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The accidental tax cut

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While the president and Congress haggle over trillion-dollar tax cuts, the declining stock market has already done most of the work for them. That giant sucking sound from Wall Street is not just investors' money going down the drain, it is also all those taxes that would have been paid on the $4 trillion in lost wealth, the taxes that in happier days contributed to generating much of the surplus in the first place.

Let's do the math. On average, capital gains from sales of stock held outside retirement accounts are taxed at less than the maximum of 20 percent. This is because some taxpayers are in lower tax brackets, because people who die are excused from paying capital gains taxes, or because the stock is held in a not-for-profit institution. A large fraction of household wealth is now held in IRAs and 401(k)s, so capital gains in those retirement accounts are taxed as ordinary income.

Brianna Dusseault of the Monitor Group and I estimated that the average tax rate on IRA pension withdrawals was about 27 percent. Add in the estate tax, and one gets about a 20 percent tax rate on stock-market capital gains. A drop of $4 trillion in the stock market times 20 percent translates to a loss in revenue of $800 billion, or two-thirds of the proposed $1.2 trillion Senate tax cut.

Now, one could quibble about when this hypothetical $4 trillion would have been cashed out of the stock market.

Presumably, some of it would have been held, unrealized, beyond the 10-year horizon of the president's proposed tax cut. But even if the effects of these revenue losses aren't felt for a couple of decades, the government will miss that revenue about the time Medicare and Social Security are scheduled to implode.

Another quibble is a more obvious one: What kind of tax cut is this? It hasn't lowered tax rates, and won't do anything to spur saving, expand economic growth, or make people feel better about the economy.

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