Capital-Gain Tax Reform

May 27, 1963

Instead of the Administration’s proposals for tax cuts and tax “reforms,” many businessmen and congressmen are advocating the cuts without any reforms. This attitude seems shortsighted. In the face of a huge prospective deficit, we cannot afford a heavy general tax cut. Yet tax reforms—of the proper type—are today not merely possible but urgent.

The most important of these reforms would be the abolition of all tax rates above 50 percent. Such rates are prima facie confiscatory. Their yield is negligible. On the personal income tax it amounts to less than 1 percent of total Federal revenues. But these rates have a profound effect in discouraging new risk investment and in slowing down the growth of employment and real wages.

If this rate reform were made, it would make other essential changes easier. One of these is reform of the capital-gains tax, today one of the most harmful of all our taxes.

Capital gains are not income. They cannot prudently be treated as income. This has been repeatedly emphasized by economists. We need not repeat their arguments here. It is sufficient to point out that the very people who are most insistent that capital gains be taxed at income-tax rates refuse to treat capital-value changes as equivalent to income changes. If a man has a short-term net capital gain of $1 million, they want to tax this at the same rate as added income. But if he has a net capital loss of $1 million, they will not permit this to be deducted from his ordinary income, but only $1,000 of it in any one year. On the part of the government this is a cynical heads-I-win-tails-you-lose tax.

GAINS VS. INCOME

Nor is the situation much improved by the lower maximum rate of 25 percent on long-term capital gains. Again there is no equivalent deduction against income tax for net long-term capital losses.

In Newsweek of Jan. 14 I pointed out not only the injustices but the harmfulness of the present capital- gains tax in “locking in” capital, in penalizing investors for transferring investments into new ventures, in discouraging investment of risk capital, and in stunting economic growth. I suggested half a dozen different ways in which the tax could be reformed. Here I should like to elaborate on one of these:

Segregate capital gains and losses from ordinary income. Have these capital gains or losses reported on a separate return. Tax these segregated net capital gains either at nominal flat rates or at the same rates as ordinary income. If ordinary income-tax rates are used, allow a reduction of, say, 2 percentage points of the capital gain for every month that the capital asset has been held. Thus if the capital asset has been held only one month, 98 percent of the gain would be taxed. If the capital asset has been held 24 months, 52 percent of the gain would be taxed. If it has been held for 50 months or more, there would be no tax. Deductions of losses would be allowed against gains, with an indefinite carry-forward of losses until absorbed.

TAPERING OFF

This would be similar to the tapering-off system used in Sweden. An individual would no longer be locked in with an investment indefinitely. After four years and two months, at least, he could sell or exchange it without tax penalty. In certain cases, for an investment held longer than six months, the tax might be steeper than today. But this could be avoided by the option of a shift to the present 25 percent maximum, and a tapering off each year to a 20, 15, 10, 5, and 0 percent flat rate respectively.

Some rate advantage might be gained from segregated capital-gain returns by a person whose income and short-term capital gains were about equal, but even this would seldom occur if the top income-tax rate were 50 percent. The great dispute about the “evasion” of income taxes through “turning income into capital gains” would practically disappear.

Such a system of taxing capital gains would be much less damaging to investment and growth than our present system. In Britain long-term capital gains are not taxed at all. In Sweden the tapering-off period is about the same as here proposed.