Obama Capital Gains Tax Hike Would Hit N.Y. Hard

As Senator Obama's presidential platform starts to take shape, economists and tax officials here in New York and Washington are warning that his fiscal policies could have a devastating effect on what is, in effect, New York's biggest crop — capital gains.

Mr. Obama is proposing to raise taxes on capital gains and dividends by a staggering two-thirds, moving the rate up 10 percentage points to 25%, which could curtail investment and business on Wall Street, a backbone of the city's and state's economy.

According to the Institute for Research on the Economics of Taxation, Mr. Obama's tax hike would knock off $2.5 trillion in capital formation over five years, or nearly 2% of gross domestic product.

"If we are only growing around 2% over the next five years, then we will have virtually zero growth for the period," the president of the institute, Stephen Entin, said. "This will create a permanent hit of 5% or greater to GDP."

The effect on New York will be even more acute: Wall Street accounts for nearly 9% of the city's tax revenues and up to 20% of the state's revenues; the city collected more than $3.3 billion in tax revenue from the securities industry in fiscal year 2007 and New York State collected $9.6 billion, according to New York State Comptroller Thomas DiNapoli. In addition, every job added on Wall Street results in the creation of two additional jobs in other industries in the city, and one additional job in the suburbs.

"New York does have a high fraction of its income earned from capital gains and dividends," a senior economist at the Tax Foundation, Gerald Prante, said. "New York would be one of the hardest hit areas; there is no doubt about that."

In recent weeks, the presumed Republican nominee, Senator McCain, and the likely Democratic nominee, Mr. Obama, have been disclosing more details of their tax proposals: Mr. McCain proposes extending the 2001 and 2003 tax cuts initiated by the Bush administration, including keeping the capital gains and dividend tax at 15%; he also proposes reducing the corporate tax rate 10 percentage points to 25%.

Mr. Obama is not only proposing raising the capital gains and dividend tax to 25% but will allow much of the Bush tax cuts to expire, including allowing the top individual income tax rate to return to 39.6%.

Defending his plan in a debate in April, Senator Obama spoke of the need for "fairness."

"We saw an article today which showed that the top 50 hedge fund managers made $29 billion last year — $29 billion for 50 individuals. And part of what has happened is that those who are able to work the stock market and amass huge fortunes on capital gains are paying a lower tax rate than their secretaries. That's not fair," Mr. Obama said. "What I want is not oppressive taxation. I want businesses to thrive, and I want people to be rewarded for their success. But what I also want to make sure is that our tax system is fair and that we are able to finance health care for Americans who currently don't have it and that we're able to invest in our infrastructure and invest in our schools. And you can't do that for free."

Writing in this newspaper earlier this month, columnist Liz Peek quoted the head of the Securities Industry and Financial Markets Association, Timothy Ryan, as saying that the expiration of the Bush tax cuts will lead to a $2.4 trillion tax increase over the next decade. "That's baked into future budgets, and it will come out of the pockets of the 30 to 40% of the population that pays most of our taxes. It will impact available pools of liquidity, reducing wealth in this country, and mean less money available to invest," Mr. Ryan said.

The prospect of an increase in the capital gains rate ahead could lead to a surge in revenue now as investors take their gains while the lower rate is in effect. But Mr. Entin said the effects of low capital gains rates are felt over the longer term, as well. "It reduces the cost of raising new money, which spurs growth," Mr. Entin said. "The effects of a capital gains tax cut is larger than the gains alone would indicate; there is not just a revenue effect, but how much good it does in raising wages and creating jobs."

Alternatively, under the Obama plan, "some of the capital we have put in place since 2003 will no longer be profitable and won't be replaced, and we will see wages and jobs decrease," Mr. Entin said.

The Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute, two center-left think tanks, said that Mr. McCain's proposal "could be beneficial," adding, "a lower corporate tax rate would encourage multinational corporations to invest more in the United States and, for a given amount of investment, to report a larger share of their worldwide taxable income to the United States instead of foreign treasuries."

Still, while there are some benefits to Mr. McCain's plan, there are also "budget gimmicks" that hide the cost of the cuts, said the report. The report also said the McCain plan was likely to increase the deficit, which would lead to higher borrowing costs, and dampen economic growth. Under the McCain plan, "the positive effects of lower tax rates will be offset by the costs of increased government debt," the report said.

There is a risk of an increased deficit under the McCain plan, but it would be worse under Mr. Obama, some officials said. "While you may tend to see higher revenue under Mr. Obama's plan, there will be lower economic growth, everything else being equal," Mr. Prante said.

This slower economic growth is key. "It has been shown again and again that higher taxes don't produce additional revenue," a fellow at the American Enterprise Institute, Peter Wallison, said. "Even though it may look on paper as if higher taxes increases revenue, what it really does is suppress innovation."