Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: TUESDAY, June 21, 1994 TAG: 9406270110
SECTION: EDITORIAL PAGE: A-5 EDITION: METRO
SOURCE: By JOHN E. BERTHOUD and CESAR V. CONDA
DATELINE: LENGTH: Long
Currently, a capital gain - i.e., the increase in the value of a capital asset when it is sold (stocks, businesses, real property) - is taxed at the same rate as regular income (2 percent to 5.75 percent in Virginia). Moreover, the state's capital gains tax is not indexed for inflation; therefore, investors, farmers and small businessowners are paying taxes on phantom gains.
Eliminating the capital gains tax would be a tremendous spur to the economy of the commonwealth and is an idea that is spreading through other states.
High capital gains taxes slow investment and thus economic growth. Since 1986, when the federal tax on capital gains rose from 20 percent to 28 percent (an increase of 40 percent), the number of new-business start-ups declined 703,000 to only 628,000 in 1991. There were 20 times more public stock offerings in 1983, when the capital gains tax rate was 20 percent, than in 1978, when the maximum tax rate peaked (it was cut that year to 28 percent and then in 1981 to 20 percent).
By slowing investment, higher capital gains taxes reduce employment opportunities for all Americans, whether they are from the upper, lower or middle class. Economist Allen Sinai has calculated that combined with reductions in payroll taxes, the reduction in the federal capital gains tax would boost GNP by 3 percent and create 2.5 million jobs.
Contrary to the myths being propagated by critics of capital gains tax reductions, lower- and middle-income groups benefit as much as upper-income groups. Beyond the job creation that benefits Americans of every income group, 68 percent of the income-tax returns showing capital gains in 1987 were from Americans earning $50,000 or less.
Lower capital gains taxes are also a boon to minorities. The tax rate cuts of 1978 and 1981 spurred a 33 percent increase in the number of black-owned businesses over five years.
Further, capital gains tax cuts pay for themselves. The federal rate cuts of 1978 and 1981 led to an increase in federal capital gains tax receipts from $8.1 billion in 1977 to $26.5 billion in 1985, according to the U.S. Department of Treasury. After inflation, this is an increase in tax receipts of 84 percent.
In considering this issue, Gov. Allen can be encouraged by examples set by other innovative governors. The historical leader in the field of cutting state capital gains taxes is Wisconsin. For many years Wisconsin has excluded 60 percent of the value of any capital gain from taxation. Gov. Tommy Thompson sees this as a key reason for Wisconsin's economic health. Thompson repeatedly touts his capital-gains break: ``What a tremendous arrow in my quiver when I go out and talk to a business about Wisconsin.'' Thompson has long argued that, ``A Wisconsin that is competitive makes Wisconsin a good state to be in business.''
Thompson's pro-growth tax policies have spawned followers. In 1989, Gov. Carroll Campbell pushed through a cut in South Carolina's capital gains tax from 7 percent to 4 percent to offset the federal capital gains tax increase. As a result of this and other tax cuts, South Carolina has experienced impressive rates of economic growth and job creation.
Gov. Kirk Fordice, rated last month by the Washington-based Cato Institute as the governor with the second best fiscal record, has made Mississippi the first state in the nation to eliminate the capital gains tax on in-state investments. By signing his proposal into law on March 23, Fordice has added yet one more achievement to a remarkable record of fiscal accomplishment. Fordice's conservative fiscal reforms have in turn created economic growth so robust as to earn the label the ``Mississippi Miracle.''
Ranked first by U.S. News & World Report in economic performance, the state's unemployment rate is below 5 percent and its new-business growth rate is fourth in the country. The elimination of the capital gains tax will further this economic progress. Fordice notes that every $1 million in increased investment in Mississippi generates $2.2 million in economic growth and 120 new jobs.
While the U.S. as a whole stands to gain from lower taxes on capital gains, given interstate competition for business and investment, states like Virginia have an added incentive to cut capital gains taxes. And the greater economic activity spurred by lower capital gains taxes will generate enough state-tax revenue to pay for the loss caused by the tax cut.
Fordice notes, ``The economic history of the United States demonstrates repeatedly that every time we cut taxes, government revenues actually increase substantially - abolishing the capital gains tax would encourage entrepreneurial activity, leading to the creation of private-sector jobs, a noticeable improvement in our standard of living, and a significant improvement in our economic climate.''
While a lower capital gains tax would be beneficial to Virginia, eliminating it at the federal level and in Virginia makes the most sense. Federal Reserve Chairman Alan Greenspan has long argued that there should be no tax imposed on capital gains. According to Greenspan, ``It is easier to make the case to eliminate it entirely than it is to merely reduce the rate. ... It is a direct tax on the nation's standard of living.''
Although the national economy is growing at a moderate rate, storm clouds lie ahead; interest rates are creeping upward, President Clinton's tax increases are beginning to dampen economic activity, and his health-care reform plan, if enacted, will lead to a 27 percent increase in federal taxes by the year 2004.
Virginia's working families and small-business people need an insurance policy against ``Clintonomics.'' Other states have recognized the tremendous economic benefits of cutting or eliminating the capital gains tax. Gov. Allen should seize this bold economic initiative and do the same in Virginia.
John E. Berthoud is an adjunct scholar and Cesar V. Conda is executive director of the Alexis de Tocqueville Institution in Arlington.
by CNB