I’ve had several people ask for a followup on my piece about David Frum and capital gains taxes — namely, what is the case for special treatment, and the case against?

Well, Greg Anrig at the Century Foundation has a good summary. Let me leave the distributional issues on one side; even if we don’t care (or neglect for the moment) the fact that low capital gains taxes overwhelmingly benefit a tiny minority, and leave us having to raise more taxes from everyone else, there are still good arguments against this preferential treatment.

So, the case for low rates on capital gains is that by taxing investment income as ordinary income, we effectively discourage saving: if you spend your income now, you pay taxes only once, while if you invest for the future, you pay taxes twice, so eat, drink, and be merry.

There is, however, no evidence that this effect is at all important.

Meanwhile, by taxing income at very different rates depending on how it manifests itself, we create huge incentives to manipulate income to make it come out in the favored form. And this has real economic costs. Anrig:

The tax-favored treatment of capital gains is a notorious source of complexity in the tax code, diverting the energies of highly paid accountants and lawyers into wasteful efforts to shelter the incomes of wealthy clients from taxes. The elaborate tax forms known as Schedule D (“Capital Gains and Losses”) and Form 8949 (“Sales and Other Dispositions of Capital Assets”) provide a superficial glimpse at how the differential tax treatment of capital gains can suck up enormous quantities of time and money for the well-heeled and their tax pros. But much more costly and wasteful than the tedious forms are the strategic energies engaged in manipulating income flowing to the wealthy in ways that minimize tax liabilities. A recent IRS study showed that the primary source of capital gains income has shifted from stocks to “pass-through” entities (gains on assets sold by partnerships, S-corporations, and estates and trusts). In 1999, corporate stock constituted 42 percent of total capital income while pass-through gains amounted to 25 percent; by 2007, those numbers had essentially reversed with pass-through income comprising 40 percent of the total while stocks accounted for 25 percent. Money managers who oversee the assets of private equity partnerships are among those who benefit from beneficial treatment of capital gains. That transformation has required an enormous investment of brainpower, administrative work, and other energy that has profited individuals engaged in those activities without any discernable payoff to the rest of society. Little of that unproductive work would continue if capital gains were taxed at the same rates as earnings from work.

So we have a dubious gain in the efficiency of intertemporal allocation, weighed against an obvious and major waste of resources in rent-seeking.

There is, I think, a kind of economistic myopia that applies here: we tend, all too often, to think in terms of a perfect, undistorted economy, and worry about anything that prevents all the marginal whatevers from being equalized. But in the real world, governments must collect taxes, and given that necessity, making that tax collection as simple and efficient as possible can easily trump more rarefied notions of efficiency.

In short: the low tax rate on capital gains is bad economics, even ignoring who it benefits.