Are capital gains key to tax reform?

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Capital gains taxes have always been controversial. When you hold an asset for more than a year before selling it, any gain, or profit, is taxed at a lower rate than your ordinary income.

Under current tax law, lower-income individuals (those in the 10 percent and 15 percent tax brackets) pay no capital gains taxes. Most taxpayers pay a capital gains tax rate of 15 percent. Wealthier individuals (those making more than $400,000 if single, $450,000 if married filing jointly) pay a 20 percent capital gains tax rate.

While the wealthy pay a higher capital gains tax rate, it’s still much lower than the top ordinary income tax rate of 39.6 percent. And it’s no secret that wealthier folks tend to have more investments that are taxed at the lower rate than those of us relying on our salaries, taxed at ordinary income tax rates, to pay our bills.

The lower capitals gains tax rates, therefore, help the richer among us often pay Uncle Sam at lower rates. That situation became a hot topic in 2011 when Warren Buffett announced in a New York Times op-ed piece that his tax rate was lower than that of his secretary.

Because of that tax inequity, many tax reformers have called for eliminating the lower capital gains tax rates.

Keep, but tweak, capital gains rates

Now, however, a new study says that some adjustments to the top 20 percent capital gains rate could help bring in more money to the U.S. Treasury, keep the tax code as progressive as it already is (that is, the more you make, the higher your tax rate) and raise enough revenue to lower all individual tax rates.

The report by the Committee for a Responsible Federal Budget, or CRFB, acknowledges that under the current capital gains tax law, the Internal Revenue Service will forgo around $1 trillion over a decade.

However, say analysts for the Washington, D.C.-based nonpartisan public policy group, eliminating the preferential capital gains tax rate and taxing all income at the top 39.6 percent rate may actually lose revenue relative to current law because investors would keep their assets rather than sell them to avoid paying tax.

Instead, says the CRFB study, tax reformers should focus on a rate that maximizes revenue while still providing tax savings to individuals. CRFB points to research by both the congressional Joint Committee on Taxation and Treasury’s Office of Tax Analysis that focuses on a capital gains rate of around 30 percent.

Other capital gains modifications, says the CRFB, include taxing the investment gains as ordinary income with a cap at, for example, 28 percent, or making a portion, say one-third, of capital gains income tax-free.

The holding period also could be changed, says CRFB, either broadly by modifying the one-year long-term holding period or more narrowly by changing other, more specific capital gains treatment for certain kinds of income, such as that now offered to coal royalties and livestock.

The key, says the think tank, is to keep capital gains in the tax reform mix.

Impossible tax dream?

I appreciate the number crunching that CRFB and others have done on capital gains and other tax expenditures that are being evaluated as part of comprehensive tax reform.

My big problem with all this, however, is that it all seems to make the tax code even more complicated rather that simplifying our current system.

The stated, and ideal, tax reform is to make our tax laws more understandable, easier to comply with and still produce enough money to operate the federal government.

Unfortunately, the more talk there is about comprehensive tax code reform, the more convoluted things seem to get.


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Veteran contributing editor Kay Bell is the author of the book “The Truth About Paying Fewer Taxes” and a co-author of the e-book “Future Millionaires’ Guidebook.”