GOP Is Poised to Cut Capital Gains Tax--and Clinton Could Join It

With the Republicans dominating Congress for the first time in four decades, Wall Street sees a spectacular chance to get a favorite wish granted: a cut in the maximum tax rate on long-term capital gains, now 28%.

Given the nation’s arguably low savings rate, Republicans have insisted for decades that people need greater incentive to save and invest. Limiting Uncle Sam’s take of any asset’s long-term rise in value has always sounded like a logical way to boost investment and spur economic growth.

But nothing is simple inside the Washington Beltway, so Democrats and Republicans have battled for years over whether a lower capital gains tax really helps the economy in the long run, or is just a costly tax dodge for the wealthy.

Now, however, it seems clear that Congress will send President Clinton some kind of capital gains tax cut in 1995. The probable new chairman of the tax-bill-writing House Ways and Means Committee, Rep. Bill Archer of Texas, appears unshakable in his commitment to a cut.

Archer introduced a bill in January that would slash the maximum effective long-term gains tax rate to 14%, the lowest rate in the modern era. His proposal is part of House Republicans’ “Contract With America,” their blueprint for immediate action in the new Congress.

Senate Republicans haven’t been specific with capital gains proposals, but it’s hard to imagine they won’t go along with a cut. When the Republicans took control of the Senate in 1980, on President Ronald Reagan’s coattails, the 1981 tax reform law that came out of Congress sliced the top capital gains rate from 28% to 20%. It went back up to 28% with the 1986 tax law.

But would a sharply lower capital gains tax rate be bullish for financial markets in 1995, as popular wisdom might suggest? Some Wall Streeters worry that the timing, in the short run, isn’t fortuitous.

With the bull market aged and thus vulnerable to selling anyway, a lower capital gains tax rate could conceivably encourage many long-term investors to take their stock profits and run back to the bank, where CD yields are alluring again.

Michael Metz, investment strategist at Oppenheimer & Co. in New York, says that any new selling pressure in the market could be exacerbated by another probable side effect of a capital gains tax cut: a slew of initial public stock offerings by private companies.

“Every entrepreneur in the world would be trying to sell his company to the public” as a way of taking out some of the accumulated wealth in the business, Metz says. Unless interest rates come down, those new issues could be fighting for the attention of a shrunken pool of stock investors.

Yet the short term isn’t what a capital gains tax cut would be about. The issue is whether Americans deserve to keep more of the capital they put at risk, long-term, in investments. For two reasons, Republican logic on a capital gains tax cut may be unassailable, even if other tax reductions (such as an income tax cut) must be limited to allow room for a capital gains cut:

* At 28%, the top U.S. tax rate on long-term capital gains--that is, gains on investments held more than one year--is higher than that of any other major industrialized country except Britain.

Germany doesn’t tax long-term gains at all. The French tax them at 18.1%. Even welfare state Sweden takes less. Coincidentally, most of the industrialized world also boasts of higher personal savings rates than the United States. Or perhaps it’s not a coincidence.

* Investing is no longer the exclusive domain of the wealthy, if it ever was. As the stock and bond mutual fund buying explosion of the last 10 years shows, Middle America has become a big investor.

Rich or not so rich, anybody who makes a long-term investment decision that ends up a winner would like to keep as much of the gain as possible. And investment winnings are likely to beget more investment, in the long run if not right away. If you know you’ll pay a 39.6% tax rate on interest income from the bank, but only 14% on a long-term stock gain, chances are you will find stocks irresistible for at least some of your savings.

Certainly, one of the electorate’s messages in Tuesday’s swing to conservatism was that more people believe the old Republican mantra: Government shouldn’t create jobs; the private sector should. If that’s the new marching order, then the private sector shouldn’t be impeded in its search for capital.

But could President Clinton sign a tax cut bill that includes a huge capital gains tax reduction without risking alienating Democrats who would initially view such a move as a handout to the wealthy? It is said that “only Nixon could have gone to China”--a reference to President Richard Nixon’s rabid anti-communism. Perhaps only a Democratic, liberal-leaning President could sign the most aggressive capital gains tax cut in U.S. history and get America’s thanks.

* GOP INITIATIVES

Future House Ways and Means chair to promote various tax cuts. A1

Capital Gains: A Survey

Here is how different countries tax gains on sales of assets. Long-term gains generally are those on assets held more than one year.

Maximum Tax Country Short-term Long-term Belgium Exempt Exempt Britain 40.0% 40.0% Canada 23.8 23.8 France 18.1 18.1 Germany 53.0 Exempt Hong Kong Exempt Exempt Japan* United States 39.6 28.0 Sweden 25.0 25.0

* Both: 1% of sales price or 20% of net gain

Source: American Council for Capital Formation