The top federal tax rate on capital gains is set to increase from 15% to 23.8% in January. The expiration of the Bush tax cuts will push up the rate by 5 points, and the new ObamaCare investment tax will add an additional 3.8 points.
Some policymakers view low capital gains taxes as an unfair loophole. But capital gains are unique, and low rates on gains boost entrepreneurship, investment and growth.
The average tax rate on capital gains among the 34 nations of the Organization for Economic Cooperation and Development is just 16.4%, By contrast, the U.S. rate including both federal and state taxes will jump to 27.9% next year.
U.S. policymakers need a refresher on why capital gains tax rates should be kept low.
1. Inflation. If an individual buys a stock for $10 and sells it years later for $12, much of the $2 in capital gain may be inflation, not a real return. Inflation — and expected inflation — reduce real returns and increase uncertainty, which suppresses investment, particularly in growth companies.
One solution is to index capital gains for inflation, but most countries instead roughly compensate for inflation by reducing the statutory rate on gains
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