On capital gains, Obama is no Reagan

Hope for tax reform in 2015 was dealt a setback in President Obama’s budget with a proposed increase in the maximum federal tax on capital gains and dividends from 23.8 percent to 28 percent. In a coy move to entice Republicans to support this hike, Obama invoked President Reagan Reagan, noting that their proposed top capital gains tax rates were one and the same.

As secretary of then-President-elect Reagan’s Transition Task Force on Tax Policy, and having later helped shepherd legislation into law, I can say with certainty that I was there, and Barack Obama is no Ronald Reagan when it comes to taxation on savings and investment.

{mosads}Over the years, capital gains taxation has evolved into a polarizing issue that is part economics, politics and religion. To Republicans it can be the Holy Grail. To Democrats, it can be the original sin.

How did we arrive here? First, a bit of history. In 1978, President Carter described the treatment of capital gains as “a huge tax windfall for millionaires and two bits for the average American.” He favored taxing capital gains at the same rate as ordinary income, which would have effectively doubled the rate for many taxpayers.

Carter’s message fell flat among the business leaders from Silicon Valley and across the country. They mobilized and made the case that capital gains tax rates shouldn’t just be preserved; they should be reduced to help spur much-needed economic growth and jobs. The message resonated, and a bipartisan group of lawmakers led by GOP Rep. William Steiger of Wisconsin came together with unlikely characters, including Democratic Rep. Kenneth Holland, who represented a poor district in South Carolina. Holland believed that lower capital gains rates could be an important ingredient to job creation and his constituents. In October 1978, the Steiger bill passed both houses and was signed by Carter, reversing a tragic tax hike into a dramatic cut. This also ushered in an era that shifted tax policy focus from income redistribution to economic growth in the ’80s.

Enter Reagan, who ran his presidential campaign on a pro-growth platform, that Americans were being taxed too heavily and that our was stifling innovation, risk taking and entrepreneurship. In 1981, he made a cut in the top regular tax rate on unearned income which reduced the maximum capital gains rate to only 20 percent — its lowest level since the Hoover administration.

Several years later, after an epic political battle over the 1986 Tax Reform Act, Reagan compromised on the capital gains tax for the good of overall reform and allowed rates to be set at the same level as the rates on ordinary income, with both topping out at 28 percent. Reagan didn’t relish raising the capital gains tax rate to 28 percent, but was willing to compromise on taxing capital gains as ordinary income since overall rates were being dramatically reduced for Americans.

Like Reagan, many Democratic leaders understood the importance of capital gains tax rates to the economy. President Kennedy eloquently said that “The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced in new ventures in obtaining capital, and thereby the strength and potential for growth of the economy.”

When President Franklin Roosevelt, who was known for a “soak the rich” approach to tax policy, and large Democratic Congresses ran the country, they adopted a capital gains tax sliding scale — the longer an asset was held, the lower the rate it paid. By claiming to encourage “investment” rather than “speculation,” Roosevelt and Democrats were able to satisfy the populists in their party.

Today, Democrats say a hike on capital gains taxation is a lifeline to the middle class; Republicans say it is Robin Hood economics. In reality, a low capital gains tax rate has an important role to play in fostering economic growth and promoting the entrepreneurial drive, which is why Silicon Valley became ground zero for the Carter revolt on capital gains tax hikes. Entrepreneurs are a major force for technological breakthroughs, whether replacing an old lathe or coding the latest app. It’s a shot in the arm that can encourage risk taking for new start-up companies and the creation of high-paying jobs. The economic ripple effect touches everyone — the middle class and the wealthy.

Economic research shows that tax policy, particularly when it comes to capital gains, can have a significant bearing on economic growth. A 2010 study by Dr. Allen Sinai, president and CEO of Decision Economics, Inc., found that raising the nation’s top individual capital gains rate by 5 percentage points to 20 percent would cut real annual economic growth by an average of .05 percent. These calculations at the time did not include 3.8 percent unearned income tax. Imagine the impact of hiking the capital gains tax rate to 28 percent.

For many, the fed hit is just the beginning. In many cases, investors face a double or triple whammy depending on where they live. Combined with state capital gains tax rates, and in some cases local, a higher federal capital gains tax rate will likely result in fewer investments being undertaken.

Beyond the impact on our economy domestically, capital gains tax rates have also had a bearing on our international competitiveness. A now outdated report by Ernst & Young LLP compares individual long-term capital gains taxes that were raised under Obama to major economies of the world as well as major trading partners of the U.S. The U.S. capital gains tax rate compares unfavorably with that of many other major economies, including Canada, Australia, Japan and Russia. Wait until the new numbers are crunched under the Obama proposal.

President Obama can draw a line in the sand on capital gains rates, or he could take one step over it and be in the good company of his predecessors, like Reagan, Kennedy and Roosevelt, who realized their importance to the economy and found common ground.

Bloomfield is president and CEO of the American Council for Capital Formation, a nonprofit, nonpartisan organization dedicated to public policies supportive of saving and investment to promote long-term economic growth, job creation and competitiveness. He also served as secretary to then-President-elect Reagan’s Transition Task Force on Tax Policy.