The Effect of Increases In The Capital Gains Tax On The Effective Tax Rate For Investments In Different Types of Firms

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Abstract

The capital gains tax rate for higher income taxpayers increased from 15% to 23.8% in 2013. Increasing the capital gains rate is thought to decrease investment, but others disagree. This research addresses the issue by constructing a mathematical model of an investment, derives the effective tax rate, and analyzes the changes in the effective tax rate when the capital gains rate changes.

This research has three basic findings. First, increasing the capital gains tax rate does not necessarily increase the effective tax rate. Second, increasing the capital gains rate always increases the effective tax rate for firms that grow, but has differing effects on firms that decline in value. Finally, increasing the capital gains tax rate has no effect on firms that pay increasing dividends.

These results may have implications for the creation of new capital. An increase in the capital gains rate may diminish the supply of capital for growth companies and shift that capital to more mature firms.

Author

• J. Kent Poff, University of North Georgia