Should It Be Cut ?

Should it be cut?

A key issue in Washington's current stock-market investigaton is the capital-gams tax. It is attacked on the one hand as a measure that stifles initiative and economic growth, on the other as a rich man's relief handout. Almost every argument about it is beclouded by a mist of special interest, politics and ignorance. Is the capital-gains tax fair? Should it be changed?

The tax on capital gains (i.e., profits made from the sale of anything from a house or business to stocks and bonds) was first imposed in 1922, set at 12 1/2% for gains held two years. Before that, such gains had been taxed as regular income (top bracket: 70%). Thus the principle was recognized that a gain in capital, which might take years to make, should not be taxed at the same rates as yearly income. If it were, then the man who had spent years building up his business and, in effect, deferring his capital gain from it, would be in such a high bracket when he sold out that the tax would take most of his profit. But as the Government's need for cash rose, the capital-gains bite became larger, along with every other kind of levy. Under the present law, a person who takes a capital gain on an asset held for less than six months must pay a tax on his profit at the regular income-tax rate. But on property held for longer than six months, the taxpayer has a choice of two alternatives: he can either pay a regular income tax on half his gain, or he can pay a flat 25% on his entire profit. In any case, the tax cannot exceed 25% of the gain. Under the graduated income tax scale, to benefit from the 25% maximum a single man must have an income of at least $18,000; a household head must earn $24,000; and a husband and wife filing a joint return must have a combined income of at least $36,000.

While most of the current talk about capital gains concerns stock market profits, the provisions of the tax actually cover a variety of operations; e.g., proceeds from the sale of timber, profits from the sale of livestock used for breeding, draft or dairy purposes, gains from coal royalties.

In the past, revenues from the capital-gains tax have fluctuated widely. In 1939, for example, they totaled only $4,000,000, and even since World War II, when opportunities for capital gains have been plentiful, the returns have been comparatively modest (an estimated $1.5 billion last year). A big reason is that the capital-gains tax is paid only when the profit is actually realized.

The most vociferous opponents of the tax are investors and stockbrokers whose job it is to funnel equity capital into the growth of U.S. industry. Why, they ask, should the U.S. discourage the accumulation of capital that is needed to finance new industries? Even under the Labor government, Britain never enacted such a tax. So many U.S. investors are frozen into their holdings by the tax that the flow of equity capital is slowing to a trickle.

The deep freeze sets in because a man with a capital gain is likely to sell his stock only if he can find another that is just as good, and at least 25% cheaper to compensate for the tax bite. Thus, in a rising market, such stock switching is hard. In the past, when income taxes were much lower, the stock market had a built-in brake since whenever stock yields dropped to the level of bond yields, investors tended to switch to safer bonds. But now, though stock yields are approaching bond yields, hundreds of investors are holding onto their stocks, since they do not want to pay out one quarter of their capital gain in taxes. Standard & Poor's investment service, which supervises thousands of accounts, reckons that the capital-gains tax has frozen about 75% Of the stockholdings it oversees.

The political realities are such that even the strongest critics of the capital-gains tax do not dream of repeal. But they make some convincing arguments for modifying the measure. If the tax were halved, to a maximum of 12 1/2%, the U.S. Government might actually collect greater revenues than it does now because of the greater turnover that would result.

Actually, there are many inequities in the tax. Because of political pressures, Congress three years ago changed the law so that a man who sells his house for a profit and then puts the money into another house within a year need pay no tax on his gain. But, a man who spends his life building up an enterprise must pay the same tax when he finally sells out as a windfall housing operator who builds an apartment house and sells it six months later--or a stock-market speculator who takes a six-month profit.

What is needed is a graduated system under which the tax would scale down the longer the asset is held, perhaps along the lines suggested by Marriner Eccles (see Wall Street). In short, political tinkering should be replaced by careful study of how equity capital can be freed instead of frozen.

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