How Do Capital Gains Taxes Affect Workers?

Assuming that the capital gains tax reduction would lower the cost of capital and stimulate additional investment and business formation, what would be the effect on jobs?

Several forecasters have attempted to estimate through economic simulation models the direct employment gain from a capital gains tax cut.

In 1994 Gary Robbins and Aldona Robbins, formerly economists with the U.S. Department of the Treasury, performed an economic simulation to estimate the number of new jobs and the increase in economic growth that would result if the Contract with America's capital gains tax provisions were adopted. The Robbinses' analysis was based on calculations of the fall in the service cost of capital for a wide range of corporate investment opportunities in response to the rate reduction. They then translated the lower cost of capital calculations into estimates of the impacts on gross national product and jobs by employing the standard Cobb-Douglas production function to simulate the long-term economywide production process.

The Robbinses' conclusion is that the GOP capital gains tax cut would, by the year 2000, reduce the cost of capital by 5 percent, increase the stock of capital by $2.2 trillion, and yield an extra $960 billion in national output. The increased capital formation triggered by the tax cut would give rise to 720,000 new jobs.

Historical experience also confirms that the corollary is true as well: when the capital gains tax rises, job opportunities are reduced.

Affects not jobs but wages

In the long term the real impact on workers of a change in the capital gains tax is reflected not in jobs but in wages. Consider the chain of events when the capital gains tax is raised:

The higher tax lowers the expected after-tax return for the owner of capital.
The lower rate of return on capital leads businesses to reduce their purchases of capital--equipment, computers, new technologies, and the like. In the very short term firms may use less capital and more labor to produce goods and services.
Because capital is more expensive, the cost of production rises and output falls.
Because workers have less capital to work with, the average worker's productivity--the amount of goods and services he or she can produce in an hour--falls.
Because wages are ultimately a function of productivity, the wage rate will eventually fall.

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