The Long-run Impact on Federal Tax Revenues and Capital Allocation of a Cut in the Capital Gains Tax Rate

Model simulations are run to obtain a range of realistic estimates of the long-run revenue impact of a capital-gains tax-rate cut to a maximum of 15 percent. The basic vehicle for the simulations is a slightly modified version of the Galper-Lucice-Toder (GLT) general equilibrium model. The key behavioral assumptions affecting the estimates are: (1) the portfolio and tangible capital reallocations implicit in the structure of the GLT model, (2) corporate payouts responses based on recent empirical estimates, and (3) illustrative noncorporate recharacterizations of regular income as capital gains. The essential message of this paper is that the strong emphasis in the literation on the realization response to a capital gains tax rate cut has been appropriate. The payout/recharacterization and portfolio redistribution/reallocation effects do not appear to be large. Moreover, the portfolio responses, within the context of the GLT model, act to raise tax revenues (substitution of taxable business capital for tax free household and state and local capital), not lower them as has been conjectured. Thus these responses offset the payout/recharacterization effects, leaving the realization response as basically the total response. Future research could, of course, modify this finding.