In last night’s Democratic presidential debate between Hillary Clinton and Barack Obama, moderator Charlie Gibson and Obama had the following exchange (courtesy of ABC News). Video is available here courtesy of the Say Anything blog.

GIBSON: All right. You have, however, said you would favor an increase in the capital gains tax. As a matter of fact, you said on CNBC, and I quote, “I certainly would not go above what existed under Bill Clinton,” which was 28 percent. It’s now 15 percent. That’s almost a doubling, if you went to 28 percent. But actually, Bill Clinton, in 1997, signed legislation that dropped the capital gains tax to 20 percent. OBAMA: Right. GIBSON: And George Bush has taken it down to 15 percent. OBAMA: Right. GIBSON: And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected? OBAMA: Well, Charlie, what I’ve said is that I would look at raising the capital gains tax for purposes of fairness. We saw an article today which showed that the top 50 hedge fund managers made $29 billion last year — $29 billion for 50 individuals. And part of what has happened is that those who are able to work the stock market and amass huge fortunes on capital gains are paying a lower tax rate than their secretaries. That’s not fair. And what I want is not oppressive taxation. I want businesses to thrive, and I want people to be rewarded for their success. But what I also want to make sure is that our tax system is fair and that we are able to finance health care for Americans who currently don’t have it and that we’re able to invest in our infrastructure and invest in our schools. And you can’t do that for free. OBAMA: And you can’t take out a credit card from the Bank of China in the name of our children and our grandchildren, and then say that you’re cutting taxes, which is essentially what John McCain has been talking about. And that is irresponsible. I believe in the principle that you pay as you go. And, you know, you don’t propose tax cuts, unless you are closing other tax breaks for individuals. And you don’t increase spending, unless you’re eliminating some spending or you’re finding some new revenue. That’s how we got an additional $4 trillion worth of debt under George Bush. That is helping to undermine our economy. And it’s going to change when I’m president of the United States. GIBSON: But history shows that when you drop the capital gains tax, the revenues go up. OBAMA: Well, that might happen, or it might not. It depends on what’s happening on Wall Street and how business is going. I think the biggest problem that we’ve got on Wall Street right now is the fact that we got have a housing crisis that this president has not been attentive to and that it took John McCain three tries before he got it right. And if we can stabilize that market, and we can get credit flowing again, then I think we’ll see stocks do well. And once again, I think we can generate the revenue that we need to run this government and hopefully to pay down some of this debt.

Both Gibson and Obama show their ignorance on the topic of capital gains taxation in this exchange. Gibson’s implying that cutting capital gains taxes raises tax revenues by the mere time series correlation he cited was a stretch. Much of the short-run response to changes in the capital gains tax rate are for tax timing purposes. This is a well-known fact, and it is why CBO projects a huge spike in capital gains collections in 2010 (the last year of the scheduled low 15% rate on long-term gains) and thereby also a large decline in 2011 (when the rate on long-term gains is scheduled to revert to 20%) under current law. There is no doubt some revenue feedback will occur over the long-run from lower capital gains tax rates spurring investment, but most estimates would say that we are currently on the left side of the Laffer Curve with respect to capital gains. (That doesn’t necessarily mean it should be increased, however, as that’s a separate question. And whether it should or should not also depends upon dividend tax policy and labor tax policy as they too can affect capital gains behavior.)

But Obama didn’t question this assumption made by Gibson. He seemed to be saying, “Okay Charlie, even if this is true, the rate should still be 28 percent.” And that’s a ludicrous statement too. Obama appeared to assume that even if we were indeed on the right side of the Laffer Curve (where revenues decrease from cutting tax rates, all else equal), he still doesn’t want a free lunch. Any truly concerned liberal who favors increasing the size of government given such a situation would merely seek to find the rate that maximizes tax revenue, and then the progressivity issue could have been dealt with on the spending side by using that money to expand a social program (or a tax/spending program like EITC). Everyone would win (i.e. a free lunch), and we could “build our infrastructure, pay for everyone’s health care, build our schools, (insert big government program here that sounds good to voters), and blah, blah, blah.”

In summary, Obama should have questioned the assumption made by Gibson in the question. But then again, Gibson shouldn’t have asked the question the way he did.

For those interested, here is a table of capital gains tax collections, and here is a table of capital gains tax rates at the federal level for the past two decades.

By the way, when Clinton was asked the question, her first line was “Well, let me start by saying that I think we know that we’ve got to get back to an economy that works for everyone.” Can you think of any more of a generic statement than that? Maybe.