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Why Cut Cap Gains Tax Rate? Our Level Is Higher Than Most
By: Adrienne Fox, January 27, 1997
It seems almost certain that Congress will try to lower the capital gains tax rate as part of a balanced-budget plan this year. Whether a cut would be broad-based or targeted at farmers or homeowners remains to be seen.
But either type of cut would narrow a gap between taxes levied on capital gains by the U.S. and those levied by other industrial nations.
The U.S. taxes capital gains on long-term investments at a 28% rate, which is the highest among most industrial countries, except for the U.K. and Australia. But those countries each index their rates to inflation, so their real rates are actually lower than U.S. rates.
For short-term investments, the U.S. is also on the higher end of the tax spectrum, with a 40% rate. Germany’s rate is the highest, at 53%, but there is no tax on gains from long-term investments. Australia taxes short-term investments at a high 48.3%, with no indexing. U.K.’s long- and short-term rates are 40%, but each is indexed to inflation.
Canada has a relatively low 23.8% rate on both short0 and long-term investments. France taxes gains at 18.1% for both terms. Italy and Sweden levy a 25% rate on short- and long-term investments.
Of the major industrial countries, Belgium, Hong Kong, and the Netherlands exempt capital gains from taxation.
Japan’s tax policy gives investors a choice between being taxed at 1% of an asset’s sale price or 20% of the net gain, whichever is lower.
Economists in favor of a cut in the U.S. rate often point to savings rates in countries with lower capital gains rates. For instance, Japan’s savings rate averaged 17% in the period between 1979 and 1994. And Belgium’s rate averaged 18%.
With one of the highest capital gains rates, the U.S. had a low savings rate average of 6.4%.
But it is hard to draw a clear connection between a nation’s capital gains tax rate and its savings rate. For example, Italy and Sweden tax gains at the same rate, but Sweden’s savings rate averaged 2.7%, compared with 20.7% in Italy.
Still, says Patrick J. Horan of Horan & Associates Financial Advisors Ltd. In Baltimore, the U.S. tax code does not reward people who save and invest.
“Savings is absolutely critical,” Horan said. “The government should learn that lesson: you don’t spend more than you earn. I can list thousands of clients who have put away 10% of their earnings. They are not reliant on government services. But they are going to have to give (almost) 30% (of their capital gains) to the government for doing nothing. What did the government do to earn its cut?”
Not only does the capital gains tax penalize individuals who saver for their retirement, Horan adds, but it deters businesses from selling assets and reinvesting in their companies.
“There are a lot of businesses sitting on highly appreciated assets, so that if they could sell, they would put that money back into the business,” said Horan. “But they don’t want to sell (them) because they’re going to get whacked on capital gains taxes.”
Margo Thorning, senior vice president and chief economist at the American Council for Capital Formation in Washington, agrees.
The capital gains tax “raises the cost of capital for new investment by between 6% and 8%,” she said. “The rate would have to fall at least to 20% to bring the cost of capital down between 6% and 8%.”
Republicans have long called for a broad-based cute in the capital gains tax rate, saying it would spur investment. GOP nominee Bob Dole vowed to slash the rate in half during his presidential campaign.
Even though Dole lost, Republicans in Congress have renewed the call for a broad0based cut in the capital gains rate. And, Democrats are starting to come on board for some type of relief. Senate Minority Leader Tom Daschle, D-S.D., recently announced that he would factor a targeted cut for farmers. And during the campaign, President Clinton promised to cut the tax on a capital gain made from selling a home.
Which is the best way to go?
President Clinton claims his plan will reward those who own a house, encouraging home buying, while making only a small dent in the Treasury’s coffers.
Bus some economists say a broad cut would not reduce tax receipts, and might even raise them.
“When you take account of the macroeconomic feedback generated by the higher economic growth that lower capital gains would bring, it wouldn’t cost the Treasury anything,” Thorning argued.
She cites a study done by the National Bureau of Economic Research, which noted that from 1978 to 1985, the top tax rate on capital gains fell to 20% from 35%. Instead of losing revenue, tax receipts almost tripled from $9.1 billion to $26.5 yearly. NBER estimates that a rate between 9% and 21% would bring in the most revenue for the Treasury.
Republicans argue that a broad cut would unlock the dams of capital formation and lead to further job creation.
Allen Sinai, chief global economist at Lehman Brothers in New York, estimates that cutting the capital gains rate in half would add 0.7% to gross domestic product annually. Capital spending by firms would increase 2.1%, he says, and between $9 billion and $18 billion would be added to the Treasury.
Rates of capital formation among most of the major industrial countries are similar – about 15% of GDP. Japan’s rate is much higher at 25% of GDP.
“When capital is freed, people spend the money,” said Horan. “They get out of (less expensive) real estate and into more expensive real estate. The money saved from taxes is used to rebuild the economy and build economic growth.”
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