The increase in the average effective tax rate, from 15 to approximately 22 percent, was accompanied by a decline in realized gains as a percent of GDP, as shown in the last column of the table. For the eight years from 1978 to 1985, realized gains as a percent of GDP averaged 3.1 percent, but for the eight years from 1987 to 1994 these gains averaged only 2.6 percent of GDP, a decline of about 20 percent. Table 1 also shows that many capital gains are realized by taxpayers who are not in the highest tax bracket. Yet, as is indicated by the third column of the table, the average effective capital gains tax rate never exceeded 23.9 percent. Evidence presented by Len Burman and Peter Ricoy at an AEI conference last summer provides further evidence that capital assets are held by taxpayers all across the income spectrum.
Capital gains are one of the primary rewards for economic risk-taking.
Investors take risks by purchasing assets today with the hope and expectation that these assets may appreciate over time. If the asset appreciates, the investor has a capital gain. Otherwise, the investor has a capital loss. Capital gains taxes reduce the reward for risk-taking, thereby reducing incentives for investment and raising the cost of capital for borrowers. Nowhere are the harmful effects of the capital gains tax more severely felt than in many of the new high technology sectors of the economy.