Cut in Capital Gains Tax Now Likely : Democrats, Fearing Defections, Are Under Pressure to Act

Congress appears ready to give President Bush the benefit of the doubt on his controversial plan for cutting capital gains taxes, possibly approving a reduction of some sort before the end of the year, congressional strategists said Wednesday.

Despite their traditional aversion to a capital gains tax cut because it chiefly benefits high-income taxpayers, Democratic congressional leaders have been dropping new hints that they may be forced at least to “consider” the President’s plan and probably pass some version of it.

Capital gains are profits from the sale of stocks, real estate or other assets. They currently are taxed at the same rate as ordinary income--28% for most taxpayers and 33% for certain high-income taxpayers.

Pressure From Dissidents

Strategists say that the House, under pressure from a group of dissident Democrats on the Ways and Means Committee, which originates tax legislation, seems likely to approve at least a modest reduction in capital gains taxes in the next few weeks, creating pressure on the Senate to do the same.

And, on Wednesday, Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.) said that he has begun exploring the possibility of cutting capital gains taxes as part of the budget deficit-reduction deal that Congress has struck with the Bush Administration.

The budget plan calls for lawmakers to raise $8 billion in new revenues without violating Bush’s campaign pledge of “no new taxes.” Cutting capital gains taxes would raise revenues temporarily because many investors could be expected to sell assets that they otherwise would have held.

Bentsen’s decision to explore the capital gains issue is especially important because it opens the door to quick action by the Senate later this year, if the House bill goes through.

Analysts say that the House still is expected to enact only a modest--and possibly temporary--cut in capital gains taxes, but Bentsen’s panel might enlarge the House proposal and make any reduction permanent. Bentsen has said that he believes a temporary cut would be “bad economics.”

The new, more receptive attitude on the part of congressional Democrats has been evolving slowly but steadily over the last few months. Although the Democrats initially opposed any capital gains tax cut, some have begun breaking ranks.

Analysts attribute the change to several factors:

--The formation of a rump Democratic group supporting a capital gains tax cut in the House Ways and Means Committee has raised fears that Southerners might bolt party ranks again over the issue--as they did in 1981--embarrassing the leadership and benefiting Republicans.

--Lawmakers have discovered that voters are not nearly as opposed to reducing capital gains taxes as some Democratic leaders had assumed and that many middle-class taxpayers even favor such a move because they perceive that they may benefit from it.

--Congressmen have discovered, in some cases to their surprise, that voters like the concept of tax reduction in general, no matter what income group will benefit the most. “A proposal to reduce taxes is extremely popular,” House Speaker Thomas S. Foley (D-Wash.) told reporters recently.

However, a change in attitude on the part of Democratic congressional leaders does not guarantee that the President’s full capital gains plan will get through both houses intact.

The Administration initially proposed reducing the top tax rate on capital gains to 15% in the case of long-term investments. More recently, it has swung its support to an alternative plan by conservative Democrats to trim rates to 20% for two years, from the current 28% and 33%.

Capital gains historically have received preferential tax treatment. But, since the 1986 Tax Reform Act, they have been taxed at the same rate as ordinary income--part of a move to make the tax code more equitable.

Mark A. Bloomfield, president of the Washington-based American Council for Capital Formation, a lobbying group that is pushing for a cut in capital gains taxes, said that a cut is “a very doable proposition” for 1989 or early 1990.

“It’s the surprise tax story of the year,” Bloomfield said. “The middle class wants a shot at it.”

Bentsen said that he is particularly interested in some provisions of a proposal by Rep. Dan Rostenkowski (D-Ill.), the House Ways and Means Committee’s chairman, that would exclude from taxation that part of investment profits attributable to inflation.

Rostenkowski offered the plan earlier this month as a way to counter the rump group’s proposal to cut tax rates on capital gains temporarily to 20%.