EFFECTS OF CAPITAL GAINS TAXES ON REVENUE AND ECONOMIC EFFICIENCY

Abstract

timates from the literature to simulate the effective tax rate on assets that produce effects on tax revenue and economic effi- capital gain than on assets that produce ciency of a 15 percent maximum tax rate ordinary income. This distorts the choice on capital gains. In estimating efficiency among assets, leading to overinvestment effects, marginal income tax rates are ad- in gains-producing assets, and induces justed to hold tax revenue constant. The investors to incur transactions costs to results depend on the responsiveness of convert ordinary income to capital gain. capital gains realizations and corporate One important source of conversion of dividend payouts to their respective tax income to capital gain is the substitution prices. With payouts fixed, efficiency in- of corporate retained earnings for divicreases but revenue declines except with the dend payouts. Households may prefer divhighest estimated realizations response. idends to retained earnings because such With payouts endogenous, revenue de- payouts convey useful information and clines. The s@gnof the efficiency change increase shareholder control of the firm.' depends on the realizations response. The higher effective tax rate on dividends than on retained earnings, however, reNDER the U.S. income tax, as in most duces the desired payout rate. The optiUOECD countries, capital income that mal payout rate is one at which the inpeople accrue in the form of increases in formation (and other) benefits of an extra asset values (capital gains) is taxed only dollar of dividends to shareholders exwhen the gain is realized by sale or ex- actly equals the marginal net tax costs of payouts to the weighted average share