Capital-Gains Tax Rises to a Boil in US Capital

Bush to make it part of economic-recovery package; analysts argue its effectiveness, fairness

THE taxes Americans pay on profits from selling investments - whether in a mutual fund, a brake-and-muffler franchise, or an apartment complex on the edge of town - are the most consistent target of the Bush White House.At the heart of President Bush's plans to shore up the long-term prospects of the US economy is his proposal to cut the tax rate on investment profits. Cutting taxes on capital gains has strong support from many Democratic quarters as well. Presidential candidates Bill Clinton and Paul Tsongas, and near-candidate Mario Cuomo, all support narrower, more targeted cuts than the president's. Two years ago, a sweeping cut in capital- gains taxes won majority support in both houses of Congress, but Senate majority leader George Mitchell (D) of Maine stopped the bill with a procedural move that raised the vote requirement in the Senate. It was a bitter defeat for the White House. It is why Vice President Dan Quayle calls this the "Mitchell recession." No serious effort to resurrect a capital-gains tax cut has arisen since. But when President Bush announces his economic recovery plan in late January, a cut in capital-gains taxes will be back on the bargaining table. But few questions are as loaded and complex as the value and fairness of capital-gains taxes. Capital gains are profits made by selling investments. Since 1986, these profits have been taxed like any other income. Arguments for taxing capital gains differently from regular pay take two forms. One is that a lower tax promotes investment, raises productivity, and creates jobs. The other is that the current tax is unfair: * Much of what it taxes as profit is only inflation and not real gain. * Corporate earnings are taxed twice when a company is sold. * And investment losses cannot always be deducted from profits, so that taxes can be on higher amounts than one's actual net gain. The main argument against a cut in the capital-gains tax is also an appeal to fairness. Since the most direct effect would be a tax break to taxpayers with the most wealth and highest incomes, a capital-gains tax cut does not spread its benefits evenly. Opponents also argue that cutting the investment tax would not spur enough growth to make up for lost tax revenues to the US Treasury. Lower taxes mean a higher budget deficit, which crowds out investment in the private economy. The latest version of an investment-tax cut that the Bush administration has endorsed was sponsored by Sen. Phil Gramm (R) of Texas and Rep. Newt Gingrich (R) of Georgia. It would exclude 10 percent of a capital gain from taxation for each year an investment is held, up to 30 percent after three years. The top tax rate for such gains would drop to 19.6 percent. Most significantly, the Gramm-Gingrich plan would index capital gains to inflation, so that taxes are due only on profits that surpass inflation. Professional economists show little agreement on what such a tax cut would mean. Only a smattering of the truest believers foresee an immediate prod to the economy in cutting investment taxes. "In terms of impacting the numbers before the election, there's very little that can be done," says Gary Robbins, a tax economist in Arlington, Va. But Mr. Robbins, who has modeled investment decisions and the economy extensively under capital-gains tax scenarios, is one of the most optimistic economists on the power of an investment tax cut. Over five years, he forecasts, the Gramm-Gingrich proposals would add $100 billion to the economy. C. Eugene Steuerle, a senior fellow at the Urban Institute and former deputy assistant secretary for tax analysis at the Treasury, doubts it. Based on historical patterns, he says, any capital-gains cut would have a fairly modest impact on the economy - and could even shrink the economy if it allowed tax shelters to proliferate. A similar dispute arises over the budget impact of the tax. The White House Office of Management and Budget figures that a cut would spur more sales and more investment, raising revenues for the government despite the lower tax rate. The OMB figures a net gain to the Treasury of $4.9 billion over five years. Congress's Joint Tax Committee figures the Treasury would lose $16.3 billion. Alternative plans from Democrats narrow the cuts to investments in new, productive ventures and to longer-range investments. Former Massachusetts Sen. Paul Tsongas would raise short-term investment taxes, but have them slide down to zero after 10 years, encouraging long-term investment horizons. Arkansas Gov. Bill Clinton would have a similar sliding scale limited to equity investments in new ventures. Governor Cuomo would apply a similar cut to "new and productive" investments.

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