TAXES, CAPITAL GAINS REALIZATIONS, AND REVENUES: A CRITICAL REVIEW AND SOME NEW RESULTS

A capital gains tax cut is once again on the legislative agenda. Proponents of a tax cut claim that it will lead to increased saving and investment, increased entre-preneurial activity, and consequently higher government revenues. Unlike in debates earlier this decade, current advo-cates of a capital gains tax cut seem not to be pushing the idea that increased capital gains realizations alone are suffi-cient to cause revenues to rise in re-sponse to a lower tax rate. Current oppo-nents of a tax cut, on the other hand, maintain that a lower capital gains tax rate will have few positive incentive ef-fects, will induce an inefficient allocation of investment, and will lower taxes paid by the well-to-do. The equity argument of opponents, therefore, does rest on the assumption that capital gains realizations are not sufficiently sensitive to the capital gains tax rate to cause revenues to rise in response to a lower tax rate. This paper reviews what is known about the relationship between capital gains re