Reduce the capital-gains tax to spur growth and revenues - editorial

Nation's Business, March, 1988

Reduce The Capital-Gains Tax To Spur Growth And Revenues

In considering tax legislation, Congress often has to choose between revenues and economic growth. That dilemma arises because too many revenue-raising measures are antigrowth--they consume funds that could otherwise be invested in new or expanding businesses. On the other hand, proposals to remove tax barriers to economic growth are frequently opposed on Capitol Hill because of the potential revenue loss.

Congress now has an opportunity to enact a tax proposal that would spur growth and revenues. This proposal would restore the favorable tax treatment on capital gains.

Under the landmark Tax Reform Act of 1986, capital gains are now taxed as ordinary income, with a top rate of 33 percent. The President is asking Congress to reconsider the tax-reform provision raising the top capital-gains tax rate by 65 percent. Reagan told the lawmakers: "The tax reforms accomplished in 1986 did much to remove provisions that inhibit economic prosperity. The most important piece of unfinished business is to reduce the capital-gains tax rate to the level that will generate the savings and investment necessary for future economic growth.

"Past experience demonstrates that lowering the capital-gains tax rate will mean increased realizations of capital gains upon which taxes are paid. . . ."

The President did not initially recommend the level to which the capital-gains tax rate should be reduced, but said he would "consult with the Congress about achieving this rate reduction as soon as possible."

The U.S. Chamber of Commerce, which has spearheaded the business drive to reduce the capital-gains tax rate, recommends 15 percent, and the discussion of this issue is expected to center on that figure.

The President's proposal has already drawn opposition, most based on the discredited arguments that lowering the capital-gains rates will cut federal revenues at a time when the deficit is already too high and that a reduction would benefit only the wealthy.

As the President pointed out, the record shows that a lower capital-gains rate increases revenues by encouraging investors to realize their gains. There was essentially no growth in the realization of capital gains when the rate ranged from 42.5 to 49 percent in 1968-78. When the rate was reduced to 28 percent in 1979, realization of capital gains increased by 50 percent over the previous year. There was another 50 percent increase between 1981, when the rate fell to 20 percent, and 1983, the first full year of the current recovery.

There is no question that most capital gains are paid by individuals in upper-income brackets, but they are also paying the larger total of tax revenues that result from the lower rate. Individuals with adjusted gross incomes of more than $500,000 paid $1.8 billion in capital-gains taxes in 1978, when the rate was 49 percent, and $4.2 billion in 1981, when the rate fell to 20 percent.

Thus, the sharp drop in the capital-gains tax rate resulted in a 130 percent increase in tax revenues from that source.

Also, lower rates encourage investors to back start-up businesses. The availability of venture capital increases as capital-gains rates fall and the risk becomes more attractive because of the greater potential return. Entrepreneurial activity declined in the period of high capital-gains tax rates, but there was a surge of investment in emerging companies when the rates were cut. There were 20 times more initial public offerings in 1983 under the 20 percent capital-gains tax rate than there were in 1978, the final year of the 49 percent rate.

And the capital-gains tax rate must be examined in the light of this country's global competitiveness. The United States currently taxes long-term capital gains at a higher rate than all of its European and Asian competitors, and taxes short-term gains at a higher rate than all but two of them.

It is difficult to understand why even the tax-and-spend coterie in Congress would oppose a proposal to increase revenues, stimulate economic growth and help the United States remain a major factor in international trade.

Photo: A reduction in the tax rate on capital gains would be a powerful incentive for economic expansion, as symbolized by this group examining a plant site.