Pro-Growth Tax Reform Must Reduce Taxes on Capital Gains

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Posted by Toni-Anne Barry on Wednesday, March 1st, 2017, 4:48 PM PERMALINK

The federal tax code is out of control. At more than 74,000 pages it is too long, too complicated and much too expensive for taxpayers. Comprehensive tax reform is imperative in 2017 and this must include reducing double taxation.

Here in the U.S. the same dollar is taxed when it is earned, invested, and yes even when you die. A key aspect of decreasing the effects of double taxation is reducing the capital gains and dividends tax. 

To improve economic growth, lawmakers should reduce taxes on capital gains/dividends, continue to treat carried interest as a capital gain, protect section 1031 like-kind exchanges, and index capital gains taxes to inflation. These changes will help promote much needed investment incentive to reboot the economy. Here’s how:

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Taxes on Capital Gains/Dividends Should Be Reduced

The capital gains and dividends tax is levied on income that has already been subjected to individual income taxes and is then reinvested into the economy in a way that increases productivity and economic growth. 

Simply put, Obama’s policies have not worked and need to be changed. During his presidency he has raised the top capital gains rate from 15 to 20 percent and imposed a 3.8 percentage point surtax on capital gains. These polices have only resulted in putting U.S. businesses at a global disadvantage.

Among the 35 developed countries in the Organisation for Economic Development and BRICS, comprised of Brazil, Russia, India, China, and South Africa, the U.S. has some of the highest capital gains and dividends rates, coming just behind France.

To put it in perspective, the average OECD/Bric rate for distributions (includes corporate and state taxes) made as capital gains is 40.3 percent. This contrasts sharply with the U.S. rate that sits at 56.3 percent.

This trend is the same when dividend rates are averaged. OECD/BRICS have an average of 44.5 percent while the U.S. is 56. 2 percent.

Carried Interest Is and Should Be Treated as a Capital Gain

Some recent proposals have promoted taxing carried interest as ordinary income. Contrary to the common misconception that treating carried interest as a capital gain is a shady loophole, carried interest is actually the same as all other capital gains. It is simply the share of an investment partnership allocated to the investor. All of the income from the partnership is derived from a long-term investment in a business or real-estate. This means that all income earned is treated exactly the same as a capital gain.

Supporters of higher taxes on carried interest classify it as a matter of fairness when in reality it would hurt a wide range of investment partnerships such as pension funds, charities, and colleges. These partnerships rely on shared investments for their savings.

Additionally, increasing taxes on carried interest capital gains would only raise $19.6 billion over the next ten years, a miniscule number that barely fluctuates the $41.7 trillion that the Congressional Budget Office estimates will be raised throughout the upcoming decade.

Like-Kind Exchanges Should Be Preserved and Strengthened

Under current law, taxpayers are able to defer paying taxes on certain types of assets when they use those earnings to invest in another, similar asset because of the provisions set by Section 1031 of the tax code. This can be used on assets such as real estate, machinery for farming and mining, and other equipment such as trucks and cars.

Section 1031 eliminates unnecessary barriers that would impede investment. Allowing an investor to not have to pay taxes until they cash out promotes more efficient allocation of capital resources.

The House GOP “Better Way” blueprint takes the code in a pro-growth direction by implementing immediate full-business expensing, which streamlines business activity by allowing the effect purchase of new assets. Section 1031 compliments full expensing by letting businesses replace less productive assets with more productive assets.

Repealing section 1031 would only lead to higher taxes on investment, hurting economic growth and incomes.

Index Capital Gains to Inflation Through Treasury's Regulatory Authority

Indexing the capital gains tax to inflation is another pro-growth option for reform. The existing capital gains tax, without an inflation index, discourages long-term investment by exposing investors to higher inflation risk than short term investors. This essentially means that a long term investors have less incentive to invest than short term investors inhibiting a healthy, growing economy.

Without indexing capital gains taxes with inflation, long term investors are also subject to pay capital gains on real capital loses. This is why it is imperative that capital gains are measured with inflation, without the adjusted values the taxes on capital gains are not accurately evaluated.

To combat this issue, the Treasury should use its authority to interpret “cost” based on inflation. In the past the Treasury has advocated for the implementation of inflation based indexing on capital gains but was impeded by congress. Allowing the Treasury to interpret “costs” using inflation indexing would help create an even playing field for investors and promote investment incentives. 

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