The Reagan administration faces a quick test in political courage in deciding whether to press ahead with a proposal to reduce the maximum tax rate on unearned (investment) income. Although Congress must rightly take a hard look at the plan -- to ensure that there is no significant long-range revenue loss for the US Treasury -- we hope that Mr. Reagan supports the reduction despite the fact that it will likely be tagged by opponents as a tax measure "for the rich."
Currently, unearned income (stock dividends, savings interest, etc.) is taxed at a rate as high as 70 percent, compared with a maximum of 50 percent for earned income (wages). The administration is contemplating lowering that 70 percent to 50 percent, or even less. The rationale is that more people, presumably well-to-do investors currently "sheltering" their wealth in tax-avoidance assets such as precious metals, cattle ventures, oil drilling programs, etc., would shift funds back into mainline productive areas and thus provide much needed new investment capital. That in turn would presumably lead to job creation and funnel more taxes to federal coffers in the long run.
Congress will want to weigh this matter carefully. Investment capital has not been all that scarce of late. Start-up capital for new firms, moreover, has been available. And it must not be forgotten that millions of investors are avoiding the equities market not just because of unfavorable tax rates, but because the financial returns have been much better elsewhere. So, in one sense , just getting the inflation rate down would likely be as important as altering tax rates in wooing investors back to the stock market.
Still, the administration is on target in proposing a lowering of unearned income rates. Generally, the tax burden borne by the individual investor in the US is among the highest in all the industrial nations. Investment -- and productivity growth -- in the US are below those of many of its competitors. Japan, for example, has no capital gains tax. In France, capital gains taxation is minimal and the tax on dividends is quite low. In fact, some analysts say that only Sweden imposes a higher burden on the investor than the US.
There are some compelling arguments for reducing the investment rates.
* Capital gains results. A recent US Treasury study found that the net revenue loss in 1979 when capital gains rates were reduced from 49 percent to 28 percent was only $100 million. That was instead of a projected loss of $1.7 billion. Investors decided to realize their paper capital gains at the lower tax rate.
At least one supply side proponent, Oscar Pollock of Ingalls & Snyder, argues that the Treasury figures, put together by the outgoing Carter administration, are too low, and that Uncle Sam actually garnered $1.1 billion more under the lower 1979 rates than under the 1978 rates. The results suggest that as tax rates are lowered new wealth is generated.
* Mobility. Investors will place more of their money on the basis of genuine investment returns rather than according to tax factors. This should improve the efficiency of the capital markets, eventually boosting productivity. Capital will be more mobile, and not frozen because of unwillingness to pay heavy income taxes. Investors may be willing to take the higher risks that are often a factor in productive investment.
Currently some 16.7 million households own stock in the US -- about one out of every five households. Of the total, about 600,000 households have personal income of over $100,000 and another 1.3 million households between $50,000 and $ 100,000. It is this pool of 1.6 million households that would first be expected to step up their investment in industry if unearned income rates were lowered. They might then be joined by perhaps several hundred thousand additional families who have totally fled the market yet are in high-income brackets.
Such tax reform and change in investment habits could eventually lead to a major change in the American economy -- away from an era of living on credit toward a new era of saving and inves tment.