Iriemon

For years conservatives have been pushing ever more lower tax rates on capital gains (and investment) taxes, arguing that doing so incentives investment. We've seen that argument many times here.

Were they absolutely right? If so, is that a major factor in the two recent causes for economic problems, the stock market bubble in the late 90s and now the real bubble?

In 1986, Reagan's simplified tax code taxed investments (capital gains and dividens) at the same rate as earned income.

Now the top tax rate for capital gains is 15%, less than half the top tax rate income is taxed at.

What is the incentive created when investment taxes are less than half of earned income taxes? If you can speculate in an investment, and be taxed at half the rate if you worked for the same income, what are folks incentivized to do? Speculate on investments.

Which is exactly what has happened.

Buy a $200k house on credit with no or little money down, flip it a year later for $300k and pay a maximum 15% tax on your profit. Beats working and paying up to 33%.


If our tax code was like Reagan had it, where investment and capital gains taxes were the same rate as earned income taxes, would we have seen the same degree of speculation in the real estate market (or even the stock market in the late 90s)?

My guess is you won't see this issue raised in the coservative financial media.

__________________
Matthew 5:9

Solidus

A couple things.

1) As of 1997 the capital gains tax on Home sales can easily be 0% not 15%. [1]
2) "Conservative" (based on how much they bash Clinton instead of the Republican Congress at the time) publications have noted it. [2], [3]
3) You're only half right.

Allow me to expand on #3. The issue here isn't so much the difference between investment rates vs. wage rates; but housing investment vs. other forms of investment. There are, of course, a multitude of factors in our current situation, from Land Use regulation to Tax codes to plain old wishful thinking.

So to answer the thread title ... No. Low capital gains taxes on housing are a factor. Low capital gains taxes on stocks (or other investments) are not.


[1] Selling Your Home - Capital Gains Tax on the Sale of a Main Home
[2] The Clinton Housing Bubble - WSJ.com
[3] A Housing Boom Built on Folly

Iriemon

I agree that there are other tax benefits to your primary residence, but I don't believe they apply to non primary residences such as those bought and resold for speculative purposes.

But if you acknolwedge that tax incentives in favor of housing over other investments such as stocks are a factor in incentivizing behavior, why wouldn't tax incentives favoring investment over earned income also incentivize behavior?

Solidus

I didn't mean to imply it didn't. Lower taxes on capital gains in general does provide an incentive to invest. However, there is comparatively little "substitution effect" between working and investing; compared to investing in asset A instead of asset B.

Again, the contributing factor isn't people quitting their job to flip houses. It's people choosing real estate instead of other investment vehicles.

J

Iriemon

If you are saying that lower cap gains does not incentive more investment then the argument for lower cap gains tax disappears and its silly to have a lower investment tax that just reduces revenues our government desparately needs while giving an unnecessary tax favoritism to trust fund babies and hedge fund managers.

If lower cap gains tax does incentive more investment, then you have to wonder whether part of the speculation was fueled by this tax incentive.

donsutherland1

Iriemon,

You raise a good topic for discussion concerning the recent housing bubble.

My guess is that there were some modest effects from 1980s and 1990s tax law changes, as well as distortions (deductibility of mortgage interest, large one-time exemption from the sale of a home, etc.). Tax deductibility offered purchasers a cushion from the full cost of higher interest payments on increased mortgage debt.

However, I suspect a much larger combination of factors i.e., regulatory gap/major financial liberalization in the absence of a gradual transition process, fundamental risk management problems (over-reliance on quantitative modeling, under capitalization, etc.) technological/financial market innovation, overly accommodative monetary policy that fueled and sustained a massive credit boom, and changes in investment flows following the Asian financial crisis and contraction of the dot.com bubble in the U.S. played a central role. Borrowers, investors, lenders, regulators/policy makers all contributed to the rise of the housing bubble that imploded and precipitated the current financial crisis.

In any case, if one examines data concerning mortgage debt as a share of GDP, one finds that the escalation in that indebtedness began to accelerate in the late 1990s (around the time of the Asian financial crisis).

Mortgage Debt as a % of GDP:
1980 52.3%
1981 50.5%
1982 51.0%
1983 52.3%
1984 53.2%
1985 56.1%
1986 59.5%
1987 62.4%
1988 64.2%
1989 64.6%
1990 65.5%
1991 65.9%
1992 64.0%
1993 63.0%
1994 61.6%
1995 61.5%
1996 61.6%
1997 61.8%
1998 64.2%
1999 67.2%
2000 69.2%
2001 74.0%
2002 80.2%
2003 85.8%
2004 91.3%
2005 97.5%
2006 102.6%
2007 105.8%
2008 103.4% (Q2)

From the data, one finds:

• A rebound in mortgage indebtedness following the end of the 1980-81/1981-82 recessions and 1986 Tax Law changes.

• A peaking in mortgage indebtedness following the start of the 1989-94 housing bust.

• Gradual de-leveraging and then generally stable mortgage indebtedness in the wake of the 1989-94 housing bust.

• A renewed rise in mortgage indebtedness that closely followed the Asian financial crisis (1997-98), capital gains tax cut (1997), and repeal of the Glass-Steagall Act (1999), among other financial system liberalization.

• The trend accelerated as the dot com bubble was peaking in 2000 and then imploded in 2001.