Capital Gains Surtax Proposal Viewed as Menace to Market : Wall Street: Senate Democrats’ approval stuns investors. Analysts say anticipatory actions could topple stock prices.

A surprise Senate proposal for a surtax on high-income investors’ capital gains stunned Wall Street late Wednesday and raised fears of a market backlash.

Senate Finance Committee Democrats, negotiating their version of President Clinton’s economic plan, agreed to a 10% surtax on the capital gains of investors who earn more than $250,000 a year.

It was unclear whether the proposed surtax will survive a House-Senate conference on the economic plan, or the full Senate.

Nonetheless, Wall Street views any suggestion of raising the capital gains tax rate as a potentially devastating attack on investors, and thus on the stock market--especially with stock prices at record heights and thus vulnerable to bad news.

Though the Dow Jones industrial average rose 19.65 points to 3,511.65 on Wednesday, news of the surtax proposal was not widely disseminated until late in the day.

“It’s the camel’s nose under the tent if it’s passed,” said a disheartened Michael Duffy, clinical professor of accounting at USC. “It’s a disincentive for people to save money, and that really seems perverse if you’re concerned about long-term savings patterns in this country.”

While the top federal tax rate on wages is 31%, capital gains--that is, net gains from investments held more than one year--are taxed at a rate of 28%.

Wall Street had assumed that the 28% capital gains tax would remain, even though the top rate on wages would be 36% under Clinton’s plan. The case for a capital gains tax break is that people should be encouraged to invest in stocks and other long-term investments to help promote economic growth.

Senate Democrats, apparently searching for new ways to raise revenue to flesh out the President’s plan, argued that a 10% gains surtax for high-income earners would affect relatively few investors, though it would reportedly raise $589 million over five years.

The surtax would, in effect, raise a high-income earners’ capital gains tax to 30.8% from 28%.

But investment experts contend that any rise in the capital gains tax, even a small one, would cause some investors to abandon stocks and other high-risk securities.

“If they’re not going to have the opportunity to earn an attractive return, people are just going to put their money in tax-free municipal bonds,” said Franz Von Bradsky, a venture capitalist at Green Tree Capital in North Hollywood.

Robert Raney, chief investment officer at U.S. Trust of California in Los Angeles, argued that a boost in the capital gains tax would induce some investors to hold assets they might otherwise sell. While that might appear to foster longer-term investing, Raney said the net effect would be to choke off the flow of capital from old ventures into new.

“Money isn’t going to go to the highest and best use” if investors hold for tax reasons, Raney said.

In the near term, however, some Wall Streeters worry that news of a possible capital gains tax hike will encourage more investors to dump securities to beat any tax rise.

“Anyone with capital gains will say, ‘Let’s take them now,’ ” said Steve Kibbey, vice president at Centurion Capital in San Diego.

When the market is vulnerable to a selloff, Kibbey said, “it’s always something out of left field that does it in.”