(Editor's Note: Tax reform could well become a major issue in the closing half of President Obama's first term. With that in mind, a guest Voicer takes a look at a little-noticed proposal from the White House's fiscal commission.)
When it comes to taxes on capital gains, the emperor suddenly has no clothes. He’s been stripped bare, in bipartisan fashion, by the co-chairs of President Obama’s fiscal commission.
The chairs are Republican Alan K. Simpson and Erskine Bowles, a Democrat. Their initial report included a call for equal taxes on capital gains, dividends and ordinary income such as wages. This runs counter to the current tax code, and it contradicts almost the entire history of capital gains taxes in America.
Implicitly, it also rejects the K Street claim that tax breaks for capital gains grow jobs, grow businesses and grow the economy. If the claim had any truth, Messrs. Simpson and Bowles would never have proposed equal taxes on all income as a way to help cut the federal deficit.
Liberals instinctively attacked the right-leaning aspects of the report. House Speaker Nancy Pelosi, in full “no” mode, labeled its recommendations “simply unacceptable”. Not quite, Madam Speaker; apropos investment income, Simpson/Bowles was a Democratic dream come true.
Income from wealth and income from work were taxed at the same rate in only two widely-separated times in America—from 1916-21, and after Ronald Reagan’s Tax Reform Act of 1986. President Clinton restored the tax break on capital gains in 1997, cutting the rate on long-term gains from Reagan’s 28 percent to 20 percent. Six years later, President Bush lowered the levy to 15 percent and did likewise for dividends. The Bush cuts were written to expire in 2010, but of course they didn't.
The Simpson/Bowles recommendations never received enough support within the commission to force a vote in the Congress on the entire package. But their proposals remain on the table, so the genie is out of the bottle. President Obama and Congress just had one showdown on extending the Bush tax cuts. Now they face another on setting a course for the nation’s fiscal future.
They could start by revisiting the tax code and creating capital gains tax breaks that really would grow jobs and stimulate the economy. Small companies with big dreams raise seed money through initial public offerings (IPOs) and secondary offerings; larger companies sometimes do the same (e.g., the resurgent GM). In a move sure to boost the ailing new-issues market, capital gains on these investments could be tax-free. Interest on corporate bonds, now taxed as ordinary income, also deserves a tax break. Corporate bonds raise the money to build corporate infrastructure, much like municipal bonds raise money to build local infrastructure. Interest from municipal bonds gets tax breaks; why not corporate interest?
How to pay for these new tax breaks? Easy: the money would come from ending the unproductive tax break on stock market gains, along with the 2003 tax break on dividends.
In 1986, President Reagan essentially traded tax breaks on capital gains for another round of cuts in the marginal rates. A generation later, the initial draft from Obama’s fiscal commission holds the makings of a similar endgame.
One major milestone has already been reached. The notion that investments deserve a lower tax than wages has been vaporized. The emperor has no clothes, and really never did.
P.S. Shortly after the Simpson/Bowles report, the Bipartisan Policy Center weighed in with its own deficit reduction plan. It differed in many ways, but it too recommended equal taxes on all income.
Gerald Scorse