How Much Do Capital-Gains Taxes Influence Savings Rates?

The fact that Mitt Romney’s effective tax rate is only about 15 percent has sparked debate on two related policy issues. One is, does it make sense for capital-gains income to be taxed at a lower level than “ordinary” income, and the other is whether hedge-fund and private-equity managers should be allowed to classify a large share of their fees as capital income. On the second point, the so-called “carried interest” loophole, I think there can be no real debate. I’m sympathetic, on the other hand, to the claim that it makes sense for the tax code to encourage savings and investment. But it is extremely difficult to find convincing empirical evidence that the capital-gains tax rate is all that important in doing so.

Take a look, for example, at this 2008 report from the American Council for Capital Formation arguing that we need to cut capital gains taxes in America. You’ll find that in the Netherlands and Germany they had a 0 percent rate, whereas in Denmark it was 45 percent and in Sweden it’s 30 percent. These are very different numbers across Northern Europe, and they lead to pretty similar social and economic outcomes. On the other hand, Germany’s savings rate is in fact much higher than Denmark’s:

But there’s a catch! Germany started charging capital-gains tax in 2009 and implemented a 25 percent rate on new investments. This seems to have changed nothing at all. I would also note that while when talking about the United States, we often hear about the impact on savings incentives of capital-gains taxes; when talking about China people generally attribute the high savings rate in part to the extraordinarily depressed yields that savers can earn in China’s state-dominated banking system. Indeed, when it comes to personal financial advice, Americans are typically told that lower expected real yields are a reason to save more not less, since the lower the real yield, the more money you’ll need to save to retire comfortably.

My bottom line is that while I’m not generally a deficit hawk, cutting the capital-gains tax rate without any budget offsets, as the Bush administration did in 2003, is incredibly irresponsible. Capital-gains tax cuts are extremely regressive, so if you really are a big believer in the growth-sparking impact of lower rates, the reasonable thing to do is offset the budgetary impact of the cut with a big progressive hike in ordinary income tax rates. If you’re not willing to do that, then you’re really just offering rich people a giveaway. Incurring the massive direct dissavings involved in a deficit-financed tax cut in exchange for some very-possibly-not-there incentive effect is crazy.