Tax Policy Feeds Rich-Poor Gap
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Jia Lynn Yang,
The Washington Post
September 11, 2011

The K Street office of Mark Bloomfield, president of the American Council for Capital Formation, is full of knickknacks collected in three decades of lobbying for cutting the capital gains tax.

The coffee table has campaign buttons that read “Capital Gains = Better Jobs.” One wall displays a blown-up cartoon retracing the steps that led President Jimmy Carter to reluctantly sign a cut in the capital gains tax rate. On a shelf sits a framed, handwritten note from President George W. Bush in December 2003 that says: “Dear Mark, I got your treatise on taxes — many thanks. I will look it over with keen interest. Merry Christmas.”

For the very richest Americans, low tax rates on capital gains are better than any Christmas gift. As a result of a pair of rate cuts, first under President Bill Clinton and then under Bush, most of the richest Americans pay lower overall tax rates than middle-class Americans do. And this is one reason the gap between the wealthy and the rest of the country is widening dramatically.

The rates on capital gains — which include profits from the sale of stocks, bonds and real estate — should be a key point in negotiations over how to shrink the budget deficit, some lawmakers say.

“This is something that should be on the table,” said Rep. Chris Van Hollen (D-Md.), one of 12 members on the congressional supercommittee tasked with reducing the deficit. “There’s no strong economic rationale for the huge gap that exists now between the rate for wages and the rate for capital gains.”

Advocates for a low capital gains rate say it spurs more investment in the U.S. economy, benefiting all Americans. But some tax experts say the evidence for that theory is murky at best. What is clear is that the capital gains tax rate disproportionately benefits the ultra-wealthy.

Most Americans depend on wages and salaries for their income, which is subject to a graduated tax so the big earners pay higher percentages. The capital gains tax turns that idea on its head, capping the rate at 15 percent for long-term investments. As a result, anyone making more than $34,500 a year in wages and salary is taxed at a higher rate than a billionaire is taxed on untold millions in capital gains.

While it’s true that many middle-class Americans own stocks or bonds, they tend to stash them in tax-sheltered retirement accounts, where the capital gains rate does not apply. By contrast, the richest Americans reap huge benefits. Over the past 20 years, more than 80 percent of the capital gains income realized in the United States has gone to 5 percent of the people; about half of all the capital gains have gone to the wealthiest 0.1 percent alone.

“The way you get rich in this world is not by working hard,” said Marty Sullivan, an economist and a contributing editor to Tax Analysts. “It’s by owning large amounts of assets and having those things appreciate in value.”

Republicans have led the way in pressing for low capital gains tax rates, but they have been able to rely on a significant bloc of Democratic allies to prevent an increase and to protect the preferential treatment of money earned through investments over money earned through labor.

President Obama and leading Democrats want to allow the tax cuts passed under Bush to expire. That would raise the capital gains tax rate from 15 percent to 20 percent. But that would still be lower than the rate under President Ronald Reagan — who raised the tax in 1986.

“Capital gains . . . veers onto theology for Republicans, but it has always been a bipartisan issue,” Bloomfield said.

A poll this spring by the nonprofit Public Religion Research Institute showed that Americans, by a 2-to-1 margin, think the wealthy should pay more taxes than the middle-class and the poor.

Billionaire Warren Buffett has become one of the loudest and most frequently cited proponents of the wealthy paying more in taxes.

“The truth is, I have never had it so good in terms of taxes,” Buffett said in an interview with Charlie Rose. “I am paying the lowest tax rate that I’ve ever paid in my life. Now that’s crazy, you know. And if you look at Forbes 400, they are paying a lower rate, counting payroll taxes, than their secretary or whomever around their office, on average.”

How the wealthiest Americans managed to get Congress to treat money made from investments differently from salaries or wages involved a variety of lobbyists, economists and lawmakers.

“Capital gains is economics, theology and politics wrapped together,” Bloomfield said.

The Greenspan effect

The theory justifying low capital gains taxes has many philosophical fathers but none as influential as Alan Greenspan, the former Federal Reserve chairman who was treated as an economic seer for decades.

Greenspan said capital gains taxes made people reluctant to move out of one investment and into other, more-promising ones.

In 1997 congressional testimony, Greenspan said the “major impact” of the capital gains tax, “as best I can judge, is to impede entrepreneurial activity and capital formation.”

“The appropriate capital gains tax rate was zero,” he added.

Greenspan’s thinking had been around for decades. The same approach was adopted in 1921, just before a stock market boom, when the U.S. government lowered the capital gains rate for the first time. Over the decades, the rate fluctuated but remained lower than the rate on wage income.

Then in 1986, under a far-reaching tax bill, Democrats cut a deal with Reagan to raise the tax on investments and lower the one for salaries. For the first time in 65 years, both forms of income would be taxed at the same rate: 28 percent.

But that moment was brief.

In 1990 and 1993, the top tax rates on other forms of income rose, while the tax on capital gains stayed put, a disappointment to President George H.W. Bush, who wanted even lower capital gains rates.

After the Republicans took control of the Congress in 1994, they again pressed for capital gains rate cuts.

Greenspan was then near the peak of his credibility in Washington. In 1993, he promised Clinton that he would lower interest rates if Clinton backed a deal to narrow the budget deficit. Both men delivered, building trust.

By 1997, the GOP leaders were turning to Greenspan for economic cover and inspiration.

“Now I agree with Steve Moore and Alan Greenspan that the correct rate is zero if you want maximum economic growth,” House Speaker Newt Gingrich (R-Ga.) said at the Cato Institute on July 16, 1998. “If you really wanted the most wealth created over the next 20 years, you would have a zero rate for the capital gains tax, which is a tax on job creation.”

Other GOP lawmakers formed the Zero Capital Gains Caucus, with 92 House members and 15 senators. The group’s chairman, Rep. David Dreier (R-Calif.), said on his Web site: “Federal Reserve Chairman Alan Greenspan has said we should reduce it. So what are we waiting for?”

The group included many members of the powerful tax-writing House Ways and Means Committee. One was Rep. James Otis “Jim” McCrery (R-La.). He formed the Committee for the Preservation of Capitalism, a political action committee that he used to give money to candidates favoring lower capital gains rates.

Treasury Secretary Robert Rubin wasn’t enthusiastic, but Clinton, seeking compromises with Congress, agreed to cut the capital gains tax rate to 20 percent.

“The irony is that Reagan got rid of the preferential rates for capital gains and Clinton put them back in,” Sullivan said.