Bush's New Trojan Horse
BROCKWAY, GEORGE P.
The Dismal Science GEORGE BUSH'S NEW TROJAN HORSE BY GEORGE P. BROCKWAY George Bush has the distinction of introducing the only tax issue into this fall's Presidential campaign. For...
...Neither you nor I nor even George Bush knows what the future will bring...
...Assuming that for a given company expansion makes sense, the necessary capital can be raised by borrowing, by selling new shares of stock, or by retaining earnings...
...It is received doctrine that the first method should be encouraged, and that adverse personal consequences of the second should be mitigated...
...Since 20 per cent of $169 billion would be almost $34 billion instead of $24 billion, it is obvious that the capital gains tax, even though admittedly mostly falling on the superrich, was paid by many whose Adjusted Gross Income was less than the $175,251 then needed to boost a married couple into the top bracket...
...But he has offered us another Trojan Horse to make the rich richer...
...To answer that question we have to look at where capital gains come from...
...Conservatives of Bush's school colors are quick to see that wage increases tied to the cost of living are inflationary...
...As a matter of fact, capital increases are even more inflationary for reasons we've previously discussed (see "Vale, Volcker," NL, June 1-15,1987...
...The question I ask is: Do we want that to happen...
...In this he is supported by Treasury Department Research Paper No...
...No matter: For Bush's scheme to work, they must more than double what they otherwise would be...
...The house you bought for $100,000 five years ago can be sold for $200,000 today, which is dandy...
...Another tax—the so-called Tariff of Abominations—led to the nullification crisis of 1832, and ultimately to the American Civil War...
...They come about in two ways: (1) a company retains and reinvests its income instead of paying it out in dividends, thus increasing its net worth and, presumably, the market value of its shares...
...Obviously, too, once the new tax law settles down and a married couple with an Adjusted Gross Income of $29,751 finds themselves in the top bracket (28 per cent), practically everyone with any capital gains will be paying the top rate...
...Of the three, he has pushed most strongly the one dealing with revenue...
...Interest payments on borrowings are a deductible business expense, while dividends on stock are not...
...Indeed, it is precisely this frenzy that Bush wants to stimulate...
...yet taxes were central issues in the great wars that made and preserved our nation...
...Taxation can serve one or both of two purposes: It can raise revenue to pay the costs of government, and it can encourage or discourage various activities...
...The raising of a revenue thereby was never intended...
...In brief, the deduction, although it seems to subsidize the borrower, in fact subsidizes the lender...
...On one level, the question is an extreme case of that raised by the Laffer Curve, and of Peter Peterson's claim that the rich pay more taxes when the rate is lower (see "In for a Penny, In for aPound," NL, June 13...
...It is a sign of the shallowness of our society that the eyes of so many people of all ages and both sexes glaze over when the subject comes up...
...The more companies grow, the more the economy grows: more goods, more jobs, more profits...
...On the same realizations, the present rate of 28 per cent would yield $47 billion, and Bush's rate of 15 per cent would yield $25 billion...
...Finally, it is urged that capital gains are, for most individuals, an unexpected and even unwanted consequence of inflation...
...Moreover, the subsidy is meaningful only to an already profitable company, given that a new enterprise typically operates at a loss for some time and can't afford to borrow at all...
...The latest figures the Treasury research paper gives us to work with are those of 1985, when the marginal rate was 20 per cent, capital gains realizations were about $169 billion, and the revenue raised was about $24 billion...
...Bush would leave you$15,000poorer, and that is better, but not great...
...All three of these theories are involved in Bush's tender concern for capital gains...
...On the other hand, interest payments are a fixed expense, while dividends, again, are not...
...it's easier than working...
...or (2) goods (especially real estate and works of art) increase in value because of market shifts or inflation, thus tending to lock holders into property they might otherwise have wanted to sell...
...It has no net income from which to deduct the interest expense, and therefore has to pay the usurious raw rate on whatever it borrows...
...Let's suppose he succeeds and manages to boost capital gains realizations to $340 billion...
...Without the subsidy, interest rates would have to fall, because few could afford the raw rate...
...The very possibility of capital gains stimulates the frenetic search for more of them...
...In addition, it is said that the possibility of capital gains attracts both entrepreneurs and investors to new businesses, which are the economy's hope for the future...
...A tax—the Stamp Tax—crystallized the colonists' dissatisfaction with England and led to the American Revolution...
...As the Treasury has told us, capital gains realizations in 1985 were $169 billion...
...There are, to be sure, special ways to handle this special problem, and some of them are embodied in the present law...
...A more general theory appears in Alexander Hamilton's classic Report on Manufactures (1791): "[T]he power to raise money is plenary and indefinite, and the objects to which it may be appropriated are no less comprehensive than the payment of the public debt, and the providing for the common defense and general welfare...
...The 1986 tax law has partially eliminated it as a personal deduction...
...Then the after-tax income from capital gains would leap to $289 billion—more than double that of any previous year...
...at the expense of other classes and individuals," and espoused the theory of taxation for revenue only...
...For anyone whose interest in government or economics goes beyond personalities, taxes are endlessly fascinating...
...A large part of what was realized in 1986 (including everything I cashed in) was in anticipation of 1987's higher rates, while a large part of what was realized in 1987 was losses in the stock market's Oktoberfest (me, too...
...8801, "The Direct Revenue Effects of Capital Gains Taxation," which argues that a lower rate brings in higher revenues...
...but it is quite certain that wheeling and dealing raises the cost of capital for all enterprises, new and old, good, bad and indifferent...
...The same is true of capital increases...
...It is not impossible that some good enterprises are thus sponsored that would not have been undertaken otherwise...
...For Bush to bring in more revenues than the present rate, he would have to push realizations beyond $340 billion, or more than twice the highest they've ever been before...
...The Revolution was fought (in part) because the Stamp Tax did the former, the Civil War (in part) because the tariff did the latter...
...There are opposing views, specifically those of the Joint Committee on Taxation and the Congressional Budget Office...
...A company that reinvests its income grows...
...An ordinary tax on your capital gain (28 per cent under the new law) would leave you $28,000 poorer than you'd have been if you hadn't moved...
...The case is extreme because Bush's proposal would cut the capital gains rate roughly in half, requiring capital gains "realizations" to double just to keep revenues running in the same place...
...Since 1966, capital gains realizations have steadily increased, from $31 billion ($67 billion in 1985 dollars) to the present...
...What is actually encouraged, of course, is wheeling and dealing...
...Balancing the foregoing considerations, a fairly prudent and sanguine management will opt for borrowing, but a company that can satisfy its stockholders with capital gains will enjoy the best of both worlds by relying on its retained earnings...
...In both cases much more than taxes was involved...
...Does it, then, make sense to encourage individuals to seek capital gains twice as eagerly as they seek earned income...
...Any attempt to offset the general effects of inflation, however, winds up by encouraging it...
...There would be no problem at all if interest payments were not a deductible business expense...
...In contast, in 1832, South Carolina passed its Ordinance of Secession that denounced the tariff because of "bounties to classes and individuals...
...It is also certain that, whatever the ills we have recently been suffering, they were not caused by a lack of wheeling and dealing...
...But you have to have some place to live, and an equivalent new place will cost an equivalent number of dollars, or $200,000...
...In 1767, John Dickinson wrote in the second of his Letters from a Farmer in Pennsylvania that before the Stamp Tax, taxes "were always imposed with design to restrain the commerce of one part that was injurious to another, and thus promote the general welfare...
...And much private ink has been spilt on both sides...
...It is likely that realizations this year will be greater...
...He wants to tax them at 15 per cent—the lowest rate since the grand Depression days of Herbert Hoover...
...It happens that, as Professor Hyman P. Minsky points out in his recent book Stabilizing an Unstable Economy, since 1966 "the American economy has intermittently exhibited pervasive instability...
...It is probable that realizations were up in 1986 and down in 1987...
...In sum, if you want to encourage new enterprise, you will eliminate the deduction for interest expense and will consider the treatment of capital gains more important for personal than for business finance...
...Bush deserves a good mark for daring to talk about taxes...
...The power to tax is the power to destroy —and also the power to create...
...As we said in discussing Peter Peterson's ideas of taxation, this is the way multimillionaires are made...
...It is a sign of the shallowness of Bush's understanding—or the deviousness of his intentions—that he wants to upset one of the best features of the 1986 tax law, which treats capital gains as ordinary income...
...I've made-the case for eliminating it for business, too (see, "A Tax Increase by Any Other Name," NL, November 24,1984) and shall only outline it here...
...Since retained earnings are rarely enough to do the job for arapidly growing concern, its real choice is between issuing new stock and shouldering new loans...
...hence the special treatment of capital gains...
...While not necessarily conclusive, the association of these facts is at least suggestive, especially when you remember that instability is another name for the volatility that comes with wheeling and dealing...
...In Britain, and generally on the Continent, they are not taxed at all, making George Bush more moderate than he may find congenial...
Vol. 71 • September 1988 • No. 16
