Tax-Cut Proposals Aimed at Bringing Economic Relief

How do you spell economic relief? T-A-X-C-U-T.

At least that’s what some in Congress think. Americans could get several tax breaks if lawmakers adopt proposals aimed at reducing the economic fallout from the Sept. 11 terrorist attacks.

It’s impossible to say whether any of the proposals will become law. Under consideration are a cut in capital gains rates; increased write-offs for capital losses; and cuts in payroll taxes, which would give a boost to lower-income taxpayers.

Here’s a look at each proposal, its prospects for passage and its likely effect on taxpayers:

What: Cutting the top capital gains rate from 20% to 15%.

Prognosis: Fair.

Capital gains tax relief is a perennial favorite of Republican lawmakers, who believe that lower capital gains rates--that is, the tax rate on gains on investments held for more than one year--stimulate investment and the economy. But it’s a red flag to Democrats, who contend it primarily benefits the rich.

Nonetheless, Washington insiders say it has a decent chance because budget negotiators are talking compromise: Republicans will approve a cut in the payroll tax for low-income taxpayers if Democrats approve a cut in the capital gains rate.

There’s another reason the tax cut might fly: It’s projected to raise more than $10 billion in revenue over the next four years as long-term holders of stock unlock their profits by selling.

The downside, of course, is the selling pressure it could create on an already depressed stock market. Stock prices have been falling steadily for 18 months, and the slide has gathered steam since the terrorist attacks.

“It’s a long-term economic stimulus. It could be at the cost of a short-term [stock market] depression,” said Martin Nissenbaum, national director of personal income tax planning at Ernst & Young in New York.

Even though lower capital gains rates could inspire some investors to sell, it also would encourage long-term investors to buy because stocks would become comparatively more attractive, countered Mark Bloomfield, president of the American Council for Capital Formation in Washington. Bloomfield thinks the net result would be positive.

However, middle-aged investors who have been racking up far more losses than gains in the stock market might get little immediate relief from such a tax cut.

“This would save taxes for people like my parents, who bought stock in the 1950s and still have it,” said Jim Seidel, senior manager of news and alerts at RIA, a New York-based tax software and research firm. “It wouldn’t help me. I have losses in just about everything.”

Moreover, changes in the capital gains tax wouldn’t affect stocks held in 401(k) plans, individual retirement accounts, Roth IRAs and other tax-sheltered savings plans.

There’s also the issue of the Alternative Minimum Tax, which currently penalizes people with big capital gains. If the AMT isn’t changed, lower capital gains rates would help far fewer individuals, Bloomfield said.

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What: Boosting from $3,000 to $5,000 or $10,000 the amount of capital losses that can be subtracted annually from ordinary income.

Prognosis: Poor.

Many younger investors would get a bigger break if Congress changed capital loss rules instead of cutting the capital gains rate. But boosting write-offs for capital losses has a downbeat tone, suggesting that today’s stock market pain may not be temporary, said Mark Luscombe, principal tax analyst with CCH Inc., a tax research and publishing firm in Riverwoods, Ill. That makes it politically less popular, he said.

Under current law, taxpayers use realized capital losses to offset their capital gains. (A loss is “realized” when stock holdings are sold at a loss.)

If their investment losses exceed their gains in any given year, taxpayers can use up to $3,000 of the additional losses to reduce ordinary income--wages, tips, dividends, etc.--that’s subject to income taxes.

The $3,000 threshold was established in 1978 and has never been adjusted for inflation, said IRS spokesman Don Roberts. If it had been, the threshold would now exceed $5,500.

Still, boosting capital loss deductions creates the same selling pressures as cutting capital gains rates, but doesn’t have the benefit of helping capital formation, nor does it have a huge constituency calling for the change, Bloomfield said.

“The capital loss deduction might give people a bit more incentive to invest, but I don’t think it’s that material,” said Ernst & Young’s Nissenbaum. “I don’t think people invest anticipating that they will have excess losses.”

Economically, money freed by selling to take a capital loss might boost consumer spending, but it also may be saved or invested in some other area.

One argument against capital gains changes is that they primarily benefit upper-income taxpayers, who need the money less and thus are less likely to spend it. The proposal could gain support at some point. But Bloomfield gives it less than a 20% chance of making it into law.

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What: An undefined cut in the Social Security and Medicare taxes paid by low-income workers.

Prognosis: Fair, if packaged with capital gains tax relief.

One of the big criticisms of the tax cuts passed earlier this year was that they bypassed low-income workers. There was a practical reason for that: People earning less than about $7,000 when single or roughly $10,000 when married don’t pay any income tax. Those who have children can earn significantly more and still not pay income taxes.

But rich or poor, nearly all workers pay so-called payroll taxes, which fund the Social Security and Medicare systems. Individuals pay 7.65% on every dollar of wages they earn up to a set amount, which is adjusted for inflation each year; their employers pay an equal amount.

Democrats would like to either cut or refund part of this levy. Besides giving low-income taxpayers a break, it also would put money in the hands of the Americans most likely to spend it. That spending could give the economy an immediate boost.

Economists add that if payroll taxes also are reduced for employers, it could spur employment by making it comparatively cheaper to hire.

Still, it’s impossible to gauge the impact without details of how the plan would be structured. If the tax cut was provided through a credit or refund of just the employee’s portion of the tax, hiring incentive would be less. On the other hand, it also would cost the government less money--an important factor when the Social Security system is projected to run short of cash within 40 years.

The shortage might be mitigated partly by boosting the amount of income that’s subject to payroll taxes for higher wage earners. However, the details haven’t been fleshed out.

“[Senate Minority Leader] Trent Lott said he might consider some type of cut in payroll taxes for people who don’t pay income taxes, if it were put into the same bill as a capital gains tax cut,” said RIA’s Seidel. “There is something in there for everyone. That’s something that could get by.”

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past Personal Finance columns visit The Times’ Web site at https://www.latimes .com/perfin.

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CAPITAL GAINS

Capital gains reported by American taxpayers increased dramatically during the 1990s bull market.

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Tax year No. of returns Net gains reported* (in millions) (in billions) 1999 27.7 $507.02 1998 25.7 446.08 1997 24.2 356.08 1996 22.1 251.82 1995 20.0 170.42 1994 18.8 142.29 1993 18.4 144.17 1992 16.5 118.23 1991 15.0 102.78 1990 14.3 114.23 1989 15.1 145.63

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* after deducting capital losses.

Source: Internal Revenue Service