Capital Gains Deal: Tax Cut for Rich, Or Economic Spur?

FOR two decades, the capital-gains tax has risen and fallen with the political mercury in Washington.

Republicans have long argued that cutting the tax on profits made on the sale of stocks, bonds, and real estate will free up money for new investment and boost economic growth. Democrats have called it a tax break for wealthy Americans. Economists are as divided as the politicians over how much impact a capital-gains cut has on the economy.

But the latest live test of who's right is about to begin again. Earlier this week, as part of the budget negotiations, President Clinton accepted in principle a capital-gains tax cut.

The White House endorsement, however reluctant, comes from a "president who recognizes that while he's busy accusing us of catering to the rich, there's an economic benefit to reducing the penalty on investment," says a GOP strategist on Capitol Hill. It's also politically expedient, he says

What Clinton got in return for the capital gains cut isn't clear yet. But this Republican says, "Bill Clinton needs a spur to what could be a very slow economy. A lower cap gains rate will help the construction industry, homebuilding, and other key sectors already lagging."

The current maximum capital-gains tax takes a 28 percent bite out of the profits made by individuals and 35 percent from corporate profits. Republicans have pushed for a reduction to 19.8 percent and 25 percent respectively.

Clinton first entertained the possibility of a capital-gains cut last spring, but he spoke of one restricted to taxpayers who had held their investments for a minimum of five years. He wanted to discourage investors from diving in and out of markets.

The decision to go along with a cut is already stirring debate over the predicted benefits.

"It won't have any kind of spectacular impact on economic growth," says economist Rudolph Penner, director of the Congressional Budget Office from 1983 to 1987.

He says "the lion's share" of capital gains already escape taxation. He notes that the tax is waived when profits are made on assets sold by heirs. Another big portion of capital gains is made on investments such as 401K accounts and nonprofit endowments that are also exempt from taxation. "If you look at all the cap gains paid in the economy, the relative average rate is only 5 percent."

US Commerce and Labor Department data show that the 1978 and 1981 capital-gains tax cuts were followed by a troubled economy and higher unemployment, but an increase in the tax both in 1976 and a decade later was followed by marked economic growth, says Robert McIntyre of the Citizens for Tax Justice.

"Experience over the last 25 years ... strongly indicates that rate decreases produce more declarations of capital gains and more capital-gains taxes," counters William Beach, a tax analyst with the conservative Heritage Foundation in Washington. And because some 40 states require taxpayers to report all capital gains declared on federal forms, they can expect an average 11.6 percent income tax revenue windfall from a rate decrease.

capital-gains tax cut proponents such as Harvard University's Martin Feldstein say government collects so much tax revenue from sales of property, stocks, and bonds that people are holding their money in already-matured investments rather than taking profits and putting them into new ventures.

Margo Thorning, chief economist of the American Center for Capital Formation worked with DRI/McGraw Hill, a Lexington, Mass.-based economic research firm, to calculate the benefits over a 10-year period from a maximum 19.8 capital-gains tax on individuals and a 25 percent ceiling on corporate profits.

She estimates it would push investment up by 7.8 percent, boost the gross domestic product by 1.7 percent, and generate an additional $23 billion in federal tax revenues. It would also create almost 250,000 new jobs by 2000, she says.