Treasury Study Backs Capital Gains Tax Cuts

Cutting the capital gains tax rate in 1978 and 1981 bolstered government revenue and should give a modest boost to long-term economic growth, according to a detailed study released Friday by the Treasury Department.

The report provides evidence in support of “supply-side” economists, who advocated the tax cuts at the time by arguing that lower taxes on investment profits would produce greater income tax revenue than keeping capital gains tax rates high.

But the report also gives sustenance to opponents of the capital gains tax break by pointing out that the cut almost exclusively benefited wealthy taxpayers--and that those with incomes below $100,000 would have been far better off if capital gains had been indexed against inflation.

Further Cut Proposed

Under current law, taxpayers are allowed to exclude from taxation 60% of the profits from selling investments held longer than six months, creating a maximum tax rate of 20% on such capital gains. Before 1978, the maximum rate on capital gains could under certain circumstances go as high as 49%.

President Reagan has proposed as part of his tax overhaul package to further reduce the maximum capital gains rate to 17.5%. By contrast, several congressional Democrats on the House Ways and Means Committee are recommending that the rate be held constant or boosted to as much as 23%.

Treasury officials acknowledged that the evidence presented in their 199-page report does not directly bolster the case for reducing the maximum capital gains tax rate below 20%. But they said a higher capital gains rate probably would not bring in much additional revenue for the government.

Assistant Treasury Secretary Ronald A. Pearlman, calling the report a “major contribution to the debate on capital gains,” said it again shows the distorting effect of inflation on the tax system.

Profits of $2 Billion

For example, the report examined one year in which taxpayers with incomes of less than $100,000 paid taxes on reported profits of $2 billion from selling stock. But because the gains actually fell short of inflation, those taxpayers had real losses totaling $5.3 billion.

On the other hand, taxpayers with incomes above $100,000 reported gains of $3.6 billion, much closer to their inflation-adjusted profits of $1.8 billion.

In its original tax reform proposal, the Treasury Department recommended that capital gains be adjusted for inflation and then taxed like ordinary income--a policy that would have spread the benefits of capital gains treatment more evenly across income groups. But when the White House finally approved a tax package in May, the inflation adjustment was reduced to an option that will be allowed only after 1991, and the exclusion that primarily benefits upper-income taxpayers was retained.