Capital gains, incentives for investors, and the tale of a soda straw

CAPITAL formation is not a new offensive backfield lineup for the Washington Redskins. Capital formation is, simply, the assemblage of money to invest in productive enterprises. It is one great necessity of the industrial age that the capitalist and communist worlds agree on. They differ, of course, on how to assemble capital, who owns what the assemblage buys, and how to price what it sells. But neither system thinks you can build supercomputers, a worldwide insurance firm, or robot-assembled cars without huge chunks of capital.

The Redskins and taxes are, as usual, the big autumnal subjects in Washington. Capital formation, unfortunately, is not. It ought to be. Especially since it should be part of the discussion on taxes. That discussion logically ought to lead to debate about restoring a capital gains tax incentive.

House, Senate, and White House negotiators might sensibly examine a trade-off of slightly higher income taxes for upper income Americans in exchange for a return to lower long-term capital-gains taxes for all. Realists would argue that the bargainers will not do so. It's too soon after the 1986 tax reform act did just the opposite. But the chain of logic for a restored capital-gains incentive is clear.

The US is only part way through the latest round of that never-ending industrial process of retooling. Specifically, many US manufacturing and service industries have not yet taken full advantage of the improved productivity and competitiveness that computerized/robotized systems create. This means that America is still trying to complete the third leg of the platform from which to return to full world competitiveness. The first two legs are: (1) pricing of exports, which has been substantially helped by the falling dollar; (2) streamlining of labor and management costs, the so-called ``lean and mean'' corporate efficiency drive.

To see why the third leg, retooling, is important, let us recall the tale of the Sweetheart straw, as simple a product as you can make (no moving parts, no bells and whistles). By introducing an automated production line, the manufacturer of these simple plastic straws, through which one swills soft drinks, cut its average production start-up time from nine hours to just 15 minutes. In other more sophisticated industries, similar retooling results in production lines that can quickly turn out alternating batches of products tailored for the varying tastes of European, North American, and third-world markets. As frequently noted, this is also an era when the average useful life of an industrial product has shrunk from about 20 years to only 3 to 5 years.

How does all this relate to capital formation, and then to capital-gains taxes?

As already noted, it takes large chunks of capital to revamp both production and service firms. In most industrial democracies such capital is supplied via a high personal savings rate - plus such sources of capital as pension funds. In the communist world the capital is assembled by the government, from taxes and government-owned business earnings.

In the US, capital formation has come from such institutional savings pools as pension funds and mutual funds, from corporate savings, and from investors abroad. But the American personal savings rate has continued to dawdle in the low single digits (less than 3 percent on average), despite the 1981-82 tax cuts and an array of tax-shielded retirement savings incentives.

Let's examine each of these components of American capital formation after the 1986 tax ``reform'' law and the 1987 stock market plunge. Institutions will continue to grow as pools of capital. But they may invest less heavily in the stock market for a while - just as in the past they shifted away from the bond market. Mutual funds are also temporarily suffering from investor withdrawals in the wake of ``black Monday.'' Corporate savings have been hit by the net effect of the 1986 tax law. And investors from abroad may become wary of investing as heavily in American stocks and bonds. All these factors would shrink capital for industrial retooling. Given this situation, lawmakers in Washington should take another look at restoring the incentive of a lower tax on long-term market gains. They could craft any return so as to minimize the factor of favoring the wealthy. One approach would be to counterbalance lost tax revenue by edging up taxes on upper and middle-bracket income. Another approach would be to consider a longer investment period (perhaps nine months or a year) to qualify for long-term capital gains treatment.

Arguments can be made against this logic. For one, the presence of a capital-gains incentive plus the retirement income incentives of the early 1980s did not help the savings rate. But congressional analysts should realize that conditions are not static. In the wake of the jolt from black Monday on the world's stock exchanges, the general public may be much more ready to save. Especially if John and Jane Public's savings could benefit from long-term status.

Earl W. Foell is editor in chief of The Christian Science Monitor.