Obama on Capital Gains Taxes: Confusion or Politics?

President Barack Obama is sending seriously mixed signals on capital gains taxes.

In the White House announcement of a "Startup America Legislative Agenda," it was declared that Mr. Obama wants a zero percent capital gains tax on small business investments.

That sounds great, right?

Details as to what this actually entails will come with the release of the President's 2012-13 budget plan. But if it is the same idea that Mr. Obama offered in his 2011-12 budget, then it will be so limited in scope as to be economically meaningless. Last time around, this measure imposed a five-year holding period, placed a limit on assets and a cap on applicable returns, and applied to only C corporations.

A holding period discourages the movement of capital to its most productive uses, as do restrictions on assets and returns, while limiting the measure to C corporations means excluding most small businesses.

Then there's the fact that Mr. Obama has been unrelenting in his desire to hike the capital gains tax rate on upper-income earners.

He has pushed for increasing the rate by 33 percent, from 15 percent to 20 percent. However, ObamaCare also is scheduled to impose an added 3.8 percent tax on capital gains for upper incomes, which would raise the Obama proposed capital gains tax rate of 23.8 percent - or an increase of 59 percent.

But it potentially does not stop there. In his State of the Union, the President declared that he wants high-income earners to pay an effective tax rate of no less than 30 percent. That means jacking up the capital gains tax rate even more. Indeed, it would seem that for some taxpayers it would require a capital gains tax rate of 30 percent - a doubling of the capital gains tax rate.

Factor inflation into the mix, and the real capital gains tax rate goes even higher.

From an economics standpoint, it's obvious that if you want entrepreneurship, business, competitiveness and job creation to flourish, then hiking the capital gains tax rate is grossly counterproductive. After all, starting up and investing in innovation, invention, businesses and jobs require the incentives and resources to do so. High capital gains taxes reduce the incentives and resources available for such critical risk taking.

As an economist, it's frustrating when elected officials miss such fundamental economic points, and push policies that will only hurt the U.S. economy.

But does Mr. Obama miss the economics of capital gains taxation, or is he merely playing a dangerous game of politics?

For example, there is the class warfare/envy card. That is, play the populist "bash the rich" card, and hope it translates into votes.

In fact, a recent CBS News/New York Times poll points to this possibility. It turns out that 70 percent of Democrats believe that upper-income Americans pay less than their "fair share" in federal income taxes, and 66 percent of Democrats believe that "capital gains and dividends should be taxed the same as income earned from work."

Putting aside how the questions were framed and the fact that capital gains and dividend taxes paid by individuals are part of multiple layers of taxes on saving and investment, the reality is that the President's political base buys into a tax system that ignores sound economics, and instead is based on envy/class warfare.

As a result, on capital gains taxes, we hear nice rhetoric about small business and entrepreneurship, but hostile rhetoric about upper-income earners. Unfortunately, economics makes clear that this does jibe with reality. In terms of how policy actually works, jacking up capital gains taxes on upper income earners quite simply means reducing the resources available for small businesses to build and grow.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is "Chuck" vs. the Business World: Business Tips on TV.