ECONOMIC ANALYSIS:

D.C. Infatuated With Investors

The current preferential tax rate on capital gains rests on a false premise and is inequitable as well. Ronald Reagan's Tax Reform Act of 1986 incorporated a fairer policy: equal taxes on income from wages and income from wealth.

by Gerald E. Scorse

The seed money that nourishes start-ups and expansions comes from a tiny subset of real investors; the rest of us merely place our bets at the tables down on Wall Street.

Over the last ten years, nobody has gotten more love from Washington than investors. It’s time to stop and ask if the love is misplaced.

Investor-love took hold on the Hill in 1997, when President Clinton cut the tax on long-term capital gains from 28% to 20%. In 2003, President Bush kept the love coming from the GOP side. He took another 5% off the capital gains rate and slashed the levy on corporate dividends as well.

All this love has worked splendidly for the loved. The tax on long-term gains and qualified dividends has been driven down to 15%. That’s a 70-year low, and it’s less than the rate on the wages of average Americans. As the multi-billionaire Warren Buffett abashedly confessed, the secretaries in his office now pay taxes at a higher rate than he does.

Buffett was quickly called out for coming up short on investor-love. Maria Bartiromo, an anchor on the business channel CNBC, dismissed his remark as “misleading”.

Misleading? Hardly, compared to the claim that buyers of stocks drive the U.S. economy by growing jobs and new businesses. If so, investor-love might be deserved. Let’s look in on the market and analyze what takes place.

Billions of shares change hands daily on the major exchanges. On any given day, only a minute fraction of those shares grows anything. Days can pass without a bona fide investment; the sounds you hear are aftermarket noise and the closing bell.

In short, “investors” do not grow jobs (except in the financial sector). The seed money that nourishes start-ups and expansions comes from a tiny subset of real investors; the rest of us merely place our bets at the tables down on Wall Street.

What’s the problem with investor-love? First, Warren Buffett has it right: it’s wrong for income from work to be taxed at a higher rate than income from wealth. Second, it has no reason for being; it’s a tax policy shaped by propaganda.

Lawmakers might better follow the policy shaped by Ronald Reagan.

Reagan’s 1981 tax cuts skewed toward the wealthy and made him a supply-side icon. But Reagan could also be fair, and fairness would permeate his last fiscal legacy. In the landmark Tax Reform Act of 1986, nearly three years in the drafting, Reagan again cut marginal rates but raised taxes sharply on investors.

The reform ended preferential tax treatment of capital gains. The tax rate on long-term gains leapt from 20% to 28%, nearly double the current levy. Higher-income taxpayers could pay as much as 31%.

The leaders in the race for the Republican presidential nomination stay miles away from the fact that Reagan leveled the tax rate on investment income and wage income. But Democrats like Barack Obama and John Edwards point to it with relish.

Reagan hailed the bill as “the dream of America’s fair-share tax plan.” He also called it “the best job creation program ever to come out of the Congress”; hyperbole, but evidence that he expected no growth falloff from higher capital gains taxes. The new 28% rate held until ’97, when a GOP-controlled Congress and a Democratic president fell under the spell of investor-love.

In their bones they know what’s fair, just like The Gipper did.

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This story was published on January 14, 2008.