- The Washington Times - Tuesday, January 30, 2001

If George W. Bush does not succeed economically, he will face a hostile Congress and will be another one-term president. With Alan Greenspan on board, there will be a tax cut. But Mr. Bush is leery to unleash the best tool for spurring growth a capital gains tax cut. A participant at a private meeting quietly told me why. Then candidate Bush explained that he saw former Senate Democratic Leader George Mitchell ruin his own father on the issue for "giving a tax break to the rich," and he was not going to let that happen to him. Good political instincts.

But things have changed. One, Democrats in Congress do not want to be blamed for a recession. More importantly, almost half of the population now own stock directly or through pensions. As recently as the senior President Bush's tenure, it was only one-third. Most importantly, many more pay capital gains taxes. When Democrats use the term "rich" it is something like the meaning of "is." If an uncle sells a business or a retired grandmother sells long-held stocks for retirement, the slick count the funds received from the sale as "income" in that year. So your poor grandmother is counted as earning the entire amount of the sale of an asset she may have accumulated for years and may spend over many more. But to the class-warfare school she is "rich" for that year.

If income is defined as income earned other than from investments as it should more than 50 percent of capital gains go to lower- and middle-class individuals. The typical household declaring a capital gain had income from other sources of only $58,729 not bad, but not rich. Another 27 percent were elderly or blind with incomes averaging $43,637 per year. In a declining market, this large group will make themselves heard as they did on the "death tax" last year especially if someone helps organize this potentially potent constituency.

Candidate George W. Bush got it right. Federal taxes are too high, consuming 20.5 percent of economic output in 1998, the highest peacetime level ever. His across-the-board cut will reduce this heavy load and increase demand. But a study by William W. Beach and John S. Barry of the Heritage Foundation should give pause. A statistical test of various means to spur the economy found that the effects of the other remedies disappear without a cut in the capital-gains tax. In 1995, the United States had the highest capital gains rate in the world. Even after the reduction from 28 to 20 percent under President Clinton, it should be noted it is still among the world's highest. There is a lower rate for certain small firms as a recognition that they have created all of the net new jobs in the economy but only a few qualify under stringent standards.

Capital-gains cuts can have dramatic effect. DRI/McGraw Hill found that about 25 percent of the increased value of the stock market in 1997-8 was due to the lowering of the rate the year before. Steven Moore and John Silva of the Cato Institute estimated that an incredible $7.5 trillion exists as unrealized capital gains that are "locked-up" to avoid taxation. Elimination of capital gains would free that whole amount and lead to an astounding recovery, which economists Gary and Aldona Robbins estimate as a $300 billion increase in output and 877,000 new jobs. Such growth leaders as Hong Kong, Singapore, South Korea and Taiwan, as well as dynamic Belgium and the Netherlands, have no gains tax at all.

True, it is not politically possible to eliminate the capital-gains tax, no matter how much good it would do. What is possible is indexing the capital-gains rate to inflation. Former Federal Reserve Board Governor Wayne Angell found the real inflation tax on Nasdaq stocks from 1972 to 1992 was an incredible 68 percent. Australia and the United Kingdom, with nominal capital-gains rates of 48 percent and 40 percent, had actual rates lower than the United States. A Congressional Budget Office study found that, excluding inflation, there would have been no capital gains at all in 1981 for those with an adjusted income below $100,000. Yet, they paid enormous taxes on paper profits, what Mr. Angell calls "the tax on phantom gains."

It is simple justice only to tax real gains. That is a fairness argument that can be won politically. And, if the rates were indexed in the United States, the amount of capital unleashed for job creation would be phenomenal. But it must be done early if it is to help by the next election. A capital gains cut is not only politically possible today, it is politically imperative for tomorrow.

Donald Devine, former director of the U.S. Office of Personnel Management, is a columnist and a Washington-based policy consultant.



Click to Read More

Click to Hide