by Hugh Mann

Created on: April 09, 2008   Last Updated: September 14, 2010

To gauge how capital gains taxes might tend to affect (a) investors and (b) subsequently the economy, we need to examine the factors that influence an investor’s decision process and then consider the influence of investors as a group within the larger framework of the economy itself.


To begin then, we need to understand which factors investor will assess prior to initiating an investment.  A typical repertoire for an investor will consist of considering, weighing individually, and collectively evaluating the interaction and net sum effect of the following:

- predictability: even if unstable, is the economy predictable: up, down, unchanging

- yield: the percentage gained after costs, such as broker fees and taxes

- risk: the monetary amount an investor can afford lose, not to be confused with the chance of failure

- duration: how long to hold on to the capital investment

- liquidity: speed with which an investment can be sold

- alternatives: how does the investment rank vs. other yield opportunities

- investor personality: investing knowledge and tolerance of risk (chance of failure)


In the list above, capital gains taxes impact primarily two factors, yield and economic predictability.


That capital gains taxes diminish yield is readily apparent.  Clearly, the investor will profit less.  Since the question is whether increased capital gains would reduce the appetite for investment, the best place to focus our attention next is on the effect of increased taxes upon investments that nominally stand to offer a marginal yield, the kind of investments that attract the most money because of their compensatory low levels of risk.  Where an increase in taxes will narrow a slim margin of profitable potential to an amount equal to zero, or even less, then quite obviously the tax will squelch the opportunity.  While this is not meant as an all-encompassing generalization of cause and effect, it is a characterization indicative of the general direction of causal influence.


Before continuing, it is important to qualify the foregoing statement by noting that serious investors, whether large or small, will normally not place all their risk capital into one proverbial basket, but will diversify their holdings amongst various instruments and venture vehicles.  Some of these investments will offer higher return potential and thus be relatively less influenced by capital gains tax increases, although they will tend to be accompanied by higher levels of

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