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May 19, 1997 No. 61
DO'S AND DON'TS FOR CAPITAL
GAINS TAX RELIEF
The budget deal between President Clinton and
Republican Congressional leaders includes, among
its many components, capital gains tax relief. This
was a key demand of Republican negotiators.
Largely at the insistence of Congressman Bill
Archer (R-TX), chairman of
the House Ways & Means
Committee, the agreement does
not specify the details of the A worthy goal
capital gains tax cut but leaves top [capital ga
that responsibility in the hands from 28% to
of Congress's tax writing being a tax
committees. merely ease o
multiple taxati
The t a x writing saving.
committees will produce a
good capital gains proposal if
several questions can be
answered in the affirmative:
Does the proposal substantially cut the capital
gains tax rate?
Does it take effect quickly rather than being
phased in slowly?
Does it apply to capital gains realized by
corporations as well as by individuals?
Does it apply to all assets, not just to particular
assets that policy makers favor?
Is it free of take backs, changes that would
adversely alter the current-law tax treatment of
capital gains?
A serious constraint the committees will face in
crafting meaningful reform of the capital gains tax
is that they need to keep the estimated revenue cost
fairly low. The budget deal authorizes gross tax
reductions over 5 years of $135 billion (net
reductions of only $85 billion because of $50 billion
of tax increases). But two big-ticket items, a child
credit and tax breaks for college students, may claim
the majority of the cuts. The remainder must be
divided among capital gains relief, estate tax relief,
expanded individual retirement accounts, and other
pro-efficiency reforms.
The current tax system imposes multiple taxes
on saving and investment, creating a strong anti-
saving, anti-investment tax bias. The core objective
of capital gains tax reform should be to eliminate
the portion of the bias attributable to the capital
gains tax. (See Michael Schuyler and Roy Cordato,
The Case For
would be to cut the
ins tax] r-ate in half,
14%1'. Far- fr-om
br-eak, this would
ne of the layer-s of
on on the r~eturns to
Restoring A Capital Gains
Differential, IRET Economic
Report No. 49, July 1989.)
Because of the revenue
constraint, however, the tax
writing committees cannot
adopt the best reform of the
capital gains tax: its abolition.
By retarding saving and
capital formation - the
economy's main sources of
improved productivity - the
capital gains holds back
growth in production, real wages (which depend on
productivity), international competitiveness, and
living standards. Many observers think the capital
gains tax has an especially adverse effect on
entrepreneurial activity. Because the tax is triggered
when investors sell assets, it also tends to lock in
old investments, impairing efficient market
valuations of alternative investments and distorting
portfolio decisions.
If the capital gains tax is not eliminated, there
should at least be a major reduction in its rate. The
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 informing the
public about policies that will promote economic growth and efficient operation of the free market economy.
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