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Capital Gains: Time For Sound Policy, Not Sound Bites

Economic Viewpoint


`The supply-side economists have delivered the largest genuinely free lunch that I have seen in 25 years, and I believe we would be a better society if we followed their advice." Who said that? Ronald Reagan? Jack Kemp? A voodoo economist? No, it was University of Chicago Professor Robert E. Lucas, the 1995 Nobel prizewinner in economics.

Professor Lucas' remark is of the greatest importance to the millions of Americans whom the Democrats and the media array against "the rich" when tax-cutting is under discussion. Liberals go after those who propose to reduce taxes on capital the way dogs go after red meat. It's a liberal shibboleth that lower taxes on capital only benefit the rich.

Supply-siders have shown that when you lower the cost of capital, you get more of it and that the benefits accrue to society as a whole in the form of higher labor productivity and higher incomes. Professor Lucas writes that "the analysis I have reviewed supports these claims: Under what I view as conservative assumptions, I estimated that eliminating capital income taxation would increase capital stock by about 35%."

What would that mean for Americans? In his Hicks Lecture at Oxford University, Professor Lucas states that "achieved over a 10-year period, such an increase would more than double the annual growth rate of the U.S. capital stock." He offers the following ways of comprehending the benefits that would flow from this: People would experience a gain in their economic well-being equal to twice the gain that would result from eliminating a 10% rate of inflation; it would be 10 times the gain from eliminating all product-market monopolies; and it would be 20 times the gain from eliminating the business cycle.

NO "GREAT SOCIETY." This would be no mean achievement. It would go far beyond any benefits that can be claimed by the liberals on behalf of income redistribution and government spending programs or by the conservatives in the name of lower deficits and interest rates.

After decades of experience with income redistribution and spending programs, we know for a fact that the liberals' claims were unfounded. Promised benefits did not materialize, but many unpromised problems and costs to society did. The "Great Society" ended in failure and left a legacy of almost intractable problems.

As for the benefits of a balanced budget, interest rates peaked in 1981, when the deficit was $79 billion. Despite the rise in the deficit and the national debt, interest rates today are less than half of their 1981 levels.

The advantages of a larger capital stock and the failure of social spending programs make the current budget dispute over taxing and spending, with its overtones of shutting down the government, difficult to understand. The capital-gains tax brings in a paltry sum--$30 billion on a $1.5 trillion budget--at the cost of slower economic growth. But Republicans are too mired in illogical distributional rhetoric to champion the abolition of this misguided tax. According to newspaper reports, even Senate Finance Committee Chairman William V. Roth (R-Del.) of Kemp-Roth fame feels impelled to defend the Republican tax-cut plan by estimating that 62% of the bill would benefit families and 27% would go toward promoting savings, investment, and economic growth.

SYMBOLIC CHILD CREDIT. Senator Roth, of course, knows that promoting savings, investment, and economic growth benefits families, but Democrats still control the rhetoric, so Republicans have to legislate a tax cut that is "balanced" between "families" and "investors"--as if they were people with diametrically opposed interests.

One unfortunate consequence of this illogic is that the bulk of the Republican tax reduction is being used for a $500-per-child credit (the rich excluded). Such a credit is mere political symbolism, not an economic-policy action. The incentive effects of the child credit are nil. Families and children would benefit far more from a reduction in capital taxation that would in turn create opportunities for their futures.

Families are denied the capital they need to maintain and raise their living standards because of irresponsible and uninformed distributional rhetoric that no professional economist would support. The burden of income taxation is borne by factors of production. Just as taxing capital reduces the productivity, and thereby the earnings, of labor, taxing labor reduces the earnings of capital. Distributionist illogic imposes a false dichotomy on a symbiotic relationship and prevents sound tax policy. If Republicans are going to lead, they will have to confront propaganda with economics.BY PAUL CRAIG ROBERTS

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