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CRS Reports on Capital Gains

FEB. 11, 2005

RS20250

DATED FEB. 11, 2005
DOCUMENT ATTRIBUTES
  • Authors
    Esenwein, Gregg A.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2005-3506
  • Tax Analysts Electronic Citation
    2005 TNT 35-22
Citations: RS20250

 

Order

 

Code RS20250

 

Updated

 

February 11, 2005

 

 

CRS Report for Congress

 

Received through the CRS Web

 

 

Capital Gains Tax Rates and Revenues

 

 

Gregg A. Esenwein

 

Specialist in Public Finance Government and Finance Division

 

 

Summary

 

The taxation of individual capital gains income is a perennial topic of debate in Congress. Taxes on long-term capital gains income were reduced in 1997 and again in 2003. The holding period to qualify for long-term capital gains treatment was reduced in 1998. This report provides historical information on the holding period, maximum statutory tax rate, and revenues from the taxation of individual capital gains income. This report will be updated as legislative action warrants.

 

Since the enactment of the individual income tax in 1913, the appropriate taxation of capital gains income has been a perennial topic of debate in Congress. Almost immediately upon enactment, legislative steps were initiated to change and modify the tax treatment of capital gains and losses. Since 1913, at least twenty major legislative changes and countless minor changes have been enacted. Capital gains tax rates were last reduced in 2003 while the holding period to qualify for long-term capital gains treatment was reduced in 1998.1

In May 2003, the108th Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003. Under this Act, the maximum tax rate on long-term capital gains income was reduced to 5% (0% for 2008) for taxpayers in the 10% and 15% marginal income tax brackets. The maximum capital gains tax rate was reduced to 15% for taxpayers in marginal income tax brackets exceeding 15%. The Act also repealed the special capital gains tax rates for assets held 5 years or longer. These changes are effective for assets sold or exchanged on or after May 6, 2003, and before January 1, 2009.

Under current income tax law, a capital gain or loss is the result of a sale or exchange of a capital asset. If the asset is sold for a higher price than its acquisition price, then the sale produces a capital gain. If the asset is sold for a lower price than its acquisition price, then the sale produces a capital loss.

Capital assets held longer than 12 months are considered long- term assets while assets held 12 months or less are considered short- term assets. Capital gains on short-term assets are taxed at regular income tax rates. Gains on long-term assets are taxed at a maximum tax rate of 15% (5% for taxpayers in the 10% and 15% marginal tax rate brackets).

Ideally, a tax consistent with a theoretically correct measure of income would be assessed on real (inflation-adjusted) income when that income accrues to the taxpayer. Conversely, real losses would be deducted as they accrue to the taxpayer. In addition, under an ideal comprehensive income tax any untaxed real appreciation in the value of capital assets given as gifts or bequests would be subject to tax at the time of transfer.2

Obviously, the current law tax treatment of capital gains income varies considerably from the ideal treatment under a comprehensive income tax. One response to this deviation from a comprehensive approach to the taxation of capital gains income has been a call for further reductions in the tax rates applicable to capital gains income.

One argument for lowering capital gains taxes has focused on the benefits of reducing "lock-in" effects. Lock-in occurs because the income tax liability on capital gains income can be deferred until the asset is sold. Tax deferral creates a bias because individuals faced with a large lump-sum tax are reluctant to sell their capital assets even though, on a pre-tax basis, they could earn a higher rate of return on an alternative investment. This "lock-in" effect tends to retard the efficient allocation of resources in the economy with tax considerations tending, in some cases, to dominate other market forces. Proponents of capital gains tax reductions argue that cutting capital gains taxes will reduce "lock-in" effects and free up resources, increase savings and stimulate economic growth, and make the tax code less complex. Critics are concerned about the distributional effects, possible tax shelter abuses, and the revenue losses associated with reductions in capital gains taxes.

Some commentators argue that reducing taxes on long-term capital gains will not reduce federal revenue but will, in fact, result in increased revenue. It is argued that as taxes are reduced on capital gains, "lock-in" is reduced, which increases realizations and investments in capital assets. The net effect is to increase federal revenues.

Although taxes on increased capital gains realizations would offset some of the initial cost of cutting capital gains taxes, there is considerable uncertainty about the magnitude of the unlocking effects. It appears that over the long-run, the revenue generated from an increase in capital gains realizations accompanying a tax cut would not be large enough to offset the static revenue loss from the tax cut itself. A net revenue gain is also less likely under current law than it was in the past, in part because the increase in realizations would be taxed at lower rates than would have been the case in the past.

The following two tables present background information that may prove helpful to policy makers as they debate the merits of further capital gains tax changes in the 108th Congress. Table 1 shows the statutory maximum tax rates on both ordinary income and long-term capital gains income since the adoption of the federal individual income tax in 1913. This table also shows the holding period required for capital assets to qualify for long-term capital gains tax treatment.

Two major observations can be drawn from the data in Table 1. The first item is that with the exception of the first nine years, the maximum statutory tax rate on long-term capital gains has been substantially lower than the maximum statutory tax rate on other forms of income.3 The second observation is that the current maximum statutory tax rate on long-term capital gains income is lower than it has ever been in the post World War II time frame.

Table 2 shows realized capital gains and federal individual income taxes paid on realized capital gains for selected years 1955 through 2000. It also shows CBO estimates of realized capital gains and taxes paid on capital gains for 2001 through 2015. The observation that is most readily apparent from this table is the dramatic increase in capital gains realizations in 1986 that occurred in anticipation of the capital gains tax hike implemented in 1987. In addition, CBO estimates that there will be another spike in capital gains realizations in 2008, the year before capital gains tax rates revert to their higher levels under pre-2003 tax law.

                 Table 1. Statutory Marginal Tax Rates

 

                   on Long-Term Capital Gains Income

 

                              (1913-2003)

 

 

                                                               Holding Period

 

                                                                   for

 

              Maximum Tax Rate on    Maximum Statutory Tax    Long-term Capital

 

               Ordinary Income      Rate on Long-term Capital  Gains Treatment

 

 Year               (%)                 Gains Income (%)         (years)

 

 

 1913-21           7 - 77                  7 - 77                     --

 

 1922-33           24 - 73                  12.5                      2

 

 1934-37           63 - 79               18.9 - 23.7                  1

 

 1938-41          79 - 81.1                  15                      1.5

 

 1942-51           82 - 94                   25                      0.5

 

 1952-53             92                      26                      0.5

 

 1954-63             91                      25                      0.5

 

 1964-67           70 - 77                   25                      0.5

 

 1968               75.3                    26.9                     0.5

 

 1969                77                     27.5                     0.5

 

 1970               71.8                    30.2                     0.5

 

 1971                70                     32.5                     0.5

 

 1972-75             70                      35                      0.5

 

 1976                70                      35                      0.5

 

 1977                70                      35                      0.75

 

 1978                70                     33.8                      1

 

 1979-80             70                      28                       1

 

 1981                70                      20                       1

 

 1982-83             50                      20                       1

 

 1984-86             50                      20                      0.5

 

 1987                38                      28                       1

 

 1988-90             28                      28                       1

 

 1991-92             31                      28                       1

 

 1993-96            39.6                     28                       1

 

 1997               39.6                     20                      1.5

 

 1998-99            39.6                     20                       1

 

 2000               39.6                     20                       1

 

 2001               39.1                     20                       1

 

 2002 - 2003        38.6                     20                       1

 

 2003 (May)-

 

 through            35.0                     15                       1

 

 2008

 

 

 Source: Statistics for 1913 through 1999, The Labyrinth of Capital

 

 Gains Tax Policy, by Leonard E. Burman. Brookings Institution Press,

 

 Washington, D.C.  1999.  Statistics for 2000 through 2003,  CRS.

 

 

   Table 2.  Realized Capital Gains and Taxes Paid on Capital Gains

 

                         (billions of dollars)

 

 

                                                  Maximum

 

                Realized       Taxes Paid        Statutory

 

                Capital            on          Tax Rate (%) on

 

 Year            Gains        Capital Gains    Long-term Gains

 

 

 1955              9.9             1.5               25.0

 

 1960             11.7             1.7               25.0

 

 1965             21.5             3.0               25.0

 

 1970             20.8             3.2               30.2

 

 1975             30.9             4.5               35.0

 

 1980             74.1            12.5               28.0

 

 1985            172.0            26.5               20.0

 

 1990            123.8            27.8               28.0

 

 1995            180.1            44.3               28.0

 

 1996            260.7            66.4               28.0

 

 1997            364.8            79.3               20.0

 

 1998            455.2            89.0               20.0

 

 1999            552.6            111.8              20.0

 

 2000            644.0            127.0              20.0

 

 2001            349.0            66.0               20.0

 

 2002            269.0            49.0               20.0

 

 2003            310.0            47.0               15.0

 

 2004            381.0            54.0               15.0

 

 2005            410.0            58.0               15.0

 

 2006            438.0            63.0               15.0

 

 2007            468.0            67.0               15.0

 

 2008            567.0            81.0               15.0

 

 2009            414.0            74.0               20.0

 

 2010            511.0            95.0               20.0

 

 2011            537.0            100.0              20.0

 

 2012            562.0            104.0              20.0

 

 2013            589.0            109.0              20.0

 

 2014            617.0            114.0              20.0

 

 2015            645.0            120.0              20.0

 

 

 Source: Department of the Treasury for years 1955 - 1999.  CBO for

 

 2000-2015 from The Budget and Economic Outlook: Fiscal Years 2006 -

 

 2015, January 2005.

 

FOOTNOTES

 

 

1 See CRS Report 98-473, Individual Capital Gains Income: Legislative History, by Gregg A. Esenwein.

2 For more information see CRS Report 96-769, Capital Gains Taxes: An Overview, by Jane G. Gravelle.

3 The effective marginal tax rate (the tax rate that a taxpayer actually faces) on both ordinary income and long-term capital gains income can be higher than the statutory tax rate because of the interaction of various other provisions in the tax code.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Esenwein, Gregg A.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2005-3506
  • Tax Analysts Electronic Citation
    2005 TNT 35-22
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