See Don Luskin’s great column this morning on why we should eliminate the capital gains tax. Luskin nicely documents the virtuous cascading effects of innovation, both for the economy and for tax receipts.
While eliminating the cap-gains tax may well induce companies like Microsoft to generate additional taxable activity, there’s a more important opportunity here. Eliminating the cap-gains tax will cause the economy to generate more innovators like Microsoft.
For each new Microsoft, the cost to government would mean $40 billion in foregone revenues. But for those new Microsofts that wouldn’t have existed otherwise, the payoff would mean raking in $268 billion.
Bruce Bartlett offered another angle on capital gains last week, with a useful analogy:
The great economist Irving Fisher came up with an analogy that precisely delineates the basic difference between income and capital. Think of a fruit-bearing tree. The tree both grows and yields fruit on an annual basis. The tree is effectively a capital asset, the fruit is the income, and growth of the size of the tree — which will yield more fruit in the future — is like a capital gain.
The fruit can be taxed without hurting the tree or diminishing its capital — its ability to grow and bear more fruit in the future. But taxing a capital gain is like sawing off limbs of the tree. That diminishes its capital value and inhibits the tree’s ability to produce fruit; that is to say, future income.