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19 IRET Congressional Advisory 1 (1993)

handle is hein.taxfoundation/iretcgadv0018 and id is 1 raw text is: IRET June 3, 1993 No. 19 THE HOUSE TAX BILL: FURTHER RESTRICTIONS ON DEDUCTION OF INVESTMENT INTEREST Under current law, investors may deduct the interest on money they borrow to purchase stock, bonds, or other property up to the amount of their investment income - whether interest or capital gains. The interest deduction reduces total taxable income, and in that sense is deductible against ordinary income subject to the even if some of the investment return is in the form of capital gains subject to a top rate of 28%. The House tax bill limits the interest deduction to the amount of investment income (interest) subject to ordinary tax rates, and excludes capital gains in computing the deduction limit. Any interest deduction in excess of that amount would 31% top tax rate In the House's situation is one lender-s ar-e taxed they r-eceive, and expenses in the current year. He could deduct the full interest cost only if he were willing to give up the 28% tax rate on the $5,000 capital gain. The House bill would worsen the anti-saving, anti-investment bias of the tax code, raise the cost of capital and reduce saving in the United States, and slow the growth of investment, productivity, wages, and employment. The correct treatment of interest outlays and investment income should not be determined taxpayer by taxpayer but activity by activity. That is, the tax should not be set by looking only at a taxpayer's end of the various transactions in which he engages. Rather, each separate economic activity involving a borrower and lender should be taxed, in toto, in an appropriate way that avoids double-taxing the economic activity in which they have jointly engaged. The economic activity in this case involves an exchange between the borrower and the lender. The view, the ideal in which all on the interest borrowers may not deduct their, interest payments. This is Heads I win, tails you lose. have to be carried forward. (The taxpayer would have the option of treating some capital gain as ordinary income to take the interest deduction earlier.) For example, suppose the taxpayer had $10,000 in interest expenses, $5,000 in interest income, $5,000 in capital gains, plus $50,000 in salary. Under current law, the taxpayer could deduct the full interest expense. Under the House bill, the taxpayer could only deduct $5,000 in interest borrower pays interest; the lender receives interest. If the lender is taxed on the interest, the borrower should be allowed to deduct the interest. The interest deduction of the borrower should not depend on what the borrower used the money for or whether his income took the form of capital gains, interest, or tips from a paper route. If the lender is being taxed on the interest the borrower pays, the borrower should be allowed to deduct the interest against any and all income. The flap over limits on interest deductions, therefore, is just another case of the House looking narrowly at the borrowing taxpayer and ignoring the other side of the transaction. In the House's view, the ideal situation is one in which all lenders are taxed on the interest they receive, and borrowers may not deduct their interest payments. This is Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501(c)(3) economic policy research and educational organization devoted to inorming the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, N., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 * Fax 202-463-6199 0 Internet www. ret.org

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