BUSINESS magazines periodically list the richest individuals in the United States. Many gained their wealth by starting a company. The latest top two so listed were Sam Walton, the founder of Walmart Stores, and David Packard, the cofounder of the Hewlett-Packard Corporation. Mr. Walton and Mr. Packard are worth billions today because they still own much of their original common stock. The value of that stock, which has gone up many times, has never been taxed because the gains have never been ``realized'' for tax purposes.
Many people hold onto their common stock to avoid the tax they would pay on gains if they sold their shares. The 1986 tax act gave owners of common stock any extra incentive not to sell because it increased by 65 percent the top tax rate on capital gains from long-term investments (from 20 percent to 33 percent).
President Bush has proposed reducing capital-gains taxes to a maximum rate of 15 percent on investments held for one year. Opponents argue that the reduction would benefit the wealthy and would add to the budget deficit.
However, there are many arguments in favor of reducing the capital gains tax rate:
1.The US is disadvantaged in international competition because of the high cost of capital. Our savings rate at about 4 percent of gross national product is one of the lowest among the major industrialized countries. This reduces our ability to innovate and compete. Japan, France, Germany, Hong Kong, Taiwan, and Korea all exempt long-term capital gains from taxation.
2.A reduction in the capital gains tax rate may actually increase tax revenues by an extra $5 billion in 1990. The rush to sell stocks at the end of 1986 to take advantage of the last days of the low 20 percent top rate proves that the size of the capital-gains tax base is highly sensitive to the capital-gains tax rate. Conversely, as rates rise, individuals enter into fewer transactions.
3.Reducing the capital-gains rate would create more jobs. Small businesses with fewer than 100 employees provide most of the new job opportunities.
In a recent seven-year period, the number of small-company startups more than doubled, creating 15 million new jobs. The number of offerings of stock in new firms has exploded every time there has been a reduction in the top capital gains rate, as there was in 1979 and in 1983.
Managers in Silicon Valley well understand the need to reward the entrepreneurial risks involved in startup situations (which can't afford to pay big initial salaries) by holding out the possibility of large capital gains from stock options. Startup companies are the acorns that will produce the future Walmarts and Hewlett-Packards.
4.In addition to federal taxes, capital gains are taxed at the state level. California has the highest combined rate of 39.2 percent. A lower federal tax which would unlock existing gains in capital assets would produce more revenue for state governments.
5.This tax is a voluntary one. Anyone, including Walton and Packard, can now avoid the tax entirely simply by not selling an asset in which a gain exists. No transaction, no ``realized'' gain, no tax! Also, an asset held until death will escape all capital gains taxes, as they receive a ``stepped-up basis'' to the heirs.
The Bush proposal will not tax capital gains at all for taxpayers with adjusted gross incomes of less than $20,000. This exclusion is very equitable and will encourage the spread of ``people's capitalism'' through more widespread stock ownership.
6.Much of the so-called gains on capital are really not gains at all, but simply inflation. While the cost-of-living index has gone up about 200 percent since 1970, the Dow Jones industrial average, which was about 1,000 in 1970, would have to go to 3,000 just to keep up with inflation. However, if you bought stock in 1970 and sold it now, the government would tax the amount from 1,000 to the present level of about 2,300, a gain of 1,300 - even though there has been no gain in real purchasing power.
This fact was recognized by Congress when it gave homeowners over 55 years old a one-time tax forgiveness of $125,000 of realized gain on the sale of their homes to compensate for inflation. They need to apply the same treatment to common stocks.
What the Bush administration adopts now as an economic game plan will be very important in determining whether the US economy can compete in the future. While the whole world, including mainland China and even Gorbachev's Soviet Union, are discovering the benefits of free markets and the advantages of capitalism, we remain most unfriendly toward existing capital and the creation of new capital - the key to economic growth in any society.
Congress should give this proposal a chance! It will help create new businesses, it will encourage savings and investments, it will create new jobs, it will help us compete, and it will unlock more gains to taxation and produce higher revenues for both federal and state governments.