Revenue & Spending
Tax Treatment of Capital Gains and Stock Trades Receives Attention as Congress Considers Tax Reform
On Sept. 20, the two congressional tax-writing committees held a joint hearing on the tax treatment of capital gains – gains on assets such as stocks, real estate, and other forms of wealth. The combined hearing – which brought together members of the Republican-controlled House Ways and Means Committee with members of the Democratically controlled Senate Finance Committee – demonstrated the commitment of both parties to address tax reform issues soon after the elections. Such reforms may come as part of a larger budget package intended to prevent the federal government from going over a "fiscal cliff" on Jan. 2, when a host of Bush era-tax cuts are set to expire and across-the-board spending cuts required by the 2011 Budget Control Act will go into effect.
Media reports suggest that Senate Majority Leader Harry Reid (D-NV) is preparing to ask Senate Minority Leader Mitch McConnell (R-KY) to appoint senators to a bipartisan committee that would negotiate details of such a tax reform package. Sen. Jim DeMint (R-SC), an ardent tax-cutter and Tea Party supporter, signaled the seriousness of the effort in September when he said, "We might as well cut a deal. If Republicans want to maintain the defense, we’re going to have to give tax increases to Obama."
Sen. Kent Conrad (D-ND), chairman of the Senate Budget Committee, has said that Congress may act to give tax writers six additional months to work on the package, possibly extending the current Bush-era tax cuts in the meantime. Conrad is reportedly part of a new bipartisan group of eight senators negotiating over a new deficit reduction proposal. In addition to Conrad, other members of the group include Sens. Lamar Alexander (R-TN), Michael Bennet (D-CO), and Tom Coburn (R-OK). Under their proposal, if Congress failed to enact a new package within the six-month window, instead of the across-the-board spending cuts that would be triggered under the current law, the group's alternative deficit plan would be "triggered."
The group's plan is reportedly modeled on recommendations from the commission informally known as the Simpson-Bowles commission, which was chaired by former Republican Sen. Alan Simpson of Wyoming and former President Bill Clinton’s White House chief of staff, Erskine Bowles. The commission’s plan failed to receive the necessary support of 14 out of 18 members to be forwarded to Congress for consideration. Since then, the two co-chairs have been speaking to the media about the need to enact something similar to their plan. They recently helped launch a new group, Fix the Debt, to advocate for their ideas.
The original Simpson-Bowles plan would have achieved 26 percent of its deficit reduction from revenue increases, 57 percent from spending cuts, and 17 percent from interest savings. Discussions of a second version of the plan appear to drifting further to the right, especially on potential cuts to the Medicare program.
Capital Gains Hearing
Two important reports on the tax treatment of capital gains were released in advance of the congressional hearing – one from the Center on Budget and Policy Priorities and another from Citizens for Tax Justice. Together, the two reports describe the highly regressive nature of current law governing capital gains taxes and how little benefit is derived from treating this income preferentially.
Highlights from the reports include the following:
- Capital Gains Are Taxed at Much Lower Rates than Ordinary Income: The top rate on most capital gains is 15 percent, while the top tax rate on ordinary income is 35 percent. In addition to the lower tax rate, capital gains taxes are not paid unless the asset is sold, which may not happen. About half of all capital gains are never taxed for this reason. Moreover, because capital gains taxes are based on the cost of the asset upon acquisition, the base price is reset when someone dies and passes an asset on to an heir. This prevents taxation on the gain that had accrued through that date. This tax treatment of capital gains upon transfer at death is a major reason why the estate tax is so important.
- The Wealthy Receive Most of the Benefits of Low Capital Gains Tax Rates: Low tax rates on capital gains are highly regressive because most capital gains accrue to the very wealthy. According to the Tax Policy Center, a joint project of the Brookings Institution and Urban Institute, the top one percent of taxpayers will receive 71 percent of all capital gains in 2012. The top 0.1 percent of taxpayers will receive 47 percent. The preferential treatment of capital gains is a major reason that the tax code often violates the "Buffett rule," which says that high-income investors should not have lower tax rates than wage earners.
- Low Tax Rates on Capital Gains Do Not Help the Economy: There is no evidence that low tax rates for capital gains help spur economic growth. The Tax Policy Center has found no statistically significant correlation between capital gains rates and real GDP growth during the last 50 years. The primary reasons are that productive investment decisions are based not on tax rates, but on risk and rate of return, and because lower taxes on capital gains accrue to the very wealthy, who do not spend the proceeds and instead save them, which does nothing to boost economic demand.
- Lower Capital Gains Tax Rates Encourage the Use of Tax Shelters: The preferential treatment of capital gains has helped create a cottage industry of tax experts in the accounting industry whose primary focus is devising ways to convert the earned income of high-earning individuals into capital gains, which are then taxed at the lower rate. One egregious example is the treatment of income of highly paid hedge fund managers, most of whose income is taxed at the lower capital gains rate.
- Low Capital Gains Taxes Are Costly: According to the Joint Committee on Taxation, the preferential rates on capital gains and long-term dividends together will cost $457 billion between 2011-2015 when compared to what would be collected if they were taxed at the same rate as ordinary income.
Under current law, the Bush-era tax cuts are scheduled to expire at the end of the year. Unless Congress enacts a new tax package, the tax rate on most capital gains will rise from 15 to 20 percent in 2013. The Obama administration has proposed continuing the current, lower rate for individuals earning less than $200,000 per year and couples earning less than $250,000.
Since most capital gains accrue to the very wealthy, the Obama approach would recapture most of the lost revenue that would occur if the Bush rules were simply extended. The Treasury Department estimates the 10-year savings will be $36 billion, a significant sum. However, this is still less than the hundreds of billions of dollars that would be saved by instead treating capital gains like ordinary income.
Financial Transactions Tax Bill Introduced in the House
Rep. Keith Ellison (D-MN) introduced legislation on Sept. 14 that would level a 0.5 percent tax on all stock trades, 0.1 percent on bond trades, and 0.005 percent on derivatives trades. The bill is the Inclusive Prosperity Act (H.R. 6411).
In introducing the bill, Ellison said it would collect billions of dollars in new tax revenue annually and also help hinder speculative high-speed computer trading. According to a statement from Ellison's office:
Almost 30 nations have some form of a financial transaction tax and the U.S. had a similar tax from 1914 until 1966. The United Kingdom has had a tax on stock trades for decades – the same rate proposed in HR 6411 – and their volume of trading has grown robustly. Supporters of a form of financial transactions tax include business leaders such as Microsoft founder Bill Gates, Dallas Mavericks’ owner Mark Cuban, and Berkshire Hathaway chairman and CEO Warren Buffet.
A similar set of bills (H.R. 3313, S. 1787) were introduced by Rep. Peter DeFazio (D-OR) and Sen. Tom Harkin (D-IA) on Nov. 2, 2011. The identical bills, dubbed the Wall Street Trading and Speculators Tax Act, would impose a 0.03 percent tax (three cents for every $100) on purchases of stocks, bonds, and derivatives. The House bill has 36 co-sponsors, and the Senate bill has three co-sponsors. An analysis of that bill by the bipartisan Joint Committee on Taxation indicated that it would raise $352 billion in new revenues over nine years.