Theodoric (R-York)

The Republicans, it seems, have a solution to every problem.  Or, to be more precise, the Republicans have a solution to every problem.  Like the medieval barbers who thought that the cure for every malady was bloodletting, the GOP believes that the cure for every ailment is tax cutting.  The economy is good?  Cut taxes!  The economy is bad?  Cut taxes!  Taxes are too low?  Cut taxes!  I await the inevitable day when the Republican Party advocates tax cuts as a means of overturning Roe v. Wade, forestalling gay marriage, and putting a massive granite sculpture of the ten commandments in every federal courthouse.  Remember, if we don’t cut taxes, the terrorists have won.

The latest GOP quacksalver to prescribe this nostrum is the Republican Study Committee, a bunch of right-wingers that used the opportunity of the Wall Street bailout to push for a two-year moratorium on the capital gains tax and, in the process, also managed to scuttle the Wall Street bailout.  According to the folks at NRO, the RSC plan would be just the tonic for an ailing economy.  “Private capital will flood into Wall Street with zero capital gains and it will come at no cost to the taxpayer.”

Now, you may be asking yourself: “how many different kinds of crazy is this proposal?”  Well, first of all, assessing lower taxes on capital gains is justified primarily as a means of encouraging investment (it also compensates very roughly for inflation, but a system of indexing could work just as well).  The problem, though, is that, in the short term, cutting capital gains taxes merely encourages the sale of capital assets.  Far from encouraging investment, the elimination of capital gains taxes would instead lead to a fire sale of assets, with the inevitable result that prices would fall.  Moreover, a two-year moratorium won’t encourage the kind of long-range investment that either the economy needs or that Republicans tend to tout as the chief virtue of low capital gains taxes.  Instead, it would, under normal circumstances, simply push more assets into the marketplace and depress prices even further.

Luckily for us, however, that scenario probably won’t happen now, because that only works if the assets have appreciated in value.  In a generally falling market, there’s no reason to sell assets to take advantage of a capital gains tax moratorium if there are no capital gains to be realized from the sale.  It’s highly unlikely, for instance, that investors who are holding shares of AIG that they bought at 70 are now overly worried about paying capital gains taxes.  They’re probably more worried about fighting the cat for that last tin of Whiskas.

This isn’t rocket science, folks, and others have been quick to point out just how nutty this proposal is.  Justin Fox, in describing the RSC plan, called it a “joke,” and stated:

It calls for a two-year suspension of the capital gains tax to “encourag[e] corporations to sell unwanted assets.” But the toxic mortgage securities clogging up bank balance sheets are worth less now than when they were acquired. Meaning that no capital gains tax would be owed on them anyway. If you repealed the tax, banks would have even less incentive to sell them because they wouldn’t be able use the losses to offset capital gains elsewhere. Seriously, where do these people come up with this stuff?

Apart from the GOP’s total lack of imagination when it comes to tax policy, is there possibly another reason for the Republicans to insist upon a capital gains tax moratorium at this time?  Well, let’s look at the calendar.  A two-year moratorium would expire in late 2010, well into the next president’s administration and conveniently close to that year’s congressional elections.  For the GOP, running on preserving the  moratorium would place them in the position of accusing the Democrats of favoring a tax increase, using the strange-but-persistent logic that allowing a tax moratorium to expire is the same as voting for a tax increase.  And that’s not taking into account the end of the other capital gains tax holiday, enacted in 2003 and extended in 2005, which is also set to expire in 2010.  That would provide a hefty club with which the GOP can beat the Democrats about the neck and shoulders during the 2010 election.

For the Republicans, bad economics has always made good politics, and this latest iteration of their traveling medicine show is no exception.  We can only hope that the current bloodletting on Wall Street is not matched by a more medieval sort of bloodletting on Capitol Hill.