Understanding Pro-Growth Tax Reform

The weak economic recovery of the past four years drives the central question of this election: How will we get our economy back on track and get America back to work? Tax policy is instrumental in shaping the health of our economy as it influences the economic decisions of every household, from purchasing groceries to buying a home, or saving and investing for long-term costs like college and retirement.
One of the key features of the Governor Romney’s approach to tax reform focuses on providing incentives for saving and investment. As the merits of different tax reform proposals are debated during this important election, much attention is being paid to the tax rate on capital gains – income that many Americans receive when they sell assets like stocks, bonds or real estate.
The current tax rate on capital gains is 15%, a rate that many correctly observe is lower than the top marginal rate of 35% paid on ordinary income from wages and salaries. The problem, however, in comparing these two tax rates is that the profit a person receives through capital gains was often first earned – and taxed – as corporate profits.
Take for example the common investment of corporate stock. When a company does well and earns a profit, that profit is taxed at the corporate rate of 35%, and the remaining earnings are reflected in the company’s increasing stock price, helping to generate higher value for shareholders.
When an investor decides to sell a stock for a profit, the difference between the price paid for the stock and the price at which the stock was sold is characterized as capital gains. As many Americans know, this capital gain is reported on individual income tax returns and is taxed – again – at the rate of 15%.
So for every $100 of profit earned by a company, it is first taxed at the corporate rate of 35%, leaving $65 for the corporation to use as it sees fit to bring value to shareholders. When a shareholder sells his stock, that $65 in remaining corporate profits is taxed again at the 15% capital gains rate, bringing the amount that the investor actually gets to enjoy down to $55.25. And, of course, before even investing in the stock, the investor would have already paid taxes on the wages or salary they earned in order to pay for the investment.
This practice of taxing the same dollar twice is known as a form of double taxation that results in a potential effective rate of 44.75% that is much higher than the 35% top marginal tax rate on ordinary income.
The debate about capital gains is about more than just what rate or the number of times profit is taxed; it goes to the heart of what economic activity we, as a nation, value and want to encourage. To get the American economy back on track, we need robust investment in entrepreneurs and businesses that are primed for growth and we need to reduce the risk that such investments raise.
Even the President’s own economic advisors recognize the value that low capital gains tax rates can have on the greater economy. As far back as 1981, Larry Summers – the President’s first National Economic Council Director – wrote that eliminating taxes on capital income “would have very substantial economic effects” and “might raise steady-state output by as much as 18 percent, and consumption by 16 percent.”
More recently, the President’s Jobs Council – led by GE Chairman and CEO Jeffrey Immelt – recommended making permanent the capital gains exemption for investments in qualified small businesses. According to the Jobs Council’s rationale, “capital is the critical fuel that lets breakthrough ideas become the breakaway companies that create the lion’s share of new American jobs.”
Conversely, raising the capital gains tax as President Obama proposes to do from 15% to 23.8% will hurt the already sputtering economy. According to economist Allen Sinai, raising the capital gains rate by just 5 percentage points to 20% reduces economic growth by 0.05 percentage points annually, kills an average of 231,000 jobs per year, and has a negative effect on the federal budget deficit.
In the end, jobs is what this whole debate is about – how to create them, how to sustain them, and how to encourage more capital to flow in the economy so we as a nation can enjoy the benefits of strong growth and higher wages. Under Governor Romney’s fundamental tax reform plan, capital gains rates are held steady at 15% for many Americans, and totally eliminated for middle-class joint households earning $200,000 or less. This will encourage more Americans to invest, save, and plan for the future, and is a key element of Governor Romney’s economic plan that will help create 12 million jobs in his first term.

Pierce Scranton is the Economic Policy Director for Romney for President, Inc.