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115 IRET Byline 1 (1993)

handle is hein.taxfoundation/iretbyln0115 and id is 1 raw text is: April 15, 1993 No. 115
Clinton's Start-up Capital Gains Proposal:
Build It Up or Shut It Down
President Clinton has proposed a targeted capital
gains exclusion for taxpayers who buy newly-issued
small business stock and hold it for at least five years.
The proposal has so many limitations that it would do
very little to generate growth and jobs. It is entirely
inadequate to remedy the sharp bias of the tax system
against equity financing of investment. It should be
expanded to eliminate or reduce the multiple layers of
taxation now imposed on capital formation.
Under the Clinton plan, investors who buy original
issue stock of a qualified start-up small business
(either directly or through investment partnerships) and
hold the stock for at least five years would be
permitted to exclude 50 percent of gains realized on
the sale of the stock. The amount of gains that might
be excluded would be limited to the greater of ten
times the investor's basis in the stock or $1 million for
each qualified small business.
Treasury's Summary of the Administration's Revenue
Proposals defines qualified small business as a
Subchapter C corporation with less than $25 million of
aggregate capitalization from January 1, 1993, through
the date the taxpayer acquires the stock, and that uses
the assets in the conduct of a trade or business.
(Personal service, banking, leasing, real estate,
farming, mineral extraction, and hospitality businesses
would not be qualified small businesses.) To avoid
abuse, the proposal would prohibit large firms from
obtaining the exclusion by spinning off subsidiaries,

Institute for
Research on the
Economics of
Taxation

IRET
Byline1 1

and forbid redeeming outstanding shares to reissue
new qualified small business stock.
The venture capital industry and the small business
community have been urging the President to expand
his program at least to cover firms with $50 million of
capitalization. Even this doubling of coverage would
scarcely begin to redress the problem of overtaxation
of capital income. The holding period is another
problem. The tax code should not try to force people
to hold shares longer than they would like. It makes
the shares less attractive and raises the cost of capital
to the firms.
The Treasury tries to justify aiming the proposal at
small businesses because small businesses are
important to economic growth and job creation in this
country... future competitiveness... [and] investments
in innovation and growth.   But so are large
businesses. It is vital to reduce the tax element of the
cost of capital for medium and large corporations as
well as small firms and non-corporate businesses.
Small businesses have created a large percentage of
new jobs in recent years, but this is due in part to
overtaxation of the corporate sector. Job growth will
not be rapid if the country's major firms stagnate.
The real reasons for targeting the exclusion to
small businesses are money and politics. Clinton
thinks that a broad-based capital gains exclusion would
be expensive, and his fairness rhetoric has blasted
capital gains exclusions as unfair give-aways to the
rich. Both charges are nonsense.
A significant cut in the capital gains tax rate with
a short holding period would induce millions of
shareholders to realize existing capital gains. Treasury
revenue estimators have concluded that this unlocking
effect would recover all of the static revenue loss
over the short term federal budget period.  The
Congressional Budget Office and Joint Tax Committee
project a revenue loss. History supports Treasury.
After the 40% hike in the maximum capital gains rate
from 20% to 28% in the Tax Reform Act of 1986,

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public about policies that will promote economic growth and efficient operation of the free market economy.
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