Tax Capital Gains and Dividends at Ordinary Income Tax Rates

Long-term capital gains and qualified dividends face different brackets and rates than ordinary income, in part to offset some of the double taxation of saving and investment that occurs under the income tax system.

This option taxes capital gains and dividends at ordinary income tax rates for all taxpayers. Taxing capital gains at ordinary income rates would interact with several parts of the current tax code, including the alternative minimum tax, in ways that increase marginal tax rates on labor and pass-through business income, discouraging work and investment. It would also increase marginal tax rates on saving, reducing the incentive to save. A higher capital gains tax rate would discourage capital gains realizations, leading to revenue losses in the first few years of the budget window, but revenue gains in later years. Although a smaller budget deficit would partially offset the decline in domestic saving, net GNP would fall because of the decline in economic output and lower domestic saving.

Over the decade, on a conventional basis, it would decrease the primary deficit by $137.0 billion over the budget window. Long-run GDP would fall by 0.1 percent and long-run GNP by 0.3 percent. On a dynamic basis, the primary deficit would decrease by $75.4 billion from 2027 through 2036, $61.6 billion less than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 174.8 percent by 2056.

Initially, reflecting the swing in realizations and initial revenue loss, some higher-income taxpayers would see increases in after-tax income, reflecting the change in capital gains realizations. Over time, however, taxpayers would see decreases in their after-tax incomes of 0.1 percent on average by 2036. The top quintile of taxpayers would experience a 0.1 percent decrease, whereas the bottom quintile would experience a less than 0.05 percent decrease. On a long-run dynamic basis, taxpayers would see a 0.2 percent decrease on average.