The Wall Street Journal-20080129-Dynamic Scoring

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Dynamic Scoring

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Now that Democrats and Republicans are passing out tax rebates in an election year, all of their anxiety about the "budget deficit" has vanished into the polling mists. No matter, those non-marginal tax cuts won't change incentives to work and invest enough to recoup much lost revenue. But if anyone still wants to reduce a tax that really would pay for itself, the Congressional Budget Office has the latest data on the revenue boom in the wake of the 2003 capital gains tax cut.

Wow. The tax rate fell to 15% from 20%, yet revenue collections have climbed by 152% in four years. The nearby table shows that the response by investors has been much larger than even many advocates had hoped to see. In 2002, the year before the tax cut, the capital gains realizations that filers report on their tax returns were $269 billion. Realizations grew smartly in each succeeding year, and CBO is now projecting that the total for 2007 will be $863 billion.

Yes, the stock market rose during that period along with the larger economy. But the lower rate also gave investors more of an incentive to "unlock" their gains, taking profits and then reinvesting the net proceeds. The government gets 15% on the gain, instead of 20%, but there are more transactions to tax as investors worry less about the tax consequences of cashing out a profitable investment. Notably, 79% of the tax returns reporting capital gains in 2005 were from filers with incomes of less than $100,000 a year. So much for that tax cut going only to "the rich."

This blowout in taxable gains has in turn translated into a revenue windfall for Uncle Sam. CBO now estimates that the capital gains tax will collect $127 billion in 2007, up from $49 billion in 2002. Capital gains revenue has undeniably been a major contributor to the decline in the budget deficit in recent years.

Ah, but wouldn't revenues have been even higher with the 20% rate? With the help of the Strategas consulting firm, we went back and looked at what CBO predicted for revenues assuming a 20% rate. CBO estimated that from 2003-2007 the government would collect $260 billion. In fact, the feds have collected $470 billion over that period at the lower 15% rate. Even Tom Brady doesn't do that much dynamic scoring.

And by the way, the capital gains rate is scheduled to return to 20% at the end of 2010 unless Congress acts in the interim. Hillary Clinton wants to raise it back to 20%, while Barack Obama and John Edwards say it should go as high as 28%. Apparently they don't mind if the government loses revenue.