Newswise — By Dr. Robert E. Pritchard, Professor of FinanceRowan University
Dear President-Elect Obama:
One way you can stimulate the economy at very little cost is to lower or, at minimum, freeze the existing tax rates on long-term capital gains. This will result in very little reduction in tax revenues while significantly stimulating the economy. Please include this in your economic stimulus package.
When you campaigned you indicated that you wanted to increase the federal tax rate on long-term capital gains from the current maximum of 15 percent rate to 20 percent. This proposal continues to dampen any upward movement of the stock markets. Investors measure returns in after-tax dollars. Since they do not know the future of the tax rates on long-term capital gains, they are reluctant to invest. Trillions of dollars sit on the sidelines waiting for signs of economic growth and for resolution of the capital gains tax issue.
Since investors hate uncertainty, not knowing how you will change long-term capital gains tax rates continues to contribute to a depressed stock market. Your campaign proposal hangs like a large black cloud over the investment community.
Now, you are considering tax reductions to stimulate the economy. If you lower the maximum tax rate on long-term capital gains to 10 percent (or, at minimum state that you will freeze them at their present rates) for as long as you are president, this will immediately buoy stock markets throughout the world.
Right now " before you become president " you could announce that you will not increase the maximum tax rate on long-term capital gains, and the result would be immediate. Your statement alone will stimulate the stock markets!
Increases in stock values are critically important to economic recovery. They will increase the wealth of those 100+ million Americans who have or depend on individual retirement accounts and/or are enrolled in company 401(k) and similar defined-contribution retirement plans. Those already retired will be able to draw more from their accounts " money they are likely to spend, thereby stimulating the economy. Furthermore, those who are planning for retirement will feel more secure as the values of their retirement savings increase. The "wealth effect" will kick in as their portfolios increase, and they too will spend more money. Again, the economy will be stimulated.
In addition, all of millions who are covered by defined-benefit pension plans, such as those provided for state, county and municipal workers as well as by many businesses, will feel more secure. Defined-benefit plan portfolios shrunk by hundreds of billions of dollars during the past 14 months. Existing and future pensioners depending on these plans are becoming fearful that they will not collect promised future retirement benefits. This is really scary. Knowing that their defined-benefit plans are heading toward being fully funded will add to their security and their spending.
What about the possible loss in revenues that could happen if you lower the maximum tax rate on long-term capital gains rates to 10 percent? Most taxable long-term capital gains are enjoyed by upper-income/wealthier taxpayers. Thus, one might argue that decreasing the tax rate on long-term capital gains would primarily benefit the wealthy. As demonstrated below, that argument is seriously flawed.
First, the operative term is "taxable long-term capital gains." Increasingly, long- term capital gains are not taxed as capital gains. Rather, they are taxed as ordinary income. The reason for this is that the taxes on those capital gains resulting from the investment of trillions of dollars held in defined-benefit and defined-contribution retirement funds are all deferred " deferred until a pensioner receives income from them. And this retirement income is taxed as ordinary income.
Second, those wealthier investors who do enjoy taxable capital gains are more likely to take those gains and pay taxes on them if the tax rates are lower. Long-term capital gains differ from other sources of income. With respect to taxation, until a long-term capital gain is actually realized, a tax liability is not incurred. Lowering the maximum tax rate on long-term capital gains will stimulate investors to take gains and pay the tax.
So, Mr. President-Elect, I ask you to take immediate action and freeze the current maximum rate on capital gains taxes. This will not only have a buoying impact on the stock markets but will also enhance confidence in you throughout the world " confidence needed to stimulate spending and revive our great nation.
NOTE: Pritchard is the senior member of the Rohrer College of Business faculty at Rowan University, Glassboro, N.J. He completed both his undergraduate degree in physics and an M.B.A. at Drexel University, his M.A. in applied economics at the Wharton School of Business at the University of Pennsylvania and his doctorate in education administration at the University of Pennsylvania. Pritchard has authored/co-authored nine books in the fields of finance, small business management and marketing and has written more than 250 trade journal articles. He has consulted and provided financial training for many businesses and trade associations throughout the United States. Pritchard's research interests include real estate, personal financial management, retirement planning and Social Security. He specializes in applied financial research and pedagogical research principally pertaining to the teaching/learning processes in business and finance.