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Spring 1991
City Journal Spring 1991.
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  N ew York Views

The Big Apple Tax
Lawrence Kudlow
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A majority of New York’s congressional delegation opposes President Bush’s proposal to cut capital gains tax rates from 28 percent to 19.6 percent. On one level that is unsurprising; capital gains has become a partisan issue. A close analysis, however, shows that the New York economy—and the state and city treasuries—would benefit enormously, and far more than most states, from Bush’s proposal.

In most years, New York State accounts for significantly more of the total capital gains taken in the U.S. than its population would suggest. In 1987, 9.2 percent of all U.S. capital gains were taken in New York, though the state accounts for only 7 percent of the nation’s population: New Yorkers hold a disproportionate share of the nation’s financial and real estate wealth.

If a cut in the federal capital gains tax rate prompts people to take more capital gains, as nearly all economists agree it would, the city and state treasuries will benefit greatly. An analysis performed by the White House but based on data and assumptions provided by the Congressional Joint Committee on Taxation, dominated by Democrats, found that this boom would amount to $649 million for the state in 1991, and $120 million for the city. These figures are based on the committee’s belief that the federal cut would cause a 30 percent increase in the volume of capital gains realized throughout New York. Using more dynamic growth assumptions, my own estimate for the revenue benefits is closer to $1 billion in the state and $500 million in the city.

The real benefits to New Yorkers, however, would far exceed these short-term gains to the coffers of government. A cut in the capital gains tax would do more than prompt people to cash in paper capital gains that they had avoided realizing because of higher tax rates. (The combined net statutory capital gains tax rate for the federal, state, and city governments has risen from 28.9 percent in 1986 to 36.4 percent currently.) It would help rebuild New York’s economy, dramatically so because of the type of business we do here.

The bulk of the relevant mainstream academic research shows that a federal capital gains cut would lower capital costs and enhance incentives for capital formation, thus raising national income, increasing the rate of growth, and generating new jobs. This is obviously so as regards the financial services industry, so important in New York: The higher capital gains tax rate not only reduces capital returns at the point of sale, it is a penalty on capital transactions. The combination of these effects has caused asset markets to stagnate.

Higher after-tax capital returns would also raise property values and improve bank balance sheets, another boon for the local economy. Lower-income New Yorkers, and our new flood of immigrants, would also benefit if capital providers were induced by higher after-tax rewards to take risks by supplying start-up money for minority-owned shops, service companies, high-tech manufacturing firms, and other growth enterprises. The New York City Office of Business Development reports that the number one concern of immigrant small businessmen is the scarcity of capital for new ventures.

The payback on such enterprises comes mainly in the form of capital gains (rather than the dividends or interest paid out by more established firms), which is why a lower capital gains rate historically has stimulated such investments. Indeed lower capital gains rates should be a central ingredient in New York’s effort to fight poverty and urban decay, since new and growth companies create far more jobs than mature firms. Of course these deeper effects on the economy would produce additional revenues for the state and city.

The past decade yielded dramatic evidence of the power capital gains tax rates have over New York’s economy. From 1978 through 1981, the Federal Government put into place dramatic reductions in the federal capital gains tax rate. In the next seven years, total reported taxable capital gains in New York State rose more than fourfold, from $3.1 billion in 1981 to $15 billion by 1988. But in the late 1980s, both the New York state and federal governments effectively raised rates. By 1990 total capital gains had fallen to $11 billion.

All told, Bush’s proposed cut could be the fastest way to restore tens of thousands of jobs the city has lost since 1987. It would bolster financial markets, banking, real estate, and minority groups and reduce the city and state deficits. Indeed, these effects would be even greater if the state and city capital gains taxes were reduced or eliminated.

If there were ever a national issue on which New York’s local interests were clear, this is it. For New Yorkers to oppose a cut in the federal capital gains tax rate makes about as much sense as Texans lobbying for a tax on longhorns.

 

 


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