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Capital gains taxation has been a divisive issue in Congress at least since the debates surrounding the Tax Reform Act of 1986, which, aiming to eliminate tax loopholes and shelters and preferences, repealed preferentially low tax rates for long-term gains.1 To bring effective capital gains tax rates back down again was President Bush’s “top priority in tax policy.“2 In 1989, Senate Democrats blocked a determined drive to reduce effective tax rates on the part of Bush, Republican Senators Packwood, Dole and others, and a few Democratic allies.3 The administration argued that the tax cuts would stimulate economic growth and induce asset sales, thereby actually increasing federal tax revenues; Congressional Democrats countered that the plan benefited mainly the wealthy, and that tax revenues would in fact decline.4 The Joint Committee on Taxation projected that budget shortfalls beginning in 1991 would sum to about $24 billion by 1994 -- and that most of the direct benefits would go to individuals with over $200,000 in taxable income. House Speaker Thomas S. Foley said that a third of the savings would be enjoyed by those with gross incomes over one million dollars.
WHAT IS MISSING FROM THE CAPITAL GAINS DEBATE?
The most frequently heard arguments for reducing capital gains taxes are:
(1) to reduce the “lock-in” effect, by which high tax rates at realization deter asset sales;14
(2) to relieve a disproportionate burden on homeowners;
(3) to compensate for the erosion of capital gains by inflation, as an alternative to indexing;15
(4) to end alleged double taxation of both capital stocks and income flows;
(5) to spur productive enterprise and investment; and
(6) to generate more tax revenue from the consequent growth in asset sales and productivity.
14 Some argue that eliminating step-up of basis at death would do more to reduce lock-in than a rate cut. See Joint Committee on Taxation (1990), p. 2 1; Gaffney (1991).
15 For an analysis of the case for inflation indexing, see Gaffney (1991).
This report calls attention to a neglected aspect of the capital gains issue -- one which bears importantly on the fifth- and sixth-named consequences.
Much of the capital gains debate today focuses on the stock market. Business recipients of capital gains are characterized as small innovative firms making initial public offerings (IPOs). In recent years such firms have been responsible for a disproportionate share of new hiring. It is hoped that corporations will be able to raise money to employ more labor and invest in more plant and equipment if buyers of their stocks can sell these securities with less of a tax bite. Stock market gains thus are held to stimulate new direct investment, employment, and output.
Typical of the campaign to reduce capital gains taxes is a Wall Street Journal editorial, “Capital Gains: Lift the Burden.” Author W. Kurt Hauser argues that when the capital gains tax rate was increased from 20 percent to 28 percent in 1989, the effect was to deter asset sales, causing a decline in the capital gains to be reaped and taxed. He refers, however, only to stock market gains, and specifically, to equity in small businesses. Citing the example of yacht producers, he suggests that taxing capital gains on stocks issued by these businesses “locks in” capital asset sales, thereby deterring new investment and hiring, and reducing the supply of yachts.16
Others contend that new productive investment is relatively insensitive to capital gains tax rates, arguing, for example, that most of the money placed in venture-capital funds come from tax-exempt pension funds, endowments, and foundations.17
What is missing from the discussion is a sense of proportion as to how capital gains are made. Data that is available from the Department of Commerce, the IRS, and the Federal Reserve Board indicate that roughly two thirds of the economy's capital gains are taken, not in the stock market -- much less in new offerings -- but in real estate. Read the whole article
Fred E. Foldvary — The Ultimate Tax Reform: Public Revenue from Land Rent
We surely agree with Roberts et al. that domestic capital formation is a crying current need; and the means is to foster saving and investing (but properly defined, as below). We also agree there is a strong, bi-partisan case for raising investment flows of the income-creating, work-activating kind. Here, however, we meet the problem of distinguishing new capital from old assets, especially land.
Land is not formed, like capital, by saving and investment; land is not reproducible. For that very reason land tends to appreciate, and therefore has to be a major source of what are misleadingly called "capital" gains. Again for that very reason, there is no supply-side kick in untaxing gains. Most of them are land gains, and should be called that. To use land as a store of value is macro-economically unproductive at best, and on balance counterproductive and destabilizing (considering its effect on financial institutions like the S&Ls).
To handle this matter we need two semantic distinctions which often are lost in the word-fencing of debate. Walter Heller, whose policies still enjoy bi-partisan support, thought and spoke in a Keynesian framework where "investment" means "investing," an affirmative, job-making action. It is a process, not a store of value; an economic flow, not a fund. It is not the asset held: this "investment" is a noun, macro-economically static and sterile. [Land may appreciate, and one may call this "investment," but the appreciation employs no one and creates no new wealth (although it may reflect the externalities of wealth created by others).]
To signalize these differences I use the present participle "investing," rather than the ambiguous noun "investment." [Webster's 9th New Collegiate defines investment both ways: it is an action, (the Keynesian usage); it is also an asset being held, a store of value. Such a two-faced word is a natural medium for double-talk, and has been so exploited, to the detriment of general understanding.]
Every Keynesian also knew in 1961 that investment means net, positive-sum investing. It does not include buying and selling existing assets like land: these are zero-sum transactions, macro-economically non-functional and barren. [Keynes, although careless of consistency, generally took care to distinguish old and new assets. " ... the competition of a high interest-rate on mortgages may well have had the same effect in retarding the growth of wealth from current investment in newly produced capital-assets as high interest rates on long-term debts ... " [General Theory, 1936, p. 241.] The old macro-economists generally refer to investing in newly produced assets as "income- creating expenditure," which is clear and correct, but too much of a mouthful.]
I use "investing" only in the sense of net, income-creating, job-making spending. [Note the difference between real turnover and mere ownership turnover. Ownership turnover generates no income (except for brokers and M&A personnel) and creates no capital. Real turnover also creates no capital, but does forward supplies of goods to consume, and flows of investing to produce replacement goods. Most of gross investing is reinvesting funds received or anticipated from sales of old capital (including inventories, which turn fast, and "fixed" capital which turns slowly as it depreciates and the funds are reinvested).]
borrowing on land, that can be worse than barren when the financial
system rises and falls on a land bubble, as it has and is. ... read
the whole article
Arthur J. Ogilvy: A Colonist's Plea for Land Nationalization (about 1890)
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Wealth and Want
... because democracy alone hasn't yet led to a society in which all can prosper