The Tax Elasticity of Capital Gains and Revenue-Maximizing Rates

This paper uses an event study approach to estimate the effect of capital gains taxation on realizations at the state level, and then develops a framework for determining revenue-maximizing rates at the federal level. We find that the elasticity of revenues with respect to the tax rate over a ten-year period is -0.5 to -0.3, indicating that capital gains tax cuts do not pay for themselves, and that a 5 percentage point rate increase would yield $18 to $30 billion in annual federal tax revenue. Our long-run estimates yield revenue-maximizing capital gains tax rates of 38 to 47 percent. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.