What is the right rate of capital gains taxation for art?

by on January 8, 2008 at 5:23 am in The Arts | Permalink

Sens. Pete Domenici (R., N.M.) and Charles Schumer (D., N.Y.) have been complaining for the past few years that the capital-gains tax rate of 28% for the sale of art and other collectibles, compared with only 15% for the sale of real estate and securities, unfairly puts art collectors at a disadvantage.

Here is the story.  Here are some fallacious views:

Reducing capital-gains taxes on art to the same 15% as real estate and securities makes sense only if one believes that art is just one more and equally important investment realm. "The government is interested in encouraging people to invest in businesses and the housing market and other areas of risk-taking that stimulate job growth and generate tax revenues, and art doesn’t really do that," said Joseph Cordes…

That view was seconded by Leonard Burman, director of the Tax Policy Center of the Urban Institute, who noted that lowering the tax on art sales could result in "shifting into art and collectibles money that should go to more productive things, which would be taxed as ordinary income. To some extent, people would do that." As an example of more productive use of capital, he suggested investing in a factory or apartment house.

That’s the well-known Junker Fallacy.  Buying art shifts money from one set of hands to another and it doesn’t discourage investment in factories or elsewhere.  (And if it did, investing in houses would involve the same problem, I might add.)  The recipient of the money, the art seller, can invest the money just as well as the spender might have.  Or in other words, the transfer of the arts doesn’t consume much in the way of real resources.  Admittedly there is a second-order effect: higher prices diverts more labor energy into the arts, although for Old Masters this effect is very small.  Or you might cite shipping and transfer costs for the art, noting that on that logic we should tax shopping carts at higher rates as well.

There is a good argument for the higher tax rate on art, namely that art yields otherwise non-taxable pleasures — the pleasure of hanging it on your wall — unlike say holding Chrysler stock.  Or you might think taxing art is another way to hike the tax burden on the rich.  But the cited argument just doesn’t fly.

Thanks to Donn Zaretsky for the pointer.

1 A student of economics January 8, 2008 at 9:05 am

“Admittedly there is a second-order effect: higher prices diverts more labor energy into the arts,”

It’s not too often I see you downplay the incentive effects of policies. Increase the returns to something, and you’ll get more of it relative to other activities. The transfer of money is a wash, so what matters in terms is any change in “real” activity.

“art yields otherwise non-taxable pleasures” This is true as well. An omniscient social planner would include the imputed income from the pleasure of art-owning in total income when allocating the tax burden. Some countries do something similar with imputed rents from owning houses.

2 Person January 8, 2008 at 10:06 am

I hang Chrysler stock certificates on my wall, and I find your post *highly* offensive.

3 cure January 8, 2008 at 11:11 am

In the case of the Old Masters, why not tax arbitrarily close to 100% on taxable gains? Isn’t this the definition of a windfall (no amount of investment in Old Masters will increase their number), hence there is no distortion, hence Ramsey says we should tax it high?

This is exactly the same argument made by George and the “Single Taxers”, a refutation of which I’ve still not heard. We clearly would rather tax windfall than productive investment.

4 Securities Guy January 8, 2008 at 11:53 am

Encouraging investment isn’t the only, or even the best, reason to tax capital gains at a lower rate. Because capital gains can accrue over extended periods of time, a portion of such gains will always be inflationary (assuming at least a nominal inflation rate) and thus will not represent a genuine accession to wealth. This is why short-term capital gains are taxed at the same rate as ordinary income.

If we assume a 5% inflation rate and further assume that an investor holds a painting for five years while it appreciates 27.6% (i.e., 5% compounded over five years), the investor will not have earned any real wealth but will pay tax on the full 27.6% nominal gain. Taxing such gains at a lower rate is a quick and dirty way of recognizing that at least some of all long-term capital gains are inflationary and should not be taxed as an accession to wealth.

5 PrahaPartizan January 8, 2008 at 4:30 pm

“…There is a good argument for the higher tax rate on art, namely that art yields otherwise non-taxable pleasures — the pleasure of hanging it on your wall — unlike say holding Chrysler stock…”

Well, it would appear that lots of folks will be able to paper their walls with Chrysler stock certificates given the way the market is headed. Besides, the problem isn’t the the tax rate on art is too high. The problem is the preferential rate capital receives over labor and has a tax rate on any investment which is . The time for redress approaches.

6 Securities Guy January 8, 2008 at 4:53 pm

“The problem is the preferential rate capital receives over labor and has a tax rate on any investment which is . The time for redress approaches.”

I refer you to my 11:53:24 a.m. post, which makes a point that you must refute if you’re going to argue that capital and labor should be taxed at the same rates.

7 Bernard Yomtov January 8, 2008 at 6:09 pm

Buying art shifts money from one set of hands to another and it doesn’t discourage investment in factories or elsewhere.

Nor does a low capital gains rate on art profits encourage investment in factories or elsewhere.

8 vic January 9, 2008 at 3:12 am

“Admittedly there is a second-order effect: higher prices diverts more labor energy into the arts,”

Not only into art producing activity but also into art trading activity, which also consume real ressources.
And this effect also applies to Old Masters.

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