows, liquidity and financial risk
feeding into numerous categories of real sector expenditures. The real spending side of the
Model explicitly recognizes “wealth” effects from equities and real estate valuations and the
effects of realized capital gains, or losses, in equities and on the physical asset, housing real
estate, valued at market prices; also for balance sheets, consumption, and tax receipts.
Expectations
Expectations of future economic and financial variables are important in the SB Model and a
distinguishing feature.
Expectations enter the Model in many ways—from surveys of consumer and business sentiment
conducted by widely-followed organizations (such as the U. of M. Survey Research Center and
the Conference Board) to calculations of expectations for GDP and prices by mathematical
formulas.
Survey expectations appear in numerous consumer and business spending equations.
Expectations constructed by formula can be backward-looking, using past values of economic
variables, or forward-looking and model-consistent, using future values of variables based on
calculations by the Model.
In the latest SB Model Version, greater use is made of surveys for the expectations of households
and businesses, including the Gallup Poll Presidential Approval Rating. Several have been
found to directly affect some categories of private sector expenditures.
-37Expectations differ across agents in the economy, formed as extrapolative or backward-looking
on income and on the inflation expected by consumers. Inflation expectations affect wage
inflation and price inflation. Expected future profits and expected interest rates affect equity
prices, hence household wealth and consumption. The long-term nominal 10-year U.S. Treasury
and AAA-equivalent new corporate bond interest rates are affected by bond market inflation
expectations formed in a second order Pascal probability distribution model and by the U. of M.
Consumer Survey expected inflation ex-food and energy.
The formation of expectations in financial and real markets distinguishes the SB Model from
many others, with forward-looking and model-consistent, “permanent,” and extrapolative
expectations of different lagged structures empirically estimated and appearing in different real
economy, or financial markets. Survey expectations also are used and are determined
structurally within the Model. Some market forward expectations variables (futures markets)
also enter into some financial market equations.
A “quick” effect of future expectations into current financial asset prices and returns
characterizes key financial markets through the generation and discounting to the present of
model-consistent expectations for some of the fundamental factors that affect long-term interest
rates, the U.S. equity market, and exchange rates. In turn, real final demands or aggregate
demands are impacted sooner through the financial-real interactions of the Model than might
otherwise occur if expectations were not so modeled.
Interest Rates
Interest rates are modeled through a segmented markets approach, where fixed income markets
reflect the demands and supplies for various assets across sectors and the interrelated behavior
and arbitrage between markets. Real after-tax interest rates provide a major input into spending
and borrowing, rather than nominal interest rates. Tax considerations enter extensively
throughout the Model, affecting asset prices and incentives such as in the aftertax weighted
average cost-of-capital and rental cost of housing. Monetary policy; credit demands; fiscal
policy and federal budget deficits; expected and current; financial intermediaries activity;
inflation and expected inflation, model-generated and survey; and foreign holdings of foreign
exchange and the exchange rate are key determinants of interest rates.
Equity Markets
The stock market reflects the demands and supplies for equities through a fundamental valuation
approach, principally based on the present value of expected earnings, expected after-tax returns
on equity, volatility of earnings, expected growth in the economy, and interest rates. The
expectations are forward-looking, reflecting market behavior that incorporates future
expectations into current asset prices. Multiple interest rates play a role in determining stock
market prices. The S&P500 Common Stock Index is modeled.
Exchange Rates
The dollar exchange rate is modeled against key bilateral exchange rates such as the yen, euro,
and pound-sterling in addition to a trade-weighted average of sixteen countries, the Federal
Reserve Major Currency Exchange Rate. The dollar is a function of expected inflation in the
United States vis-à-vis several key OECD countries, relative short- and long-term interest rates
in the United States and abroad, trade flows and the current account, expectations of relative
economic growth across countries, the expected U.S. Government structural budget deficit, and
some elements of overseas demand for U.S. assets.
Transmission Channels: Financial-Real and Real-Financial Interactions
A considerable number of channels for financial-real interactions are modeled, including
multiple effects of numerous interest rates on aggregate demands through direct impacts on
spending and borrowing and indirectly through sectoral balance sheet positions and various
measures of financial risk as defined on the balance sheet.
The channels for the effects of the stock market on spending and elsewhere are numerous—
household wealth, capital gains realizations, the weighted average cost-of-capital (debt and
equity), consumer sentiment and consumption, and also the external financing of business. Tax
receipts at the federal and state level also are affected by the stock market through realized
capital gains, e.g., capital gains tax receipts and the federal budget. Impacts are on consumption,
business fixed investment, residential construction, exports and imports, and on the long-term
interest rate on expected federal budget deficits.
-38Exchange rates, set by demands and supplies for the U.S. currency vis-à-vis other major
currencies, impact interest rates, inflation, profits, trade flows and the current account, the federal
government budget deficit and thus spending aggregates, directly and indirectly.
Quick discounting of future expected values that relate to profits, the economy, deficits, and
relative economic growth across countries impact current financial asset prices, including interest
rates, thus spending through the channels financial and real asset prices to the economy.
The real economy and real final demands—consumption, business fixed investment and
inventory accumulation, federal and state and local government spending, and export and import
financing—drive demands for finance, short- and long-term, with loans and credit responsive to
real economic activity, as well to the interest rates and costs of borrowing that go with the
demands.
The segmented markets approach to interest rates reflects these demands and sector uses of funds
in a flow-of-funds framework to help determine various “prices,” e.g., interest rates and equity
market costs, as transmission points from the real economy to finance and credit. In turn,
various asset prices such as interest rates affect, with lags, real economy spending aggregates.
Financial conditions in the various sectors—households, business, financial institutions and
government—evolve over time measures of credit and financial risk which also can feed back to
the real economy.
Other linkages also exist that impact private and public sector spending—federal, state and local.
Expected future budget deficits affect current interest rates, particularly longer duration but also
short-term interest rates through U.S. Treasury financing, and then through financial-real
linkages off interest rates, debt service, the cost-of-capital, and then private sector expenditures.
Transmission Channels: Mortgage and Housing Finance
Financial conditions and mortgage-housing finance affect housing, residential construction and
consumption, with recent versions of the Model adopting an elaborate mortgage finance-housing
channel to depict how housing and mortgage finance affect the economy.
The housing market affects consumption through a number of channels. There is a real estate
wealth effect and effects on consumption and housing from equity in residential real estate
liquefied by home-equity borrowing and cashout financing.
Interest rates, the cost-of-borrowing, cost-of-capital and a rental price of housing, traditional
channels for monetary policy to the real economy, help determine consumption, housing activity,
residential construction, and business capital spending in numerous ways. One is directly as a
choice for households between saving and spending. A second operates through debt service-toincome and debt service-to-cash flow, or “financial risk” variables, into consumer spending and
business capital spending. A third operates through interest rates, the present value of expected
future profits, the stock market, cost of capital, equity wealth, and household spending. A fourth
occurs through the effects of interest rates and mortgage financing on affordability as it relates to
home sales; in turn, affecting home prices, real estate wealth, and consumer spending.
The wealth effect induces consumers to spend out of both real estate wealth and non-real estate
wealth (consisting of financial assets, including equities, less liabilities). Capital gains
realizations from gains (or losses) realized on sales of stocks or realized gains on sales of
residential real estate impact on spending and saving, with the funds obtained in this way spent,
saved, or used to pay taxes at the federal and state and local levels.
Consumers also have a channel of spending out of the liquefied home equity resulting from cashout financing as affected by home prices and interest rates. By refinancing a home mortgage,
homeowners can convert the appreciated value of real estate into spending on consumer goods
and services. This is a relatively recent channel in the U.S. economy which initially emerged
during the late 1990s and has developed further through this decade.
Price and Wage Inflation
Prices and inflation rates are determined in a stages-of-processing approach that flows from
producer prices through consumer prices to chain prices for the GDP deflator components.
Prices also reflect the production and supply side of the economy through the “gap” between
potential and actual output, and industrial capacity or capacity utilization. Wages and benefits
are determined by labor market conditions and are influenced by price inflation and inflation
expectations. Unit labor costs and markup pricing by business to maximize profits are an
important determinant of prices and inflation. Inflation expectations, formed with lags, affect
-39wage-setting, then product prices through unit labor costs and, in turn, price expectations, then
wages, price inflation, etc..
There is no explicit Noninflationary Accelerating Inflation Unemployment Rate, NAIRU, in the
SB Model. Instead, there is a highly disaggregated and structural setting-out of inflation at all
stages-of-processing. A NAIRU-like result can be produced by the Model and results from
underlying factors that raise inflation and lower unemployment until the demand for labor,
relative to the supply, along with expected inflation, gets to the point where at a low
unemployment rate, inflation begins to accelerate. In the SB Model, this result does not occur
from a “natural rate” calculation feeding directly into price and/or wage inflation, but instead
from behind-the-scenes structural inflation and wage-setting behavior that generate a relationship
between inflation and unemployment which superficially looks like a Phillips Curve in twodimensional space and a “NAIRU.”
Crude oil prices are determined in a global demand-supply fundamental framework, with
country-by-country demands for oil and supplies of crude oil entering. Crude oil prices
estimated in this way are endogenous to the global economy and to the open-economy
macroeconomics of the SB Model. The SB Model is open to the global economy and the major
economy GDP growth rates, exchange rates, trade flows, and current account flows. Major
country macroeconometric models are part of the worldwide linkages of macroeconomies and
form the macroeconomic structure of the global economic system, as modeled by DE.
Crude oil prices, along with demands and supplies for other energy costs, enter the inflation
process in numerous ways—mainly through unit energy costs and markup pricing by goodsproducing and services-producing companies in the U.S. economy. Energy costs and the
derivative inflation effects reduce purchasing power for households, businesses, states and
localities and companies involved in international trade, thus feed back to various spending
aggregates and to U.S. economic growth.
Rest-of-the-World and Linkages
The Model is “open economy” in its orientation and considers extensively the interactions of
money, finance, credit, and sectoral balance sheet states in the real economy. Trade and
international capital flows are integral to the dollar exchange rate, which has significant effects
on inflation, interest rates, and the economy.
The Model uses foreign demand variables, prices, exchange and interest rates to link the rest-ofthe-world to the U.S. economy. Exports are driven by foreign demands, exchange rates, and
prices. Price variables from key foreign countries help determine prices in the U.S. through
costs-of-production and prices at retail, capturing the increased openness of the U.S. economy
and trade that have emerged since the 1990s. Foreign exchange rates play a part in interest rate
determination, directly affect trade flows, and indirectly affect the stock market and cost-ofcapital.
The components of the current account, goods, services, income receipts and payments and
transfers are modeled in detail. Financing of the current account, purchases and sales of
financial assets by shareholders also are included in the Model.
Policy and Exogenous Variables
The Model contains a large number of exogenous variables, 537. This is not unusual in a largescale macroeconometric model, with many of the exogenous variables simply identities, or
definitions, that are used or complete the coverage of the model.
Main policy levers include tax rates at all levels, personal, business, social security, for capital
gains, estate taxes and excise taxes; federal government expenditures, defense and nondefense;
population and the demographics of age groups; nonborrowed reserves and Federal Reserve
credit; numerous fixed parameters representing institutional or legislated rules or laws; and
definitional derivations of capital stocks for equipment, plant, residential housing, sectoral
balance sheet assets and liabilities, and other such items. Balance sheet stocks are definitionally
determined with some minor components exogenous.
-40Table A.1
The Sinai-Boston (SB) Model of the U.S. Economy (2007 Version)
Behavioral
GDP and Final Demands
GDP
Consumption
Business Fixed Investment
Residential Investment
Inventory Investment
Exports
Imports
Government
Federal
State and Local
Final Sales, etc.
Supply, Potential Output, and Capacity
Capital Stock
Prices, Wages and Productivity
Producer Prices
Consumer Prices
Chain GDP Price Deflators
Wages
Productivity
Prices—Other
Deflator Inflation Rates
Expected Inflation
Incomes
Wages, Salaries and Supplements
Personal Income—Other
Corporate Profits
Dividends
Interest
Consumption-Related
Investment-related
Business Investment
Residential Investment
Financial System
Monetary and Reserve Aggregates
Financial Markets
Interest Rates
Stock Market
Exchange Rates
Flows-of-Funds or Uses and Sources of Funds
Households
Nonfinancial Corporations
Depository Institutions—Banks
Nonbank Financial Intermediaries
Government—Federal, State and Local
Sectoral Balance Sheets
Households
Nonfinancial Corporations
Depository Institutions—Banks
Nonbank Financial Intermediaries
Government—Federal, State and Local
Identities
Behavioral
Total
Exogenous
Total
Variables
45
3
16
6
5
2
5
6
2
122
2
35
23
3
6
11
10
17
167
5
51
29
8
8
16
16
19
147
1
37
37
6
9
12
15
21
314
6
88
66
14
17
28
31
40
0
28
1
112
29
6
47
13
3
14
0
1
22
4
12
6
1
3
11
24
1
23
15
8
23
60
0
1
36
5
12
1
5
0
21
3
12
6
0
2
1
27
7
20
15
36
24
172
29
7
83
18
15
15
5
1
43
7
24
12
1
5
12
51
8
43
9
18
21
91
22
0
50
4
5
9
0
0
18
1
13
4
0
3
3
13
3
10
24
54
45
263
51
7
133
22
20
24
5
1
61
8
37
16
1
13
15
64
11
53
163
10
194
15
357
25
162
13
519
38
59
7
10
19
8
4
78
15
14
54
11
26
132
26
40
73
26
36
3
2
6
94
23
35
0
2
36
167
49
71
3
4
42
95
18
24
0
4
52
262
67
95
3
8
94
4
0
0
2
2
0
4
22
26
1
2
3
8
22
26
3
4
3
0
0
0
0
4
0
8
22
26
3
8
3
-41Table A.1 (continued)
The Sinai-Boston (SB) Model of the U.S. Economy (2007 Version)
Behavioral
Rest-of-the-World
Identities
Behavioral
Total
Exogenous
Total
Variables
21
22
43
25
68
Demographics
1
2
3
8
11
Miscellaneous
Expectations
Forward-Looking (Model Consistent)
Backward-Looking
“Bond Market”
Expectational Lags
Adjustment Lags
Market-Formed
Surveys
Rates of Return
Saving
8
7
0
73
22
8
81
29
8
24
8
2
105
36
20
0
1
0
2
4
0
1
2
1
0
1
0
35
16
2
2
0
3
4
35
17
0
1
0
1
2
9
7
2
3
0
4
6
44
24
416
529
947
537
1491
23
2
0
0
23
2
23
2
11
3
7
6
5
0
0
0
0
0
11
3
7
6
5
0
0
0
Nonresidential Business Fixed Investment
Via Interest Rates
Via Debt Service
Via Rental Price of Capital
Via Aftertax Cost-of-Capital
6
1
5
0
0
0
0
2
Residential Investment
Via Interest Rates
Via Mortgage-Housing Finance
Via Rental Cost
6
4
2
0
Inventories
Net Exports
Total
Addendum:
Financial Transmission Channels
Consumption
Via Interest Rates
Via Wealth
(Asset Markets, Real Estate, Equity)
Via Debt Service
Via Mortgage Finance
Via Cashout Financing
Via Capital Gains
0
0
0
0
11
3
7
6
5
6
1
5
0
0
0
0
0
6
1
5
2
0
0
0
1
6
4
2
0
0
0
0
0
6
4
2
1
1
0
1
0
1
6
2
8
2
10
-42Table A.2
The Sinai-Boston (SB) Model of the U.S. Economy (2007 Version):
Sample Historical Performance—Full Model Simulation, 1990:1-2004:4*
Variable
RMSE
% RMSE
111.7
98.7
35.6
1.25
1.60
8.78
77.8
27.3
27.6
0.4
49.1
51.0
10.84
10.47
2.67
0.37
5.65
4.43
Unemployment Rate (%)
0.4
7.54
Prices & Wages (Level)
GDP Deflator
GDP Deflator (% chg.)
PPI
Nonfarm Bus. Comp.
0.01
0.76
0.04
0.02
1.10
36.86
3.82
1.74
Profits
S&P500 EPS ($/share)
1.41
13.36
Interest Rates (%)
3-Mos. T-bill
10-Yr. Treas.
1.04
0.45
26.74
7.72
Exch. Rate (Level)
FRB Major Cur. Exch. Rate
0.10
10.56
Real GDP (Bils. 2000 $s)
Consumption ( “ )
Resid. Inv.
( “ )
Bus. Fixed Inv. ( “ )
Equip.
Plt.
S&L Govt.
( “ )
Fed. Govt.
( “ )
Exports
( “ )
Imports
( “ )
*See Table A.1 for Model breakdown and numbers and types of equations.
-43Simulation Description
This part of Appendix describes how capital gains tax rate changes were simulated
using the Sinai-Boston (SB) Model of the U.S. Economy.
The period covered was 2011 to 2016, or six years, long enough to observe in
simulation the short-, intermediate-term, and longer-run effects of the tax policy changes.
Implementation of the simulation involved changes in parameters and add factors.
Parameters that changed for the simulation involved statutory and effective personal tax
rates faced by consumers. Personal tax rates appear in a wide range of equations
including consumption spending, consumer holdings of financial assets and liabilities,
after-tax rates of return and consumer sentiment. Because the capital gains tax rate is a
component of the overall personal tax rate, it appears directly or indirectly in a large
number of equations describing consumer behavior.
Six simulations replaced the current-law 15 percent personal capital gains tax rate
with a range of alternatives. These alternatives were a lower capital gains tax, reductions
to 10-, 5- and 0-percent, and higher capital gains tax rates, increases to 20-, 28- and 50percent, respectively. The key changes in tax parameters set the economy moving
towards a different solution based on the alternative tax rate simulated, instead of what
might happen under the current 15 percent rate. The direct effect of capital gains taxes
on capital gains realizations is a key part of the simulated effects from the tax changes.
The tax on capital gains is only one component of the personal income tax. A
decrease in the capital gains tax rate decreases the overall effective personal income tax
rate faced by individuals. As the capital gains tax rate moves from the current 15-percent
rate to a hypothetical, lower, 10-percent rate, e.g., the reduction in the effective tax rate
reduces tax payments by individuals. The lower effective personal tax rate, relative to the
Baseline, is implemented in the Model by reducing the effective personal tax rate on
capital gains realizations to 10 percent for the simulation of a hypothetical 10-percent tax
rate. In the simulation of a 10 percent capital gains tax rate, the effective personal tax
rate on capital gains is reduced to 10 percent while the overall capital gains tax rate is
reduced to 10 percent.
This process of tax rate reduction (or increase) was repeated for each of the six
alternative simulations. The effective personal tax rate was changed from 15 percent to
10-, 5- and 0-percent for tax rate reductions and to 20-, 28- and 50-percent, respectively,
for tax rate increases.
From the reduction in the effective capital gains tax rate to 10 percent from 15
percent, the consumer faces a lower effective tax rate, resulting in more spending because
of the tax rate reduction. The impact on the economy flows from lower taxes on sales of
capital assets to higher income to increased consumer spending on goods and services
and purchases of assets.
The key changes that cause the simulations to vary from the Baseline are a result of
changes in the personal capital gains tax rate and the effective personal tax rate. No other
exogenous variables were changed, except for technical reasons.
To present the results in a manner that makes for easy comparison across simulations,
the key short-term interest rate in the SB Model, the federal funds rate, is maintained at
-44its Baseline level in the six alternative simulations. This represents an unchanged
monetary policy. Nonborrowed bank reserves are increased or decreased in the
respective simulations to maintain the federal funds rate at the same level as in the
Baseline simulation. This is necessary because a higher, or lower, federal funds interest
rate would represent a purposeful change in monetary policy and result so as not to get
the isolated effects of changes in the capital gains tax rate.
In a simulation, the change in the capital gains tax rate and the change in the effective
personal capital gains tax rate (which also affects the overall personal tax rate) are
sufficient to generate the bulk of the results in the simulation. But future expectations are
an important part of the SB Model. In the course of the simulations, the expected future
path of some key variables, such as the federal budget deficit, expected S&P 500
operating earnings per share, expected exchange rate (Federal Reserve Major Currency
Index), expected real GDP and the expected consumer price index (CPI) were solved in
simulation. This mechanism of using future expectations during the solution of the SB
Model captures the impact of expectations on the model solution as it is being generated.