Lowering the Capital Gains Rate To ZERO February 1, 2002February 21, 2017 (Like yesterday’s column, this one is adapted from a column I wrote for Time a decade ago.) A broad tax break for capital gains, as has been pushed by some, would be expensive and dumb. To begin with, applying the break to investments we’ve already made does relatively little to encourage new ones. Any tax break should be on future investments only. But even there, aggravating our already problematic two-tiered system – with one income tax rate for “ordinary” income and a much lower one for capital gains – would do little more than increase the incentive to concoct schemes to convert the former to the latter. As a nation, we don’t need more tax lawyers devising tax-driven strategies; we need a simple tax system that doesn’t distort economic decisions. The notion of indexing gains to inflation – to tax only “real” gains – would add a whole new level of complication in computing taxes. And is it fair? It insulates those with assets from the effects of inflation, but not those without assets, whom inflation already hits hardest. (And homeowners ALREADY have big tax breaks. The first $250,000 in gains on the sale of a primary residence, or $500,000 if filing jointly, are tax-free.) Furthermore, insulating voters from inflation makes them more tolerant of it and, thus, its rise more likely — but its effects, ultimately, no less devastating. And why cut the capital gains rate on real estate or fine art or collectibles? To inspire construction of even more shopping centers? Yes, the capital gains rate should be cut — to ZERO! — but only on future investments, and only on the purchase of newly-issued stocks and bonds. Found a company in your garage? You are the owner of newly-issued securities. The tax rate on gains when you sell would be zero. Dump some venture capital into your neighbor’s garage start-up? You, too, have bought newly issued securities. The tax rate on gains when you sell would be zero. Snap up a few shares when the stock eventually goes public? You, too, are the owner of newly-issued securities. The tax rate on gains when you sell would be zero. But once those securities start trading in the secondary market, they are no longer newly-issued. There would be the same tax as now on trading gains. There’d still be just as much reason to buy and trade in the secondary market as there is today – God bless America’s liquid capital markets – but the ZERO capital gains rate would be reserved for the thing we most want to encourage: funding new enterprise. Such a rifle-shot tax cut would be a huge incentive to invest in new companies, and to fund the expansion and modernization of old ones, but at a tiny fraction of the cost of an across-the-board cut. It would be a boon for Wall Street, making it that much easier to find buyers for newly issued stocks and bonds. And it would be a snap to administer. If you’ve ever bought stock in a public offering, you’ve seen that the broker’s confirmation slip already denotes this. (‘Prospectus sent under separate cover,’ the confirm you get in the mail usually says.) So the computer already knows which shares and bonds you own from a new securities offering. The year-end statement you get would have one more box with this information. TaxCut and TurboTax and H&R Block could all handle this with ease. It would be cheap, it would be simple, and it would do exactly what the administration claims it wants to do: stimulate new investment to improve productivity and create jobs. (Meanwhile, it should be noted that the emphasis on a “long-term holding period” – or the new ultra-long 5-year holding period beginning with assets purchased after the year 2000 – may be overdone. Why reward people for holding something even a minute longer than they think it represents the best available value? Why distort the market this way and dampen its liquidity? Why shackle the invisible hand? The decision of how best to invest one’s capital should depend on where it can get the best return, not on tax strategies. There’s ALREADY plenty of reason to hold assets a long time: first, you minimize brokerage commissions; second, there’s NO tax due until you sell – you can let your profits build tax-free for decades! The real movers and shakers in the market, the pension funds, pay no capital gains tax anyway, so imposing a long-term holding period on the rest of us would have little impact on management’s rightly-lamented short-term focus.) You can argue for the old six-month holding period, or even today’s one-year period, as a means to discourage our worst gambling instincts (not that it always does much good). But five years? The beauty of the capital markets is their ability to allocate money efficiently. That’s the ideal, anyway. So why erect artificial barriers to capital’s free flow? Unlike yesterday’s much more important tax proposal – a huge gasoline tax phased in from 2004 through 2016, every penny of which would be used to lower the tax on working and saving (with an increase in the earned income credit to help the working poor) – this one, it seems to me, actually would have a prayer of passing. It’s the sort of targeted, stimulative tax cut Democrats have been talking about, and contrasts sharply with the massive tax cuts geared largely to the rich and to large corporations that our friends in the other party seem to believe are needed to get the economy moving again. Yet how could any Republican oppose a zero percent tax rate on capital gains, even if it were limited to where it might actually do some good?