Congress’s two tax-writing committees, the House Ways and Means Committee and the Senate Finance Committee, held a joint hearing Thursday to discuss capital gains taxes and how they might be reformed.
Max Baucus
Currently capital gains are taxed at a maximum of 15 percent, compared to the top rate of 35 percent on ordinary income. Senate Finance Committee chairman Max Baucus, D-Mont., said the process of reforming the nation’s tax system must include a comprehensive review of the rates on capital gains to find a level that sparks broad-based growth, creates jobs and strengthens the economy.
He added that the reform process needs to consider the capital gains rate in conjunction with those on individual wage income, corporate income and dividends. Baucus also noted that many high-income earners have a lower effective tax rate than middle class families, because the capital gains tax rates are lower than those on wages.
“Our entire tax code—including its treatment of capital gains—needs to be rebuilt for the 21st century economy. We need a system focused on broad-based economic growth and jobs,” Baucus said. “In order to get tax reform done, we’ll need members of both parties and both chambers willing to tackle the tough issues.”
At Thursday’s hearing, Baucus questioned whether it is feasible to lower wage income tax rates substantially without an increase in the capital gains rate to maintain revenue. He also noted the fact that capital gains taxes are a major driver of the tax code’s complexity. Experts say about half the code—more than 20,000 pages— exists solely to address capital gains. Baucus said because of that complexity, and because the capital gains rate is lower than the standard income tax rate, many people try to skirt their tax responsibilities and game the system.
“The taxation of capital gains is one of the most widely discussed areas of our individual tax system, and it needs to be reviewed as part of comprehensive tax reform,” said Ways and Means chairman Dave Camp, R-Mich., in a statement. “With both the Ways and Means Committee and the Senate Finance Committee actively pursuing tax reform, it will be critical for Congress’s two tax-writing panels to continue working closely together.”
Rep. Kenny Marchant, R-Texas, noted, "The investors I've talked to, at 15 percent, they do not spend any time or money on tax avoidance, but they say there is a rate at which they will avoid the tax."
"Everyone wants reform as long as it doesn't affect them," said Rep. Charles Rangel, D-N.Y.
Leonard Burman of Syracuse University testified that capital gains ought to be treated much like ordinary income. “How should capital gains be taxed?” he said in his prepared testimony. “Under an income tax, the answer is that capital gains should be taxed in full as they are earned, not when realized. Capital gains are income, not really different in substance from interest, rents, and royalties: other kinds of capital income that are taxed as ordinary income. Under the pure comprehensive income tax, corporate income would be allocated to shareholders and taxed as ordinary income, in the same way that S-corporations and partnerships are taxed.
"Obviously we don't tax capital gains or corporations that way," Burman added. "Capital gains are taxed only when realized, and gains on assets held for at least a year are generally taxed at a lower rate than other income. Capital gains on assets held until death or donated to charity, however, are never subject to income tax. And corporations are subject to a separate tax that is not integrated with the individual income tax. The consequence is that some corporate income may be subject to two layers of tax: the corporate income tax plus the individual income tax on capital gains and dividends.” Burman recommended that Congress should look into the legislation on 1031 exchanges to stop them from being misused.
Dr. Lawrence Lindsey of the Lindsey Group noted the complexity of the issue. “This is a very complicated issue, but in the interest of time, there are three themes that are critical,” he said. “First, the key to escaping the economic and fiscal morass in which we now find ourselves is to make America the best place in the world to invest, start a business, and create jobs. This involves a focus on the overall rate of taxation of both capital and entrepreneurship, and not on the capital gains tax rate in isolation. Second, there is a strong relationship between the rate of taxation and the level of the economic activity being taxed, and therefore on the revenue collected from such a tax. This relationship is not as strong as some believe, but it is far stronger than that implied by static revenue models.
"Moreover, the focus should not be on the revenue-maximizing tax rate, but on the additional economic burden created for each dollar of revenue collected. This means that the optimal rate of taxation is well below the revenue-maximizing level," Lindsey added. "Third, the revenue collected from capital gains taxation depends not only on the capital gains tax rate, but on the tax rate on ordinary income as well. A large differential between these rates skews the design of investment and financing just as the current huge differential between the taxation of debt and equity. These are important issues in designing the taxation of capital.”
David Verrill, chairman of the Angel Capital Association and managing director of Hub Angel Investment Group, noted that taxing capital gains at ordinary income rates could discourage investment in startup companies by angel investors, who would change their behavior if the tax rates changed. “An increase in capital gains rates will reduce angel investment in promising, job-creating companies at the very time our country needs to create jobs,” he said. “It would be like taking our foot off the gas pedal at the very time when we are trying to get our economy moving faster.”
William Stanfill, a general partner at Montegra Capital Income Fund, argued against continuing the capital gains tax rates. “The preferential tax rates for capital gains and dividends are simply a windfall for wealthy investors,” he said. “In my view this special tax treatment is neither fair nor equitable or available to any other professional endeavor. After all, a gifted teacher who is inspiring and challenging our children and enriching human capital gets no such special treatment. Some predict that firms will locate overseas, taking jobs and tax revenue out of the country.
"My firm is too small to play in the international field—the learning curve is too steep and the costs are too high," Stanfill added. "And because we believe in seed investing, we’ve always found sufficient deals in our own backyard. Further, my accountant advises me that if we did move our fund offshore, as a U.S. citizen, I am still subject to U.S. tax on my income.”
27 Comments
Having read all of the comments above I have kind of formed an opinion. I don't want to see retired people, who depend on selling down their stocks in order to have money to live on, be taxed at higher rates than they pay now. They bought these stocks throughout their working years in order to have them to pay for their retirement. But if a person is a professional investor he/she should pay normal rates just like, for example, a professional gambler. Those gains should be claimed on a schedule C and should not only be taxed at the normal rate but should be included in SE taxes. There is a difference between someone buying a few assets hoping to have a gain and someone who does it for a living. I don't know what the percentages are elsewhere but I have quite a few clients that have made the wrong choice all along if we change the rules on them now. These are not professional investors, they don't sit home every day and "day trade" and they don't make a living watching the stocks and buying and selling. Every time the politicians get ahold of taxes they become harder and more confusing. That does keep all of us in a job, but, really can't we have a sanity check first.
Posted by: takingcare | September 28, 2012 10:05 AM
Report this Comment
I have never understood why taxing dividends at the much lower capital gains rate has not created more controversy. While proponents use double taxation as the basis for this tax policy, no one bothers to address the obvious inequity to individual taxpayers that those who rely on dividend income are taxed at a substantially lower rate than those who rely on wages, interest income, business profits, rental income, etc. To argue that those receiving dividends are the "risk takers" ignores the fact that the recipients of this favorable treatment are mainly passive investors whose risk is the stock market, not job creation. I could write a treatise on why allowing a deduction to corporations for dividends paid is not only more equitable, but would also be a far better economic stimulus. Unfortunately, that policy proposal does not appear to get any serious consideration.
Posted by: stonemetz | September 28, 2012 9:56 AM
Report this Comment
There are some thought provoking comments. The thought that has amazed me for years, is why are there no statistics, which are definitely available from tax returns filed, on which income groups report the most dividends and capital gains?
The claim that every family and individual in America owns stocks is very misleading but seems to be used as one of the reasons to support the lower capital gains/dividend rates. While it is true that many families/individuals own equities, they get no benefit from such ownership. Why? Because the bulk of the stocks owned are in tax-deferred retirement accounts. Therefore, when retirement income is paid out, it is taxed at ORDINARY rates, in spite of the fact that perhaps a large amount of the assets in the retirement account came from dividends and capital gains.
So, the question remains, who really benefits from the low, low, capital gain/dividend rate?
Posted by: m2cw | September 27, 2012 9:37 AM
Report this Comment
That's right, say hello to "UNREALIZED LOSS CARRYFORWARDS" and good luck keeping track of them, not to mention documeting them. And what do you go on.. the value at year end? Say another hello to a wave of massive manipulation.
Posted by: GFTax | September 26, 2012 10:10 AM
Report this Comment
First problem...you cannot have people who've never prepared a tax return making tax law. They are completely out of touch with the actual reality of how tax law affects people. Second, if you tax gains when earned rather than realized, then what happens when you have unrealized LOSSES? Of course you would have to be able to deduct those as well, no? Imagine the mess of "unrealized loss carryforwards" and the undo burden of paying tax on phantom income. To even suggest such a thing is a display of complete idiocy.
Posted by: GFTax | September 26, 2012 10:04 AM
Report this Comment
In my opinion Burman of Syracuse univ is totally wrong in his idea. It's ridiculous to pay capital gains tax when you realize a profit. You haven't sold the gain nor do you have the money to pay the tax. How about the the price and profit or loss fluctuates daily. How do you report that. Can't believe somebody from Syracuse would come up with such a stupid idea
Posted by: Alan93 | September 25, 2012 10:22 PM
Report this Comment
I am pleased whith the debate regarding this very important area of taxation.
It is unfortunate, that some of our elected officials cannot join the same discussion since most of them have signed the Grover Norquist "Tax Pledge" that commits them to oppose any tax increases.
My vote, keep the tax rate equal to the taxes paid by people that go to work every day.
Posted by: jeromanix | September 25, 2012 7:19 PM
Report this Comment
How the devil did they count 20,000 pages of the Internal Revenue Code? The most recent edition written by Congress is 5,296 pages and the corresponding regulations written by the Internal Revenue Service/Treasury is 14,260 pages. Less than 20,000 total and only the 5,296 pages are LAW!
Posted by: bmoore1964 | September 25, 2012 5:20 PM
Report this Comment
Why not give a tax rate of 15% to self employed and small bu siness corporations? I am sure that many new jobs would be created. The 15% tax rate for capital gains should only be given to new corporations that need to raise funds to start or grow their business and not to investers that trade stocks for a profit. Most of the money that is put into the stock market only goes to investors that are gambling that a stok goes up in price and none of the money goes to companies that need it to expand their business's and hire more employee's.
Posted by: FASTTAX | September 25, 2012 4:53 PM
Report this Comment
I do not think Baucus has a clear understanding of tax law as he is attempting to fix a small part of the problem by addressing capital gain taxes without tackling other tax issues.
The most valid points came from Lawrence Lindsey. Item one capital gains rates do not alone solve the tax problems. See other comments above that correctly point out that if you tax caital gains as ordinary what about all the unused capital losses carry-forward from all those investors who lost money in their investments through economic downturns and through flat out fraudulent tax schemes (ponzi schemes)
In addition his point about the direct relationship between tax rates and economic activity is correct. The question is this... does passive activities create employment? I think not. Isn't the Treasury attempting with penalties and enforcement trying to bring US tax dollars back into the Treasury under Title 26 and Title 31 (FBAR and the OVDP program)? Isn't the Treasury looking at International Tax issues due to abuse?
So is the idea not to maximize tax rates but providing stability in tax rates without increasing the burden to collect taxes? We have not had any long-term tax policies for years. We have been playing "politics" with tax funds.
Lastly does anyone really believe that a tax on "UNREALIZED GAINS" is the way to go? Who gets to decide what the FMV of your home is on a yearly basis so you can pay this tax each year? How did we get to the financial meltdown in the real estate industry to began with? Was it due to too much regulation or rather lack of enforcement with rules on the books? I think it was lack of enforcement based on "politics" Taxes should not overburden the middle class so that they no longer can provide for their families. Perhaps taxes should provide an incentive for families to save for future generations while currently providing for the current generation. Should taxpayer's rely on the government to "redistributed wealth"? Taxes have always been a way that all governments (not just the USA) administer social programs. So the question is what is the function of government? And how much money does the government need to function? Tax Reform is long overdue but not just capital gains rates.
Posted by: daperc | September 25, 2012 12:59 PM
Report this Comment
A number of years ago, back when there was a capital gains deduction, not a special rate, I read that the logic behind the deduction was to take into account the inflationary gains.
I never quite understood this logic as the inflationary increases in my wages (think the 1970s) were totally subject to income tax.
Posted by: LaLafayette | September 25, 2012 10:26 AM
Report this Comment
The first thing that MUST be done for the American people to believe in thier goverment again is the removal of Rep. Charles Rangel, D-N.Y. from the House Committee on Ways and Means. You can not have a tax cheat making tax law
Posted by: Dmagrino | September 25, 2012 10:16 AM
Report this Comment
Throw out the tax code. Through out the politicians who either don't understand it or manipulate it to get votes. There is comprehensive tax reform in the form of a bill already. The FAIR TAX bill, H.R. 25 and S. 13. Make taxation transparent. The true "effective tax rate" is hidden in multiple forms of taxes that are deceitful.
Posted by: Taxpreparer | September 25, 2012 10:11 AM
Report this Comment
Since when is tax policy supposed to administer social justice? Last time I checked the purpose of a tax system is to generate sufficient revenues to fund the federal government. And while you are on the topic of taxing capital gains--if you remember, when Ronald Reagan took office, he reduced the capital gains rate which substantially increased total tax revenues to the federal government. Apparently, some of you are lacking in priciples of economics
Posted by: memphry | September 25, 2012 10:03 AM
Report this Comment
Since the Federal Reserve was founded in 1913 we have suffered -96% currency debasement (restated CPI(U)). 1913 $1,00 = 2012 $0.04, averaging -3.2% per year. Chairman Bernanke's -2.0% target results in -86% per hundred years. While currency does not function as a store of value, the public naturally looks for tax-advantaged, leveraged alternatives. Congress seems happy to oblige.
We need two fundamental changes. First, a change in monetary policy that de-emphasizes employment and focuses strictly on a stable price level, with a margin of error on the deflationary side due to increased labor productivity. Approximately 74% of GDP originates from labor, 26% from capital. Therefore a 2% increase in labor productivity should produce a 1.5% more highly valued dollar in the absence of monetary inflation.
The second change is that a base layer of financial income equal to per-capita GDP whould be exempt from taxation. This will put financial assets on a neutral status vs. non-financial assets.
If an individual saves $1.00 his working life he/she can accumulate $2.00 to $3.00 in wealth by earning a per-capita GDP return. This is a more favorable rate than the merry-go-round by which labor is taxed then redistributed, bypassing higher domestic and international capital returns. If we can't generate wealth via capital savings and investment we certainly can't generate wealth and raise our standard of living via taxation and income redistribution, while exporting profits and importing savings.
Our household savings rate is a very low 4% of GDP and should probably by at least four times as high, resulting in a personal savings rate of about 20% of gross income. This is enough to fund retirement income at a rate which is the reciprocal of ones prior savings rate, resulting in continuously rising consumption throughout working life and retirement.
Posted by: rollswrangler | September 25, 2012 9:48 AM
Report this Comment
Keep in mind, whatever the tax rate you feel should be charged, those costs will be passed along to the buyer of the goods or services that company produces or to the investors, some of which are middle income families who do not get any return on their savings at local banks, but must go into the markets. The wealthy will always get their rewards, fair or not.
Posted by: Dennisrl | September 24, 2012 3:53 PM
Report this Comment
I think the first thing congress MUST do in order to start on the path to meaningful tax reform in repeal the "Gramm - Rudman Act".
Posted by: joeltaxpro | September 23, 2012 9:46 AM
Report this Comment
The double taxation argument doesn't hold water. Just as a business recognizes different types of revenue in different ways, the Federal government recognizes incomes in different ways.
Still, the tax code needs to be revised to be truly progressive: whatever type of income a person makes is taxed more as it increases. Carving out exceptions for dividend wealth or capital gains above a certain level (say, above the national median income) is favoritism pure and simple.
Posted by: JAscher | September 22, 2012 9:37 AM
Report this Comment
This is all a ruse. I only have two words for this dividend tax debate which no one seems to be talking about.....double taxation. Hello. Theoretically, we shouldn't tax dividends at all since the profits from which they are paid are already taxed at the corporate level...unless they allow dividends paid as a corporate deduction. Otherwise, corp's will leave this country faster than you can say adios.
And, yes, I would like to be able to deduct my full capital losses now, thanyouverymuch. While they are at it, how about fixing the Alt Min Tax that we get dinged with every year for no reason other than the state tax add-back? Wasn't that originally supposed to go after tax shelters and not us ordinary taxpayers? True tax reform needs to fix all of this...no cherry picking...that's not tax reform, that's called duping the public.
Posted by: mondolulu | September 21, 2012 4:23 PM
Report this Comment
I do not think it's the government's duty to compensate risk-taking with lower tax rates. But I think capital gains from a small company built by an entrepreneur should be taxed less than gains from holding AT&T stock. Overall I think our tax rates are upside down. Why should a laborer or electrician (ordinary income tax rate + self-empl tax) pay a substantially higher rate of tax than a speculator/investor?
Posted by: JimL | September 21, 2012 11:36 AM
Report this Comment
Let Capital gains tax go lower the longerou hold the asset before the sale. Start at 30% and drop 1% PER YEAR you hold the asset, and go down to ZERO if you hold it over 30 years.
Posted by: jp1950haas | September 21, 2012 11:21 AM
Report this Comment
Did Rep. Rangel squirm at the mention that rents are taxable?
Posted by: EnrolledAgent | September 21, 2012 11:08 AM
Report this Comment
Lower risk stocks, like AT&T, are going to have much smaller gains/losses therefore the impact will be smaller. But investments in start-ups which succeed do improve the job market. If we start to have Investment tiers with different tax rates it will overly complicate an already complex set of rules.
Posted by: ThinkAhead | September 21, 2012 11:04 AM
Report this Comment
I do believe that there needs to be some risk reward for entering activities that have the potential to grow the economy. I have often questioned, however, how me buying, say ATT stock, grows the economy. All my purchase does is redistribute existing assets between two entities. I don't think I should get a capital gains tax break on my sale of ATT
Posted by: Marion F | September 21, 2012 10:47 AM
Report this Comment
Capital Gains should be taxed at a lower rate to compensate for the risk that's being taken. Paying tax on a salary that is guaranteed if you perform is very different than taking market risk. Higher risk should warrent a higher reward, e.g. lower taxes on gains.
Posted by: ThinkAhead | September 21, 2012 10:19 AM
Report this Comment
If Congress makes a change in the rate upon which capital gains are taxed, they should also revise the current limitation on capital losses which is $3,000 and has been decades. Under the current tax code, unless an investor has "other" capital gains to offset a loss, in some cases it could take a taxpayers life time to utilize the carryover losses.
Posted by: Wfhjr0 | September 21, 2012 10:01 AM
Report this Comment
Don't forget that quite a few countries levy wealth taxes but capital gains are not taxed. US citizens who live in such countries take a double whammy. They cannot claim a foreign tax credit for wealth taxes but must pay US income tax on income which has been taxed in a different manner by their country of residence.
Posted by: RogerC | September 21, 2012 7:50 AM
Report this Comment
Add Your Comments...
Already Registered?
If you have already registered to Accounting Today, please use the form below to login. When completed you will immeditely be directed to post a comment.
Not Registered?
You must be registered to post a comment.