It’s time to lower the capital gains tax rate.
As Clinton did in 1997. The result was an increase in tax revenue, robust growth, and a surplus in the government budget.
In 1996, President Clinton was faced with the typical economic dilemma. The economy was growing too slowly. The recession in 1992 had long ended yet the economy did not spring back to a high growth rate as is typically the case after a recession. He also had to deal with large government spending deficits. Clinton decided to look at the capital gains tax rate.
At the time, capital was taxed at 28%. That rate didn’t generate sufficient new capital to allow the economy to grow, especially considering the US was in the beginning of a technological boom. The internet has just been created which spurred many new technology firms.
Clinton knew that for the economy to expand and for new technologies to develop, sufficient capital would be needed. At the same time, he recognized that he could not allow the public debt to grow, so he needed to increase tax revenue.
How could Clinton possibly grow the economy, increase capital formation, and increase tax revenue? After much thought, he came up with a solution that worked perfectly. He decided to cut the long-term capital gains tax rate which was then at 28%. He proposed cutting the rate to 20% effective in 1997. Congress agreed.
Tax revenue from capital gains soared from $66 million in 1996 to $79 million in 1997. Then capital gains tax revenue increased $89 million in 1998, $111 million in 1999 and $127 million in 2000. Tax revenue nearly doubled in four years.
Meanwhile, economic growth accelerated, averaging 4.5% annually from 1997 to 2000. Working with Speaker of the House Newt Gingrich, Clinton was able to eliminate the annual deficit and in fact, ran a budget surplus each year from 1997 to 2000.
This is a supply-side economic solution that worked perfectly. President Biden should consider this action.
Currently, the capital gains tax rate fluctuates depending on income. Short-term capital gains are taxed as ordinary income, meaning the tax rate could be as high as 37%. Long-term capital gains are taxed at different rates depending on the size of the capital gain, with the highest rate at 23.8%. Wealthy investors who create most of the new capital pay the 23.8% rate.
Today, economic growth is slowing. In the first quarter of this year, growth was only 1.3%, down from 5% in the third quarter of 2023 and 3.4% in the fourth quarter. It looks like the second quarter of this year will see growth in the 1.5% to 2% range.
At the same time, inflation continues to be a very stubborn problem. While it is true that the very restrictive Monetary Policy of the last 12 months has brought the annual inflation rate down from its peak of 9.1%, inflation has hovered in the 3% to 3.5% range for the last nine months.
The government spending deficit continues to be problematic. With this year’s deficit forecasted to be about $2 trillion, most government leaders believe the deficit must be reduced mostly because the total public debt is now $35 trillion.
If Biden convinced Congress to lower the capital gains tax rate to 15%, he would achieve the same results that Clinton saw after 1996. That lower rate would vastly increase capital formation. Since the economy is currently experiencing a labor shortage along with high capital costs, the increased capital would increase economic growth.
The resulting increase in total supply in the economy would put downward pressure on prices and help to reduce inflation. The increase in tax revenue would help to reduce the size of the federal government spending deficit. And economic growth would increase avoiding a potential recession.
This would be a big win for Biden, yet there is virtually no chance that he would support a reduction in the capital gains tax. Why?
The lower tax rate would benefit holders and creators of capital. All those individuals are wealthy. So, Biden would just say that this is just a tax cut for the wealthy and he wants no part of it.
However, if he looked at the past, he could forecast the future and it would look good after a decrease in the capital gains tax rate.
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