President Obama said a good thing yesterday. He proposed cutting taxes to small business to help spur job creation and economic growth. This is good. Very good. Here's why:
Beyond the theoretical justifications for cutting the capital gains tax, how much wealth would actually be added to the economy if we cut the current capital gains tax rate of (an average of) 15%? I estimate that every dollar of capital gains collected by the government costs the US economy approximately $6.80 in economic wealth. This is how I came up with this estimate.
For every $100 in corporate earnings, a 15% capital gains tax represents $15 that the firm could have either distributed as dividends (for a 0% net growth rate in next period’s earnings), or reinvest in the company to generate future growth (with a growth rate of 20% per year considered healthy). Most experts agree that a reasonable estimate of a sustainable annual growth rate in earnings is somewhere between these two extremes, say 5%.
I combine this 5% growth rate with a ten-year investment horizon and a discount rate of 12% per year (using the 80-year average rate of return on the S&P 500) and find that the Present Value of the annual savings of $15 in capital gains taxes is $102. So every dollar of Capital Gains protected from taxes produces approximately $6.80 ($102/$15) in new economic wealth for our economy.
This increase in economic value enables economic growth in America, while also creating more jobs for Americans as companies create more revenues to allocate to new hires and higher salaries. Every dollar that is collected by the government in capital gains taxes could have supported an additional job instead. In an economic time when the unemployment rate nears 10%, cutting the capital gains tax and increasing the production value of our economy is critically important.
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