Technical Note on the Economics of Taxing Capital Gains

This technical note describes how, under the current system of capital gains taxation, capital gain income is taxed at lower rates than labor income—and only upon realization of the gains and with a step-up in basis at death. This system distorts the economy and contributes to inequality. Lower tax rates on capital gains income do not yield economic growth, as proponents of the current system suggest. In fact, an IMPA analysis projects that higher tax rates on capital gains would be mildly expansionary. Eliminating tax preferences for capital gains income would reduce inequality, correct the inefficiencies created by the realization-based system, and raise significant revenue, all without sacrificing economic growth.