President Donald Trump is considering a change to the capital gains tax calculation.
The change would result in the creation of about $10 billion of new capital the first year. This capital would contribute to the economic expansion by creating more business investment.
President Bill Clinton had the same idea in 1996.
Clinton wanted to increase economic growth, which had been less than desired during his first term in office. He was presiding over a technology boom. The high growth technology companies needed capital to continue to grow. Clinton decided that the best way to raise new capital would be to lower the capital gains tax rate.
In 1997, Congress agreed with Clinton and lowered the rate from 28% to 20%. This created billions in new capital. Business investment expanded and the economy grew at a 4½% rate for the next four years.
During debate on the rate change, it was noted that more than 90% of the initial benefits could go to the top 1% of income earners. Still the bill passed and the economy grew.
Trump knows that a lower capital gains tax rate will stimulate the economy to grow even faster than the 4.1% rate recorded last quarter.
He also knows that getting any capital gains tax rate reduction through Congress is impossible at this time. However, he believes he can implement a change in the tax code without going through Congress.
Trump believes that he can index the tax liability to inflation. That means if an investor, buys an asset for $400 and sells it 10 years later for $700, the investor would be taxed on the $300 gain, under the current system. Trump’s proposal would allow the purchase price to be adjusted for inflation.
So if the purchase price was adjusted to be $500 (instead of $400), the taxable gain would be only $200 (instead of $300). The net result is that all Americans that sold long term assets would have their tax bill drop by about $10 billion the first year.
Although total capital gains tax revenue may fall in the first year, history shows that in subsequent years tax revenue would rise significantly. In the long term, the lower tax rate would yield higher tax revenue, which is exactly what happened after Clinton’s rate cut.
After all, isn’t 20% of $1,500 ($300) more than 28% of $1,000 ($280)?
A problem though, more than 90% of the tax reduction would initially go to the top 1% of income earners.
While it is clear that increases in capital will fuel further growth in our capital intensive economy, Trump’s proposal is strongly opposed by the Democrats in Congress.
“At a time when the deficit is out of control, wages are flat and the wealthiest are doing better than ever, to give the top 1% another advantage is an outrage and shows the Republicans true colors,” said Senator Chuck Schumer, D-NY.
The Democrats suffer from what I refer to as the “Chocolate Milk Syndrome.”
When my three children were young, they would often come home on a hot summer afternoon, very thirsty. “We want chocolate milk,” they would scream. So, I sat them down and put three identical-size glasses in front of them. I then filled each glass with about the same amount of chocolate milk.
Surprisingly, their primary concern was not the absolute amount of chocolate milk in their glass. Rather, they first looked at the amount of chocolate milk in their siblings’ glasses. As long as no sibling had more than they had, they were happy.
If one sibling did get slightly more, the others complained wildly until the glasses were even. It didn’t seem to matter to them how much they got; the amount in their glasses mattered only relative to the others’ amount.
“What’s the difference how much she got as long as you are content with how much chocolate milk is in your glass?” I would ask. But they just wanted to make sure no one had more chocolate milk than they had. As long as no one had more, each was happy.
As I watch Schumer complain about tax cuts for the wealthy, I often wonder if he just wants more chocolate milk.
Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years. @mbusler www.facebook.com/fundingdemocracy