Money Angles

By Andrew Tobias

Suddenly there are a lot of tax proposals back on the table. This is too bad, because changing the tax law every five minutes enriches accountants and attorneys but just confuses everyone else. So there's a lot to be said for leaving things alone. That's certainly the case if the alternative is the President's broad capital-gains cut. A focused capital-gains cut would cost far less and accomplish as much or more, and without the paperwork. But first a little background:

-- A Texas millionaire in 1981, at the dawn of the Reagan/Bush era, was in the 70% marginal tax bracket. Of the next $1,000 he earned, $700 went to the Federal Government. Today he's in the 28% tax bracket.

-- By contrast, the rich Texan's plumber, self-employed and earning $30,000, was in about the 40% marginal tax bracket. Of the next $1,000 he earned, $400 went to the government -- $100 or so to Social Security, $300 to income tax. Today he's in the 43% bracket.

Into this breach rides Mr. Bush with a plan to cut the capital-gains tax as much as 30%. Oh, sure, the wealthy would reap 90% of the cash benefit. But those who've pegged the plan a giveaway to the rich Mr. Bush calls "demagogues."

All of which would be fine -- really -- if the plan met its stated goal: to encourage investment and thus help America grow. But it doesn't. The rich already invest most of their money. What else are they going to do with it? Mr. Bush's broad capital-gains cut would not persuade the rich -- or anyone else -- to forgo a second VCR and invest that $300 instead. Yet that's exactly the kind of persuasion America needs these days: less consumption, more investment.

Under Mr. Bush's plan, the great middle class would supposedly be lured to invest because after that $300 had grown by $200, say, the tax on the gain would be $15 or $20 lower. "Honey! Forget the VCR! The President says that if things work out with our investment, we could save $20 on our 1996 taxes!" (Bush's other proposal -- the family-savings plan -- would mainly encourage people to move money from their current savings accounts into these new ones.)

Liberalizing the limits on Individual Retirement Account contributions, by contrast, would give the typical middle-class taxpayer an immediate $85-to- $115 tax break for choosing the IRA over the VCR, depending on local tax savings, if any.

Either plan -- a broad capital-gains cut or liberalized IRA deduction -- would cost a fortune. (A bargain capital-gains tax rate would shake loose revenues at first as investors sold to take advantage of it but in the long run come back to bite us.) So it may be that given the deficit, we can afford neither.

Yet if the goal is truly to spur investment, there's an efficient, inexpensive way to do it: cut the capital-gains tax drastically, but apply the cut only to founder's stock (anyone who starts or invests in a new company) and to securities purchased in a public offering (for example, when a new company goes public or when GM issues $1 billion in new securities to modernize its factories). And don't make the cut retroactive, as the President inexplicably would. How does that help spur future investment? Just apply it to investments made from now on.

A focused capital-gains tax break would cost little, or nothing if it fostered growth, because it would not apply to most transactions -- barely 1% of all stock-trading volume represents purchase of new shares -- or to profits on real estate, art, gold or the like. Yet precisely because it would be focused, it would skew investment toward the things we need even more than new malls: new businesses and the expansion and modernization of existing ones.

Focused or not, two things any capital-gains tax cut should not include are provisions for indexing and a holding period. Indexing gains to inflation introduces a whole new level of complication and paperwork at a time when taxes are, to put it mildly, complicated enough. And it protects the wealthy who have assets to protect from inflation, but not the average family, with little in the way of assets besides its house (already largely sheltered from capital-gains taxation) and its retirement funds (sheltered as well).

A long-term holding period would lead investors back to the old days of basing decisions on tax strategy instead of economics. And it would put a chill on trading, which means less liquid markets, especially in small stocks. Liquid markets are a prime U.S. asset. A long-term holding period would do little or nothing to cure management's short-term perspective, since the big market action comes from pension funds and others not subject to tax at all. And there are already big incentives to holding investments for the long term. You minimize commissions and pay zero tax until you sell. Your money can compound tax free for decades.

Finally, one must mention the onerous Social Security tax. As all but the rich know, it is onerous. But now, with the nation running a large deficit, is not the time to cut it. (Let alone privatize it, which makes no sense at all. You'd just have to pass a new "emergency net" for the millions who, despite good intentions, would not manage to save for their old age -- which was all that Social Security was intended to be in the first place.) Cutting the Social Security tax would just mean a larger deficit and, on the margin, the purchase of more VCRs. Now is not the time for increased consumer spending.

But Senator Moynihan is quite right: in light of the Social Security tax burden, it would be outrageous to give rich folks yet another broad tax break. It's mind boggling that this actually passed the House last term, to be kept from enactment only by the Senate. One hopes the Senate, led on this issue by the likes of Senators Bradley, Bentsen and Moynihan, will show the same good sense again.