The push to trim capital-gains tax

Nation's Business, July, 1989 by Joan C. Szabo

The Push To Trim Capital-Gains Tax

When Darrell Wilburn decided to start his own computer-electronics company in 1977, he waited until he was sure that Congress would enact then-pending legislation to lower the tax rate on capital gains. He knew that a lower rate would make it easier to attract investors to his new venture.

Just before Wilburn launched his company, the top capital-gains rate was a whopping 49 percent. In 1978, Congress cut it to 28 percent, and three years later the rate was reduced to 20 percent. Tax revenues rose, more jobs were created, and more people started and invested in small businesses like Darrell Wilburn's.

There's no question about the impact on his plans, Wilburn recalls: "If Congress had not lowered the tax rate on capital gains, there would be no company." His firm, Step Engineering, in Sunnyvale, Calif., now has annual sales of over $6 million.

Another consideration for Wilburn was the 18 months he went without pay while starting his business. He was willing to make that sacrifice, he says, because he knew there would be a long-term payoff when he sold his firm. Now, however, he is worried that his return will be eaten up by hefty capital-gains taxes if he ever sells his firm.

That worry stems from the turn-around in the capital-gains-tax situation. As a result of the 1986 Tax Reform Act, capital gains now are taxed at the same rates as ordinary income. For individuals, the top tax on gains has gone from 20 percent to 33 percent--a 65 percent increase.

The higher rate is not only discouraging the growth of small-business start-ups but is also depressing federal and state tax collections and is weakening the U.S. competitive position, say those who actively support legislation to restore a lower capital-gains rate. Backers of the effort include the Bush administration, a bipartisan group of lawmakers, and business organizations such as the U.S. Chamber of Commerce.

David Burton, manager of the Chamber's Tax Policy Center, says the organization supports a "reduction in the capital-gains rate to 15 percent with a reasonable holding period. We believe that all capital assets, whether owned by corporations or individuals, should be eligible for the capital-gains differential."

Burton's position reflects the views held by the many advocates of a lower rate, and those views are embodied in several of the bills introduced in both the Senate and the House. Congress this summer may begin drafting a final bill for floor consideration, say congressional tax experts. "There is a very good opportunity to pass a capital-gains differential this year if the president holds firm and the business community communicates its support for the legislation to Congress," Burton says.

The measures vary in details such as top rates, holding periods, corporate eligibility, and types of assets covered. The Bush administration's proposal, for example, would lower the top capital-gains rate to 15 percent for individuals, but corporate capital gains would continue to be taxed at the ordinary rate--generally 34 percent. Taxpayers with adjusted gross incomes of $20,000 or less would pay no capital-gains tax.

The president's approach would include land owned by individuals but exclude business assets, such as depreciable and other real property used in a trade or business, and collectibles, such as works of art. While the measure would not go as far as most business groups recommend, those organizations view the president's leadership as critical and hope that he will be willing to go further on specifics in the inevitable compromise talks on the many differences in the pending bills.

Legislation sponsored by Rep. Bill Archer of Texas, the senior Republican on the House Ways and Means Committee, would cover corporate capital gains. His bill, H.R. 1601, would establish a flat capital-gains tax of 15 percent for individuals as well as for corporations. Besides equity investments, the bill covers business assets and real estate. Assets would have to be held for over a year to be eligible for the rate.

In the Senate, Republican Robert Kasten of Wisconsin has introduced a meausre, S. 171, that would establish effective capital-gains tax rates ranging from 7.5 percent to 14 percent for individuals. A top capital-gains tax rate of 17 percent would apply to corporations.

Kasten's bill would index capital gains to adjust for inflation--a provision that would be particularly helpful for those who have held their investments for many years. The legislation is targeted at equity investments but would cover certain other assets as well. Assets would have to be held over one year to be eligible for the rate.

Kasten says restoring the differential would help foster the growth of small companies. "Without a capital-gains differential, investors aren't going to take a chance on smaller, riskier companies with a lot of growth potential when they can make safer, dividend-paying investments in larger corporations," he says.