Capital-Gains Tax Cut: A Gain for the Rich

O cut in taxes on capital gains, no tax deal.

That's the message from congressional Republicans to the White House.

"It is premature to predict how the budget negotiations will go," notes Washington think-tank economist Iris Lav. "But President Clinton seems to have gone out of the way to send signals that a capital-gains tax cut is not off the table."

Republicans have long sought a cut in capital-gains taxation as a key benefit to the well-to-do among their supporters. But they haven't had much success, with most Democrats opposed. "But now the politics have changed," says Alan Blinder, a Princeton University economist who was vice chairman of the Federal Reserve.

For one thing, Republicans control Congress. Second, Democrats are more divided on the issue. They are hearing from constituents with small businesses and farms who could face sizable tax levies on their profits should they sell their properties.

Ms. Lav takes the Republican leadership to task in a report written for the Center on Budget and Policy Priorities. The GOP proposal would exclude from taxation half the profits from the sale of stocks, bonds, real estate, and other property. This change would bring the maximum effective tax rate on capital gains down from its current level of 28 percent to 19.8 percent. That, she notes, would be the lowest level in 40 years.

A second change, Lav says, would assure that most capital gains would be taxed even below the 19.8 percent rate. Taxpayers who sell assets held for at least three years could exclude from taxation any profits that reflect the effects of inflation.

Lav gives an example: A taxpayer buys $100,000 of stock, sells it after five years for $134,000. With 3 percent annual inflation, the Republican proposal would give the taxpayer a 62 percent tax cut - $3,580 versus $9,520 under current law for an investor paying at the maximum 28 percent rate.

That's "a lower effective rate of tax on this profit than moderate-income families must pay on their wages and on interest they receive on modest savings accounts," she says.

Most capital gains would escape any taxation, she says.

Mr. Blinder says investors with capital gains already have an advantage - the choice of when to pay tax on their gains. By contrast, a saver in a bank certificate of deposit must pay taxes on the interest each year. And a wage earner is taxed every payday.

Further, when stocks are passed on to heirs, no tax is due on capital gains up to the time of death. And third, for high-income taxpayers, the 28 percent tax on capital gains is less than their 39.5 percent marginal tax rate on ordinary income. An even bigger advantage for capital gains will prompt tax lawyers to find new tax loopholes, converting regular income into capital gains, Blinder says.

Tax-cut proponents argue that a growing number of Americans own stocks and would benefit. But a newly released Fed survey finds that the proportion of families owning stocks directly has slipped from 16.9 percent in 1992 to 15.3 percent in 1995. Investing in non-retirement-account mutual funds, though, rose from 10.4 to 12 percent of families.

Lav reckons that three-quarters of all capital-gains income goes to households with incomes in excess of $100,000.

Another Washington think tank, Citizens for Tax Justice, finds that 64 percent of a capital-gains tax cut would go to the top 1 percent of households, those with incomes exceeding $240,000.

Proponents argue that a cut would stimulate investment and thereby economic growth. "People say that," Blinder says. "But there is no evidence."

Lav cites the finding of one economist and proponent that a capital-gains tax cut would raise the level of national output an extra 0.2 to 0.3 percent after five years. "That's not perceptible," she responds. "That's in the same order of magnitude that a natural disaster reduces gross domestic product."

Lav also points to revenue losses for the federal government: an estimated $14 billion by 2002, $20 billion by 2007.

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