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The federal revenue surge won’t last

There were many happy faces in Washington on Friday with the Treasury Department’s announcement of robust tax revenues for April. Individual income-tax receipts surged to $240 billion for the month, taking the total for 2013 to $483 billion. This is far greater than the $393 in tax revenues the federal government collected for the first four months of 2012. The increase far surpassed the Congressional Budget Office projections in February.

The influx surprised the CBO and many other observers, but it shouldn’t have. Neither should the dramatic drop that is likely to follow, though policy makers will be tempted to behave as if the revenue flood will continue.

Much of the increase in 2013 receipts is due to final tax payments for 2012 deriving from a rush to realize long-term capital gains before the 15% ” Bush ” tax rate on such gains expired at the end of 2012—and before the new 23.8% rate on long-term capital gains for higher-income taxpayers took effect on Jan. 1. How do we know this? Because virtually the same tax change occurred during the Reagan years, when the long-term capital gains tax rate jumped eight points, to 28% in 1987, when the Tax Reform Act took effect, from 20% in 1986.

Here are the 1980s data expressed in current dollars: In 1985, before any talk of the Tax Reform Act, individual taxpayers reported about $310 billion in long-term capital gains. In 1986, with the Tax Reform Act signed into law but not yet in effect, reported long-term capital gains ballooned to $580 billion. The following year, with the act’s 28% rate in place, reported gains plunged to $250 billion. Tax revenues naturally followed—long-term capital gains tax revenue doubled to $90 billion in 1986, or 14.7% of total individual incomes taxes, before falling off again in 1987.

After these gyrations, long-term capital gains did not hit the 1986 peak again for a decade. This tax revenue pattern was replicated in many states whose tax systems peg off the federal system.

The pattern is likely to repeat today. Late last year, fear of a virtually certain steep impending tax increase gave investors every incentive to realize all available gains beforehand, raiding the gains that might have been reported in future years.

We don’t know how many gains were taken late last year or, therefore, how much of recently reported income-tax revenues came from capital gains. But clearly they were substantial.

Such was the incentive to beat the impending tax hike that investors seem to have grabbed every available gain.

If 2012 resembles 1986 as a banner year for capital gains, then 2013 will look a lot like 1987, when there were hardly any to be had. Of course, the longer-term horizon depends on the performance of the stock market. It’s hitting new all-time highs just now. Just as it was in 1987 before the famous crash.

The danger is that lawmakers and planners on the federal and state levels will mistake the current tax-revenue influx as a surge to a new, long-lasting plateau. It isn’t.

As appeared in The Wall Street Journal on May 13, 2013.


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