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The Reality of Raising Taxes at the Top, Part 3: Would Tax Increases Affect Savings and Investment?

The second installment in this series on how tax increases at the top might affect economic growth noted that changes in tax rates don’t substantially affect high-income people’s decisions about how much to work.

Today, we’ll consider their potential impact on savings and investment.  Opponents say that raising the capital gains and dividend rates — which would primarily affect high-income taxpayers, since they receive most of the capital gains and dividend income — would discourage saving and investing, thereby slowing the economy.

But the research doesn’t support that claim, as our new paper explains.

Capital gains tax increases do reduce after-tax returns to saving, and this may cause some taxpayers to save and invest less. But, other people may save and invest more in order to reach a certain savings goal, balancing out those who scale back. On the whole, the Congressional Research Service (CRS) concludes that capital gains tax rate increases appear to have “little or no effect” on private saving.

This squares with billionaire investor Warren Buffett’s observation:

I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 [they are now 15 percent] — shy away from a sensible investment because of the tax rate on the potential gain.  People invest to make money, and potential taxes have never scared them off.

Moreover, what matters for economic growth is the impact of tax increases on national saving, or the sum of public and private saving.  If the federal government devotes the revenue generated by tax increases to reducing deficits (which represent public “dissaving”), the resulting increase in public saving is likely to more than offset any reduction in private saving.

That’s why the CRS concludes, “capital gains tax increases likely have a positive overall impact on national saving and investment.”

Looking for a link between capital gains tax rates and economic growth more directly, tax expert Professor Joel Slemrod concluded that “there is no evidence that links aggregate economic performance to capital gains tax rates.” Similarly, capital gains tax expert Len Burman has explained on his blog, and reiterated during a conference call for journalists earlier this week that “there’s no obvious relationship between capital gains, tax rates, and the rate of economic growth.”  (You can listen to the call here.)

As our paper discusses, there is also no sound evidence that increasing top income tax rates depresses saving or investment.

Our next installment will look at how tax increases at the top might affect small businesses and entrepreneurship.