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

Abstract

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-Lucke-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, and (2) household realization and corporate payout responses based on recent empirical estimates. The essential message of this article is that the strong emphasis in the literature on the realization response to a capital gains tax rate cut has been appropriate. The payout 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 untaxed household and state and local capital), not lower them as has been conjectured. Thus these responses offset the payout effects, leaving the realization response as basically the total response. Future research could, of course, modify this finding.