Q: What do you think of the president’s proposal to raise capital gains and qualified dividend tax rates for high income earners to 44.6%?

A: First, it is unlikely to become law, barring a strong democratic majority in the next Congress. Second, a 1988 report by the Congressional Budget Office found that increasing capital gains rates reduced the number of realizations. This means fewer transactions generating taxable gains. Though the data from that report is old, it makes behavioral sense in our experience and more recent projections support the conclusion. Realizing capital gains is elective. In most cases, we can choose when to realize a gain. If tax rates are unattractive, we simply hold the asset longer. This is why revenue estimates for tax changes are so unreliable. They are are based on current patterns of behavior.

Some argue that capital gains should not be taxed differently than income. Being fans of lower taxes generally, we think lower long-term capital gains rates encourage better investor behavior through longer-term thinking. Changing the tax law in this way would also have a negative effect on many business owners who experience a major windfall event, such as the sale of a business. For those individuals, such an event is often a one-time experience and hardly a habitual abuse of the tax system.

Whether higher earners should pay more is another question, but given the potential for fewer taxable events, the higher tax might not achieve its stated aim and so does not seem like the best policy. We will look at qualified dividends later.