Controversy Over Capital Gains Tax
“Index the Gains Tax; Don’t Cut It,” by John Makin and Jonathan Morgan (Op-Ed Page, Sept. 27), argues that indexing capital gains taxes is preferable to cutting capital gains taxes, and that Rep. Dan Rostenkowski’s (D-Ill.) counterproposal to immediately index capital gains is therefore superior to Rep. Ed Jenkins’ (D-Ga.) proposal to cut the tax rate for 2 1/2 years, then index them. While they are correct in the case they make in favor of indexing, they are incorrect in presenting the issue as an either-or decision. There is a case to be made for both lower rates and indexing, not one or the other.
Indexing capital gains has long had the overwhelming support of economists, as a way to reduce uncertainty and avoid paying taxes on illusory gains (as well as on nominal gains that do not even keep up with inflation, which are real capital losses). There is no cogent reason, other than losses to the Treasury, for opposing this (although one wonders why it took the prospect of a Democratic revolt on capital gains for party leaders to suddenly want to rectify this longstanding inequity that they have consistently supported).
However, correcting the inflationary “tax” on capital gains by indexing solves only one problem involving such gains, leaving another that argues for lower capital gains rates as well; capital gains taxes are but one of several taxes levied on capital, with the combined rate far higher than the capital gains rate alone, so that capital gains rates would have to be lower than personal income tax rates to receive equal treatment.
Consider an investment in corporate stock. The original investment must be made with already taxed earnings. Then it is subject to local property taxes. Any earnings are then subject to state and local corporate income taxes, before adding to share value. If the increased value is paid out as dividends it gets taxed again as personal income; if it is retained in the firm, it gets taxed as capital gains when the shares are sold. The effective cumulative tax rate on capital income from these sources is estimated at between 60% and 70% (strict limits on deductions for capital losses are also enforced).
No principle of equity calls for capital gains to be taxed at the same rate as other income even if such gains are indexed, since these gains have already been subjected to several other taxes, and thus pay a far higher effective tax rate than other forms of income. Makin and Morgan ignore this little detail.
Rather than misleadingly presenting a case for indexing instead of lower rates (which is not the actual choice being considered) which relies on faulty fairness comparisons, Makin and Morgan should be making the case for both indexing and lower rates on a permanent basis. Unfortunately, however, their argument has sacrificed logic and accuracy in favor of partisan politics.
GARY M. GALLES
Associate Professor of Economics
Pepperdine University, Malibu
