Examining the Relationship Between Effective Income Tax Rates & Capital Gains Realizations

The relationship between capital gains realizations and the effective income tax rate is one that has been thoroughly explored by economists in recent years to better understand how to enact effective policy. Capital gains are commonly defined as profits from the sale of property or investments and are realized when they are sold for either a profit or a loss. Realization does not account for any fluctuating asset prices between the time that the asset was acquired and when it was sold, it only entails the value of the asset at the time of sale. When capital gains are sold for a net profit, they are taxed as individual income and generate tax revenue, making them a policy variable of considerable interest. Policymakers have long since speculated that raising the effective income tax rate could result in individuals holding their assets for a longer period of time, rather than realizing gains on their assets. This assumption has led to the exploration of the relationship between capital gains realizations and the effective income tax rate, with hopes of establishing better tax policy at both the state and the federal levels. In this experiment, I suggest that policymakers can increase tax revenue by lowering the effective capital gains tax rate rather than raising it. Based on previous literature, raising the income tax rate can lead to individuals holding on to capital longer rather than realizing their gains