Capital Gains: How about Amnesty?

Article excerpt

"Common sense" might suggest that the powerful upward spiral in stock prices of recent years would be followed by a comparable upward surge in capital gains tax revenue to the federal government. This has not, and likely will not, be the case. The reason? Savvy investors--anxious to avoid the "high" capital gains tax rate--are making rational financial decisions to hold onto assets and minimize recognition of capital gains. Until such time as more rational tax treatment of capital gains emerges from Washington, how about a temporary lowering of the capital gains tax rate--similar to an "amnesty" period?

The dollar value of U.S. financial and real assets with gains is astronomical. At a minimum, $8-$10 trillion of assets, with gains exceeding perhaps $2 trillion, are currently "locked up" in the U.S. economy. The key to "unlocking" much of this money would be a significant reduction in the capital gains tax rate.

Capital gains taxes are unique because they are a "voluntary" tax. Unlike taxes upon wages, interest, and dividends, holders of assets that generate capital gains control the decision-making process as to when, if ever, a gain is recognized and the associated taxes are paid. A significant portion of capital gains taxes are never paid, as the eventual death of an asset holder results in a new fair market asset valuation for the heirs.

While reducing the capital gains tax rate might be obvious to investors and selected policymakers, political emotions run high. Politicians fear 1. voter backlash regarding perceptions of tax "fairness", and 2. the loss in government revenue that might result from a tax rate reduction. With regard to the fairness issue, the key is creating an incentive for asset owners to voluntarily pay additional taxes. What is unfair about lowering a tax rate and enticing investors to voluntarily step forward, sell an asset, and pay a substantial amount of tax which might otherwise never be collected?

The second issue of revenue loss is a classic example of the Beltway propensity to underestimate consumer/investor intelligence. "Common wisdom" in Washington still has it that raising the capital gains tax rate increases tax collections, while cutting the tax rate reduces tax revenues--despite years of data to the contrary (see chart).

One concern frequently expressed regarding a temporary or permanent reduction in the capital gains tax rate is that such a reduction would open the floodgates to sellers, thereby severely depressing stock prices. …