Capital Gains Cut: Your Loss

Erik Melander

LOOKING FOR A SOLUTION to the federal budget deficit? Just look in the mirror, because the government thinks it has one: you.

You—meaning the poor, the working class and the middle class. You—despite a decrease in the incomes of the poor of almost 10% in the last decade, the decline of real factory wages to their 1960 level and a one-third increase in the incomes of the rich. In comparison with 1979, the average individual is now paying more taxes while the rich have enjoyed a 25% tax cut.

The federal government is so strapped that the only discussion about social programs concerns the level of cuts to be made (some claim that this was Reagan’s conscious policy). In combination with the $500 billion Savings and Loan debacle and other assorted favors performed for his friends, Reagan looks to have succeeded too well.

Not only is the government broke, but there are no more cuts to be made from social programs either. The solution: Raise money from the poorest 80% of the population. Things are so desperate that even some small cuts are being made in the defense budget, but they will not begin to repair the financial damage that eight years of Reaganomics has wrought.

We now have the ever-changing, a!-ways obscure Bush program. Whether he calls it ‘no new taxes’ or “revenue enhancements,’ it will mean higher excise taxes. These will be on such luxury items as gasoline, oil and telephone calls. That time taxes fall more heavily on the poor is ignored.

Worse yet, Bush is proposing a capital gains tax cut for the rich.

A review of the financial and popular press would elicit a variety of opinions regarding the merits of a cut in the capital gains tax rate. Unfortunately, most of the opinions are in favor of the tax cut or, if opposed, resigned to it.

The New York Times is typical—railing against cutting capital gains taxes, but then advocating that we index gains for inflation This is only a slower route to the same end as Mr. Bush.

Gains And Losses

The basic argument revolves around the cost of a rate cut Bush and his cohorts insist that a cut in the capital gains rate will actually increase revenues. But this is another capitalist fairy tale. The Congressional Joint Committee on Taxation estimates that Bush’s proposed cut would lead to a static loss of $100 billion over the next six years.

One-time sales will temporarily obscure this loss of revenue, but cannot offset it When the rate goes down more people will cash in their capital gains, but this is only temporary. It’s like taking your savings out of the bank and pretending it’s income.

In 1986,a tradeoff was made whereby the capital gains rate was raised from 20% to 28%, thus equaling the new, lower top rate for earned income. (Capital gains refers to unearned income, such as profits from selling stock at a higher price than you bought it—ed.) This top income tax rate had previously been 50%, itself a huge decrease from the top rates that prevailed in the past-70% in 1981 and 91% in 1963.

This tradeoff will now be cancelled for the rich. The capital gains rate will be cut to an even lower level than before, while the income tax rate for the rich will be left as it is and everyone’s excise taxes will skyrocket The unfortunate consensus is that some sort of capital gains cut will be passed. The only debate concerns what token the Democrats will receive in return.

The unspoken assumption in this whole debate is that since the tax rates on both capital gains and ordinary income are now at 28%, the rich with their capital gains are treated the same as everyone else. Nothing could be further from the truth. Capital gains are already extremely privileged. This essay will show how these rarely mentioned privileges work.

Taxscam

Currently, the tax rate on capital gains never exceeds 28%. The minimum rate goes all the way to zero.

A further benefit of capital gains is that they are not subject to withholding tax. In theory, this is only a minimal tax benefit In practice, it allows for massive under-reporting of capital gains as well as interest and dividend income.

There is no effective enforcement system. If you sell anasset, you have the ultimate responsibility of telling the Internal Revenue Service (IRS). If you don’t, there is often no paperwork given to the government tolet them know you sold it, let alone informing them what you paid for it The paperwork that is sent in so overwhelms the IRS that they often do not ever make use of it.

When a withholding law, which would ensure the payment of tax regardless of its being reported (like the taxes alwayswithheld from your paycheck) was last passed, it was shortly thereafter rescinded due to an outpouring of opposilion from the small savers of America as organized by their bankers.

Because the law included all savers, it let the rich organize to their own benefit what appeared to be campaign against big intrusive government A simple withholding system that exempted small savings accounts would have solved the problem, only affecting the upper class.

The Bush program is to refrain from increasing the budget of the IRS, portraying calls to do so as advocacy of big government.

Capital gains are not merely free from withholding tax. The benefits written into the tax code for capital gams are legion. One of the most generous is the deferral of taxes on any gain until the asset is sold or transferred. This, too, seems like a small benefit But how would you like an interest-free loan from the government?

For assets held five years before being sold, the value of this loan” is an effective tax rate of 21%. The longer an asset is held, the lower the effective tax rate.

The delay in taxing capital gains until the assets are sold is justified by asserting that taxes cannot be paid while the money is still invested. This plea of all one’s funds being tied up is rarely accurate. These are not the poor or working people we are talking about, but rather the richest people in America.

Further, astute investors would not have all their monies locked into one investment Even if the claim about tied-up funds is true, lack of funds is never a valid excuse for nonpayment of taxes Try it yourself next April 15!

A humane tax system would allow people to provide for their basic needs before taxes are owed. Instead we have a system that taxes wages as they are paid, and allows taxes on capital gains to be deferred.

Their Exemptions And Ours

The most outrageous benefit associated with capital gains is a complete and absolute exemption from taxation upon the death of the investor. This arcane provision of the tax code provides that if you inherit an asset and later sell it, your cost will be the value of the property when it came into your possession.

Thus a piece of property is purchased for $10,000 and then increases in value to $50,000. At this time its owner dies.

Neither the original owner nor the heir will pay any tax, which for a live investor would have been $11,200, on this increase in value. When the heir sells the property, he is allowed to use $50,000 as the cost when figuring his profit.

This provision cost the government $5 billion last year and will cost even more in the future. Mull that over as you pay a user fee on your next six pack or fillup at the gas station.

Social security is another area where capital gains enjoy a complete exemption from taxation. This regressive system of taxation has been sold to the public as an insurance scheme.

Senator Moynihan has raised the issue of reducing the social security tax rate, but he never broaches the idea of expanding the income base subject to taxation by including capital gains. His proposals, mild as they are, are in the process of being interred.

For those families in which both husband and wife must work in order to live, both are subject to social security taxes. An executive with a nonworking spouse will be exempt from social security taxes on income over $51,300. Another inequality occurs during the first five years of retirement Earned income in excess of $9,360 per year reduces your social security benefit by $1 for every $3 earned.

No reduction in social security benefits is made for capital gain or other unearned income.

As if all these tax benefits were not enough, many tax provisions are written specifically to benefit individual taxpayers. The beneficiaries of the provisions are well nigh impossible to identify from a mere reading. They are written to cover the exact situation of the favored taxpayer.

Some of the most egregious manipulations were severely limited by the tax reform act of 1986. Its most telling blow against tax shelters was the equalization of capital gain and ordinary income rates. The principal purpose of tax shelters was to transform ordinary income taxable at a 50% rate into capital gain income taxable at 20%.

Setting both the capital gains rate and the ordinary income rate at 28% at least limited the incentive to create tax shelters. With a capital gains cut they will be back, giving employment to lawyers and accountants as well as a tax cut for the well to do.

The practical effects of our present tax code are easy to summarize. A working couple earning together just over twice (exactly how much over depends on the number of exemptions and deductions) the average factory worker’s wage, $15,000 per year, will pay on any additional earned income 28% in federal tax and 7.65% in social security. Their employers’ will pay another 7.65% in social security.

The tax burden will thus be just over 43%. This does not even include state and local taxes, sales taxes, and the new Bush excise taxes. If someone had only capital gains income their worst case is a twenty eight percent tax rate, if capital gains have been deferred for five years, the effective rate is lowered to 21%. This rate decreases the longer the assets are held until it approaches the worst indignity of the tax code, the exemption from taxation for assets owned at death.

The tax rate of 43% for working people and the zero to 28% rate for capital gains are not the even playing field that our president would have us believe exists He wants to lower the capital gain rates even more.

The first rounds of the capital gains tax battle have already been lost At this rate, the debate in 1996 will be over how much we will pay people to invest We should understand that the tax system is run and regulated by the same people who own the wealth of this country.

Regulators and Congresspeople are paid for results. If conservative, they will rail about supposedly overgenerous transfer payments and the difficulties the economy faces due to a lack of investment incentives, if liberal, they will add some fine sounding noises about fairness and equity. They will then join in a bipartisan coalition to raise taxes for the bottom 80% of the income distribution and lower them for the top 20%. You earn it, you have to report it and you pay it They don’t earn it, they don’t always report it and they often don’t pay it.

November-December 1990, ATC 29