The capital gains tax has another debilitating effect on investment that's called the "lock-in" effect. People who have made a capital gain on an investment know that if they were to sell they would have to pay the capital gains tax. Therefore, for tax reasons, they often hold on to that investment longer than they otherwise would. With a reduction or elimination of the capital gains tax, instead of people's decisions being driven by tax considerations, they would focus more of their portfolio to areas in the economy with a higher long-run growth potential.
There are other taxes that impede capital formation, such as dividend and corporate profit taxes, but the capital gains taxes, as well as the death tax, are particularly vicious. In 2004, the capital gains tax generated $56 billion, about three percent of federal revenues. The death tax generated $25 billion, a little over one percent of federal revenues. The death tax, like the capital gains tax, has an impact on capital formation because people often have to sell producing assets. These high-powered dollars are shifted from production to government consumption. The capital gains tax and the death tax are insignificant in terms of federal revenue. They only serve our collective taste to tax the so-called rich.
President John Kennedy saw much of the folly in our anti-capital formation tax policy when he said, "The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital . . . the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy."