List Joe Average as a Loser If Capital-Gains Plan Dies

Critics of President Bush’s proposal to reduce capital gains taxes oppose such a cut because they believe it will lead to larger budget deficits and a more inequitable distribution of wealth. In fact, the proposal will lead to smaller budget deficits and a more equitable distribution of wealth.

Capital gains cut opponents come to their erroneous conclusions because they simply do not understand the vital role capital formation plays in fueling economic growth. Nor are they familiar with the scarce availability of risk capital in our country today. Instead, they are stuck in a zero-sum world where it is more important to prevent affluent investors from benefiting than it is to provide middle-class and lower-income workers and entrepreneurs the opportunity to move up the economic ladder by creating wealth from new ventures.

A cut in the capital gains tax will have the following positive effects:

- Federal revenues from capital gains taxes will increase in 1990 and 1991, because individual and institutional investors will realize capital gains earlier than they would under the higher tax rates.

- Starting in 1990, and continuing as long as capital gains are taxed at a lower rate, individual and institutional investors will move significant amounts of capital from interest-bearing investments (such as bank certificates of deposit, leveraged buyout junk bonds and government debt instruments) to equity investments in new ventures that offer innovative products and services.

- Federal revenues in 1992 and beyond will be greater, because of corporate income taxes paid by the ventures founded with 1990 risk capital and the income taxes paid by the employees of these ventures. In addition, capital gains revenue will increase as the absolute volume of capital investment offsets both the lower tax rate and the effect of the early realization by investors of some capital gains in 1990 and 1991.

- Tens of thousands of middle-class entrepreneurs will obtain the risk capital necessary to launch ventures. At present, many excellent new concepts go unfunded, because of a severe lack of risk capital.

Uncollateralized debt financing is virtually impossible for these entrepreneurs to obtain. Even with collateral, debt financing in American is twice as expensive as it is in Japan or Europe.

Equity capital from the larger venture funds in America is also now virtually impossible for small, middle-class entrepreneurs to obtain, since these funds shy away from providing the seed financing to “two guys in a garage” start-ups. Instead, the organized venture funds now prefer to invest in the leveraged buyouts of existing corporations or other activities that they perceive as less risky. Today’s entrepreneurs are limited to finding capital from their own savings, from the modest bank accounts of believing friends and relatives or from the occasional financial angel (angels are an informal nationwide network of successful entrepreneurs who collectively are the largest source of risk capital for start-ups today).

A reduction of the capital gains tax will provide financial angels with incentives to invest more capital in start-ups and may increase the net return to venture funds sufficiently enough to allow them to get back in the seed capital arena and out of the leveraged buyout business.

- Those new ventures that succeed will provide jobs and career opportunities for middle-class and lower-income workers, enabling many of them to take the next step up the economic ladder. Most new jobs in the 1980s have been created not by the expansion of Fortune 500 companies but by the success and growth of small companies. The lower capital gains rate will create more small companies, and more jobs.

- Investors will benefit from a higher return on their investments. Though many of their equity investments will provide no return as some companies struggle and ultimately fail, some investments will succeed extraordinarily well. The average return on invested capital to investors will be greater with a lower capital gains tax. More importantly, capital will be more wisely invested in activities that create and spread wealth, as opposed to activities that simply preserve wealth.

If capital gains tax opponents are truly concerned about the standard of living for middle-class and lower-income people, they should be willing to step out of their anachronistic assumptions that anything beneficial to the well off must automatically be bad for the rest of us. The 1990s should be a decade in which all Americans can pursue enlightened economic self interest, not one where political grandstanding polarizes our country by conjuring up outdated visions of class struggle.