Contextualizing Elasticities for Policymaking: Capital Gains and Revenue-Maximizing Tax Rates

Capital gains revenue estimates rely on a long history of research empirically estimating the tax elasticity of capital gains realizations. These elasticity estimates have varied from zero to well over 3 in absolute value depending on numerous factors, such as the time frame studied, the type of capital asset, and the estimation strategy employed. Often, the headline elasticity from a study of this nature is used to calculate the implied revenue-maximizing capital gains tax rate. Unfortunately, this last, policy-relevant step has received insufficient scrutiny. The standard approach fails to sufficiently acknowledge that the estimates of the revenue-maximizing rate are a product of the estimation procedure used and the context of the tax system from which the data were generated. Such an approach yields a single capital gains tax rate which applies to all realized gains and mechanically overstates the resulting revenue-maximizing rate.