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Clinton Would Complicate the Capital-Gains Tax

Paula Dwyer writes editorials on economics, finance and politics for Bloomberg View. She was London bureau chief for Businessweek and Washington economics editor for the New York Times, and is a co-author of “Take on the Street: How to Fight for Your Financial Future.”
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Hillary Clinton's economic prescriptions seem like they came from a marriage counselor, trying to get warring spouses to focus on what they have in common instead of what divides them. The problem, though, is that neither side finds the result all that satisfying; sometimes the median is a muddle.

That's how I feel about Clinton's capital-gains tax plan. She wants to discourage short-term thinking (that's good), raise tax revenue to fund new government programs (unlikely), and demonstrate to Elizabeth Warren's fan base that she can soak the rich and limit Wall Street's winnings, too (a pander). To do all this, Clinton will reportedly propose a sliding scale of taxes on stocks, bonds, real estate and other assets, depending on how long they're held.

Current tax law has two rates: Short-term gains (on the sale of assets held for less than a year) are taxed as ordinary income, or as much as 43.4 percent for top earners. Assets held for more than a year are taxed at 23.8 percent.

Instead, Clinton is said to propose multiple levels of long-term. For assets held at least two years, the tax would be more than 28 percent, the Wall Street Journal reports, up from today's 23.8 percent. If assets are held for five years, the rate would be lower than that. (We may learn how much lower on Friday, when Clinton is set to release a tax-policy blueprint.)

She may have a fourth level in mind: The Center for American Progress, a think tank that is almost an extension of Clinton's campaign, has suggested a fourth and lower levy for investors with 10-year horizons.

Confused? You would be, especially if you're an investor who's had to cope with the roller coaster investment taxes have been riding for the past few decades. Under President Ronald Reagan, rates went from 20 percent to 28 percent, then back down to 20 percent under President Bill Clinton. In 2003, President George W. Bush's tax cuts set investment taxes at 15 percent, only to be followed by an increase to 23.8 percent under President Barack Obama -- whose 2016 budget plan proposes yet another bump up, to 28 percent.

Even Hillary Clinton seems conflicted. As a candidate in 2008, she said she wouldn't raise capital-gains taxes above her husband's 20 percent level, if at all, because she believed that higher investment taxes would starve the economy of capital. Now, Clinton seems to think the tax code should be a tool for social and economic policy to reward patient capital, raise new revenue to finance social programs, and discourage in-and-out investing.

She's not alone in having a change of heart. For decades, economists believed that the optimal tax rate on investment returns was zero. The idea was that the more you taxed gains, the less people invested -- making capital more costly, innovations fewer and jobs more scarce.

But economists have since refuted the concept of zero taxes on asset sales, especially in a country where the richest 10 percent of families command about 75 percent of household net worth. The wealthiest also derive most of their income from investments, not salaries, giving them proportionately lower tax bills than the working poor. What's more, most companies don't make investment decisions based on their taxes. One recent study even showed that lower investment taxes had zero effect on corporate investment.

So Clinton's desire to increase the tax on investment earnings makes sense. But her proposal would also make the tax code far more complicated and confusing than necessary. She also overlooks a simpler, more economically justified way to tax investment returns: the same rate at which wages and salaries are taxed.

A nonpartisan Congressional Research Service study showed that raising capital-gains taxes would hardly dent private saving or investment, and could even increase public saving by reducing budget deficits. The Office of Management and Budget has estimated that taxing investment returns at the same rate as salaries would raise more than $1 trillion over a decade, and that was when the top marginal rate was 35 percent, not the current 39.6 percent.

Clinton is right to want to encourage long-term thinking by raising capital-gains taxes. But she shouldn't overlook the simplicity of taxing capital and labor at the same rate.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Paula Dwyer at pdwyer11@bloomberg.net

To contact the editor on this story:
Christopher Flavelle at cflavelle@bloomberg.net