Latest Tax Plans Can Help, But Just a First Step

The news on taxes is that suddenly Congress wants you to pay less. The House Ways and Means committee has just approved a cut in the tax rate for capital gains, and the Senate Finance committee will get a proposal this week from its chairman, Sen. Lloyd Bentsen (D-Tex.), to broaden eligibility for tax-deductible individual retirement accounts.

To be sure, the public won’t get both a cut in the capital gains rate and expanded IRA deductibility. Political scrimmaging, rather than solicitude for taxpayers, accounts for the two being proposed.

But both ideas--tax breaks for investments, or for savings--will be debated in the next two weeks as Congress puts together legislation to reduce the budget deficit. So taxpayers have an opportunity not only to let lawmakers know what they want but also to see some results. Because one idea or the other will become law.

Here are the specifics: The capital gains proposal would allow you to exclude 30% of your profits from the sale of stock, real estate and most other investments if they are held more than one year. It would tax the other 70% at a top rate of 28%--the 33% super rate would not apply--meaning the true tax on capital gains would be 19.6%.

The Bentsen proposal would allow taxpayers not now eligible to deduct from taxable income $1,000 of the $2,000 they put into an IRA.

Inescapable Fact

So which is better--savings or investment? Obviously, the question is nonsense. Savings are invested, and most people’s investments represent their savings. And the inescapable fact is that Americans need to invest more and save more. Republicans and Democrats agree on that, which is why in a time of deficits, Congress is considering tax incentives that theoretically reduce government revenue.

But in debate, many Democrats oppose capital gains reductions as doing more for the wealthy than for the general public. Republicans counter that the constituency for capital gains is broader than the Democrats claim.

Who is right? Forgetting for a moment that there can be a serious philosophical question about taxing capital earnings less than wages for labor, the Republicans are right when they say the capital gains constituency is broad.

Opinion polls consistently show that Americans support a lower tax rate on capital gains. “Even people who are not going to have a capital gain anytime soon support it,” says a Washington tax expert.

There are several reasons for that. More people hold assets--inherited or pension fund stock, real estate, etc.--that they will sell at some point. Also, more Americans are in business for themselves these days--even part-time--and building up capital assets. A Treasury survey taken in 1985 showed that most capital gains transactions were on tax returns reporting income of less than $50,000.

So capital gains tax reduction looks like a winner. And the present legislation--a short-term law that expires in two years--will also reduce the budget deficit, because it will spur people to sell stocks they’ve held for a long time. Their tax payments will raise Treasury revenue for the next two years.

Too Quick a Fix

The proposal’s weakness, however, is that it’s a quick fix. The Bush Administration would prefer reducing capital gains rates to 15% if investments were held for three years. And the Rebuild America Foundation, which is backed by Democratic politicians, would reduce taxes to zero on investments held seven to 10 years.

The fact is, those are the kinds of capital gains tax measures that need to become law in America.

Because the competitive statistics are becoming embarrassing: In 1989 Japan will invest more in plant and equipment than the United States--$569.9 billion for Japan, $513.9 billion for the United States.

And that’s sad. Because Japan’s economy is only 60% as large as the U.S. economy. Yet it is investing more in its industry and workers.

So what does Japan do on taxes? It keeps them low on investment and savings. Until last year, Japan imposed no tax at all on capital gains or savings income. Now it taxes capital gains at 5% and savings at 3%.

U.S. taxpayers, and the Congress, might keep those figures in mind during the coming debate.