This chart is worth at least 1,000 words on the subject of tax policy, and the Obama administration and Congress would do well to study it carefully before plunging ahead with Obama's plan to raise an extra trillion or dollars in revenues over the next 10 years by raising all sorts of taxes (e.g., higher income and capital gains taxes, new climate taxes, limitations on deductions, etc.).
Note how capital gains revenues soared in the year before the capital gains tax was scheduled to rise in 1987. Taxpayers respond significantly to incentives: if they know taxes will rise in the future they will accelerate income and accelerate the realization of gains. The CBO projected in 1986 that the rise in the capital gains tax would lead to a revenue bonanza over the next several years that completely failed to materialize. In fact, capital gains revenues were abysmally low for the next 8 years.
Note also how a reduction in the capital gains tax in 1997 resulted in a huge increase in capital gains realizations in subsequent years. I would argue that a lower tax on capital helped boost the stock market and the economy, through increased investment, and that in turn led to higher capgains realizations. Of course, then we had the stock market collapse of 2001-2002, brought on largely by tight monetary policy, which resulted in a huge decline in capgains revenue.
The Obama folks are projecting that a 2010 rise in the capital gains tax rate for the rich, to 20%, will result in an extra $118 billion in revenues over 10 years. They are also projecting that the expiration of the Bush tax cuts, and new limitations on personal exemptions and itemized deductions for the rich, will generate over $500 billion in new revenues over 10 years. If history and human nature are any guide, the actual revenue gains could be much less.
As Art Laffer always says, when you tax something less you usually get more of it; and when you tax something more you usually get less. Higher taxes on anyone, coming at a time (next year) when the economy will likely still be struggling to recover, are quite simply a very bad idea.
And this helps explain why the stock market is celebrating Obama's "new era of responsibility" with lower and lower prices.