McCain Subscribes to the Gibsonian School of Economics

You have to wonder if the folks at ABC have dipped into the ranks of tabloidesque journalism for the sake of their own personal bank accounts. It would make sense.

On top of the debate/debacle that occured last week was also a sit down one-on-one with John McCain. Now, I didn’t watch it, and I had read in a few places that McCain actually got a couple of tough questions, but when it came to capital gains, Stephy was all about giving McCain room to spout off the same Republican talking points while at the same time delivering an “Out of touch” dig on Obama.

Well, at least they’re fair and balanced. Also, where the hell are the flag pins? If Obama’s going to get slimed in the middle of a debate for not wearing a flag pin, I expect McCain to receive the same treatment.

Anyway. The fortunate aspect of this is that it allows me to continue upon a topic that we began last week in the capital gains tax. Gibson, who went ten shades of pitbull on the subject, made much ado about how revenue goes up when capital gains taxes go down.

My wonderful colleague DrGail immediately came back with what I thought was a pretty stellar counter argument to that:

I think I found out the answer to the capital gains tax rate vs. revenue issue: Capital gains accrue when an asset is sold. Except in a few specialized instances, people have a choice about when to sell an asset. If they know the capital gains tax rate will be going down as of a certain date, they are likely to sell assets AFTER that date rather than before it, in order to minimize the tax due. So the increase in revenues experienced once the capital gains tax rate goes down is largely due to the fact that more people are selling assets.

Short answer: Charlie Gibson was technically correct, but his statement reflects an artifact.

In a retort to this argument, however, the Heritage Foundation’s Conn Carroll reaffirmed the value of the individual data points that Gibson used to make his argument, while falling almost perfectly into the old Republican formula I had mapped out by calling the cap gains taxes a punishment.

Left unresolved, however, is the fact that these individual data points of revenue increase are being treated as though they are solid state trends, or, that because it happened twice, it should be assumed that it happens like this all the time.

Now, like McCain, I freely admit that I don’t know much about the economy (unlike McCain, however, I’m not running for president in a country whose economy is being accompanied by the sound of a flushing toilet), though I think there are a few concepts here that do not require a doctorate in economics to think through.

Besides, practice makes perfect and all that jazz.

If you’ll remember, our prime counterargument was simply that, yes, revenue does go up when cap gains taxes are dropped because when people know the cap gains taxes are going to drop, they hold off on making transactions until after the cut in order to pay less in taxes.

Makes sense right? But according to some this seems as though it should be a permanent effect. But the next question that must be asked is, what governed the rate of transactions before the tax rate drop was made public?

Answer: It doesn’t really matter, all that really matters is that some forces outside those of government imposed taxes were governing the state of the market. And that’s why the argument that began with Gibson was a flawed argument and remains so. In order for Gibson, Conn, and McCain to be effectively right, one has to assume that taxation is the prime influence on the rate of capital gains transactions.

Somehow, I don’t think that’s the case. It could be if you were to run taxes up so high so as to make such transactions effectively extinct, or unprofitable to engage, but outside of that, what’s going to happen is that the market is going to react to whatever the government does, and then, after an initial reaction faze, it’s going to essentially assimilate itself to the new tax rate and go back to being governed by other market forces.

In other words, most the time the market is going to do what it is going to do, and people who do the whole capital gains transaction thingamabobiwhosits are going to do what they do based on whatever it is they base their actions on. No one bases their decision on the tax rate because it’s constant; it’s going to take its constant share, and move on. So while the rest of the market forces are dynamic, the cap gains tax remains static and therefore a fixed factor in the behavior.

But when the tax cut is announced, all of a sudden it becomes a dynamic factor and everyone says, “OOOH we can make more money if we just wait until after the tax is dropped!” They wait, the tax rate drops, they sell, buy, or do whatever those people do, they make their money, the government benefits from a flood of new transactions and everybody is happy.

But on the next day new transactions come to the table. People look at the government, the government looks back at them and says, “What? I’m not doing anything,” and they then go back to doing whatever it is that they are doing.

So I think you have to employ something of the frog in boiling water principle here. Remember, people do not react to gradual changes, but they do react to rapid ones. As a result, if you really want to create a system where we are picking up more revenue from capital gains, the trick is to establish a certain level that provides an optimal amount of revenue collection without overtly impeding the market and you just leave it there. Only when you need to inject some heavy activity either to punch up revenue or stimulate the market or whatever other reasons out there that may be do you drop the cap gains tax.

This will result in the kind of surge that all the cons are talking about which would drive up transactions and while you’re picking up a smaller percentage of each, there’s a whole lot more of them so you get a quick boost. Then, while the market is shifting back from where the taxation is a prime motivating force to where the rest of the market forces are governing everything, you slowly creep up the cap gains tax rate back to where it originally was.

This should work because the only time revenue is going to go up when cap gains go down is when the revenue is going up BECAUSE the cap gains tax went down. In all other times, as long as the taxation rate isn’t too much of a burden, it’s not going to have hardly any effect on the market at all, so more revenue will be generated by a higher tax rate.

Pretty simple huh?

3 Responses to “McCain Subscribes to the Gibsonian School of Economics”

  1. Fargus says:

    Also, you’ve got to look at the context of what was going on when the rates were dropped. Namely, bubbles. Dot-com and housing, respectively. The market was going up independently of the change in the capital gains tax, and there’s nothing in Charlie Gibson’s formulation that asserts that revenue was higher with the tax cut than it would have been without it. Only that taxes were cut and revenues went up. That formulation ignores any other possible contributing factors, of which there are many.

  2. well from what i have discertned thus far, he has no understanding of the diff between macro and micro economics. and dont talk about indicators that reflect a recession — love the new digs folk

  3. Here’s an article from last year that explains the reason why taxes (collected) go up when rates go down. It has some good references on the laffer curve which shows how there is a “sweet spot” to have a tax rate before increases cause returns to sink. (Ask Nixon’s folks about the 49% capital gains rate and how much it collected).

    There are two reasons why collections go up when the rates go down. Your explaination (holding until the rate drops, selling before it rises) is one of them, but would only explain a short term increase in collections. After that, revenue should level off, but it doesn’t.

    The reason they continue to rise is that it takes less time for an investment to be worth selling with a lower rate. People are more willing to sell the investment earlier, usually to reinvest, with a lower rate because it takes less time to make up what they lost in taxes on the investment. Because investments are rolled faster, the taxes (at a lower rate) are collected more often than at a higher rate. The net effect ends up being more tax income on the lower rate.

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