Congress to Taxpayers: Keep More of the Change

A cut in capital-gains taxes has been an economic holy grail for Republicans for many years.

This year they likely will get it.

Capital gains are profits from the sale of stocks, bonds, real estate, and other assets. Many Republicans argue that cutting taxes on these profits will thrust the economy to higher heights by sparking investment in businesses and real estate, among other things. One economist asserts stock prices alone would jump 4 percent if the rate is lowered.

Since 1987, the highest capital-gains tax rate for individuals has been 28 percent. It's expected to drop to 20 percent as part of the budget bill President Clinton is likely to sign later this summer.

But a resulting economic boom isn't a sure thing. A wide debate rages over the true effect of capital gains. Here are the basics.

How big a factor?

Supporters of a capital-gains tax cut argue the tax acts like a big kink in the hose of the nation's economy: Individuals and businesses don't sell off their investments - or don't invest in the first place - because they are loath to pay taxes on profits. So the flow of the economy is slow - compared with what it could be.

If the rate is lower, the logic goes, there will be a bigger incentive to invest. The kink will be gone, allowing freer flow of funds. This would create more jobs and spark greater productivity.

But opponents of the cut argue it isn't such a big factor in individual and corporate decisions. So many variables are considered in a decision to invest, they say, that the prospect of paying somewhat lower capital-gains taxes has little if any effect.

"There is no credible evidence it will have a significant impact," says Thomas Sullivan, an economist with Tax Notes, published in Arlington, Va. And, in a fit of collegial criticism, Mr. Sullivan says economists' claims to the contrary make "those in my profession look like a bunch of idiots."

"Does anyone say they don't know? That's what they should say," he asserts.

Welfare for Rich?

Critics of the cut say it would unfairly help the rich. They make most of the profits from capital gains - and are the ones who benefit most from a lower tax.

This assertion seems mostly true, but not totally. According to a new study from the nonpartisan Congressional Budget Office, more than one-half of capital gains (excluding taxes on the sale of homes) were made by the 1 percent of taxpayers - those who make $200,000 or more.

It is "welfare for the well-heeled," charges Bob McIntyre, director of Citizens for Tax Justice, a liberal Washington group.

He argues it is unfair to tax the capital gains of a stockholder at a lower rate than is applied to the ordinary income of some wage-earners. Besides, capital-gains taxation provides a degree of "progressivity" - the more you make, the bigger portion you pay - in the tax system, he notes.

But, to the surprise of many, the CBO study found one-half of US families own assets that might produce capital gains. That proportion rises to three-fourths if homes are included.

"The distribution is a lot more uniform than people thought," says Gary Robbins with the Institute for Policy Innovation, a conservative Dallas think tank.

Costly tax cut?

Most economists agree that a cut would prompt many investors to sell some assets sooner rather than later. But over the long term, many see a big drop in tax revenues - which has implications for the budget and the deficit - and therefore the economy.

Federal revenue from capital gains taxes was $42.7 billion in 1995. The estimated revenue loss from cuts now being considered in the House would be $3 billion in the first five years, $38 billion in the next five years, and steeper still in following years.

Defenders say a cut would pay for itself by encouraging investors to cash in on profits by stimulating the economy, thereby bringing in more tax revenues.

Congress MULLS Cuts

A House bill would:

* Reduce the top capital-gains tax rate for individuals from 28 percent to 20 percent. Individuals making less than $24,650 a year would pay 10 percent.

* Allow profits on sale of a primary home to be exempt up to $500,000 for couples, $250,000 for individuals.

* Cut the top rate for corporations to 30 percent - from the current 35 percent.

* Reduce taxable gains by the amount of Inflation for assets bought after 2000.

A Senate bill would:

* Reduce rates as the House bill would and include a similar home-sale provision.

* Provide special capital-gains reductions for small businesses and venture capital.

* Leave corporate rates at current levels.

* Not index gains for inflation.

WHO PAYS

CAPITAL-GAINS TAXES?

Not just the rich:

* About one-half of US families own assets such as stocks, bonds, real estate, and businesses that might produce capital gains. That ratio rises to three-fourths if homes are included.

* Over a 10-year period, about one-third of taxpayers report at least one transaction with a capital gain or loss.

* Nearly two-thirds of tax returns with capital gains are filed by people with incomes less than $50,000 a year.

But the rich do make the lion's share of gains - and pay most of the taxes:

* More than half of capital gains (excluding homes) were made by the 1 percent of taxpayers making $200,000 or more.

* Three-quarters of gains were made by the top 5 percent of Americans - those with incomes of $100,000 or more.

Source: Congressional Budget Office