Obama on Capital Gains Taxes: Confusion or Politics?

President Barack Obama is sending seriously mixed signals on capital gains taxes.

In the White House announcement of a "Startup America Legislative Agenda," it was declared that Mr. Obama wants a zero percent capital gains tax on small business investments.

That sounds great, right?

Details as to what this actually entails will come with the release of the President's 2012-13 budget plan. But if it is the same idea that Mr. Obama offered in his 2011-12 budget, then it will be so limited in scope as to be economically meaningless. Last time around, this measure imposed a five-year holding period, placed a limit on assets and a cap on applicable returns, and applied to only C corporations.

A holding period discourages the movement of capital to its most productive uses, as do restrictions on assets and returns, while limiting the measure to C corporations means excluding most small businesses.

Then there's the fact that Mr. Obama has been unrelenting in his desire to hike the capital gains tax rate on upper-income earners.

He has pushed for increasing the rate by 33 percent, from 15 percent to 20 percent. However, ObamaCare also is scheduled to impose an added 3.8 percent tax on capital gains for upper incomes, which would raise the Obama proposed capital gains tax rate of 23.8 percent - or an increase of 59 percent.

But it potentially does not stop there. In his State of the Union, the President declared that he wants high-income earners to pay an effective tax rate of no less than 30 percent. That means jacking up the capital gains tax rate even more. Indeed, it would seem that for some taxpayers it would require a capital gains tax rate of 30 percent - a doubling of the capital gains tax rate.

Factor inflation into the mix, and the real capital gains tax rate goes even higher.

From an economics standpoint, it's obvious that if you want entrepreneurship, business, competitiveness and job creation to flourish, then hiking the capital gains tax rate is grossly counterproductive. After all, starting up and investing in innovation, invention, businesses and jobs require the incentives and resources to do so. High capital gains taxes reduce the incentives and resources available for such critical risk taking.

As an economist, it's frustrating when elected officials miss such fundamental economic points, and push policies that will only hurt the U.S. economy.

But does Mr. Obama miss the economics of capital gains taxation, or is he merely playing a dangerous game of politics?

For example, there is the class warfare/envy card. That is, play the populist "bash the rich" card, and hope it translates into votes.

In fact, a recent CBS News/New York Times poll points to this possibility. It turns out that 70 percent of Democrats believe that upper-income Americans pay less than their "fair share" in federal income taxes, and 66 percent of Democrats believe that "capital gains and dividends should be taxed the same as income earned from work."

Putting aside how the questions were framed and the fact that capital gains and dividend taxes paid by individuals are part of multiple layers of taxes on saving and investment, the reality is that the President's political base buys into a tax system that ignores sound economics, and instead is based on envy/class warfare.

As a result, on capital gains taxes, we hear nice rhetoric about small business and entrepreneurship, but hostile rhetoric about upper-income earners. Unfortunately, economics makes clear that this does jibe with reality. In terms of how policy actually works, jacking up capital gains taxes on upper income earners quite simply means reducing the resources available for small businesses to build and grow.

_______

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is "Chuck" vs. the Business World: Business Tips on TV.

Governor Romney and Taxes on Capital

Republican presidential candidate Mitt Romney is sending mixed signals on capital gains taxes.

Many of us realize Mr. Romney's troubles on the issue of health care. Specifically, RomneyCare passed while governor of Massachusetts, which included an individual mandate, a state insurance exchange, expanded government and higher costs.

But it's not just the health care issue that presents problems for Romney. Capital gains taxes are another challenge.

On the corporate side, Romney's recently released economic plan calls for cutting the corporate income tax rate to 25 percent. That's a positive step in making the U.S. corporate tax code more competitive internationally. And since the same rate applies, the corporate capital gains tax rate also would fall to 25 percent.

In terms of the individual income tax, which is paid by most businesses (for example, as sole proprietorships, partnerships, S Corps and LLCs), the Romney plan pledges to leave the current tax rates in effect, but only offers a vague promise of tax reform some time in the future. That means most businesses would not experience tax increases as proposed by President Obama. But the Romney plan also offers nothing in terms of income tax relief for small firms.

As for individual capital gains, the Romney economic plan says: "Mitt Romney will seek to make permanent the lower tax rates for investment income put in place by President Bush. Another step in the right direction would be a Middle-Class Tax Savings Plan that would enable most Americans to save more for retirement. As president, Romney will seek to eliminate taxation on capital gains, dividends, and interest for any taxpayer with an adjusted gross income of under $200,000, helping Americans to prepare for retirement and enjoy the freedom that accompanies financial security. This would encourage more Americans to save and to invest for the long-term, which would in turn free up capital for investment flowing back into the economy and helping to facilitate economic growth."

The Romney plan gets it right in that eliminating taxes on capital would boost incentives saving and investment. He should have added that it would be a big plus for entrepreneurship.

But there's a glaring question here: Why does the Romney plan only eliminate taxes on capital gains, dividends and interest for those earning under $200,000?

After all, it makes economic sense to eliminate such levies on upper-income earners as well, given that they would have expanded resources and incentives to take the risks - i.e., starting up, building and investing in businesses - that drive innovation, economic growth and job creation. There's no getting around the reality that these upper-income earners have the greatest ability to invest and aid the economy.

Of course, one could always say that at least his current plan is far better than what he favored during his losing 1994 Senate race against Ted Kennedy. In an October 28, 1994, story ("The 1994 Campaign: Massachusetts") covering a debate between Romney and Kennedy, New York Times reporter Adam Clymer noted: "Mr. Romney shifted on one issue tonight, saying he now opposed longstanding Republican proposals to reduce the Federal tax on capital gains."

At that time, the top individual capital gains tax rate stood at 28 percent, which was 87 percent higher than today's rate of 15 percent.

Let's hope that Romney has truly left that kind of thinking behind on capital gains taxes. He now wants to make permanent the top capital gains tax rate of 15 percent, as opposed to President Obama, for example, who wants to hike the top rate on upper-income earners to 20 percent - though he, too, has toyed with the idea of pushing the rate up to 28 percent.

The President, of course, is known for playing the class warfare game with tax policy. While clearly an improvement over what the President wants, by calling for eliminating capital gains, dividends and interest taxes on certain levels of income but not for those earning more than $200,000, Mr. Romney is flirting with, and in a real sense validating, class warfare tax policy. After all, sound economics, again, dictates that the biggest impact on the economy would come by eliminating all capital gains taxes, thereby making the U.S. a global magnet for attracting innovation-driving, economic-growth-enhancing and employment-boosting capital. The only reason to maintain destructive taxes on higher incomes, while eliminating such levels for everyone else, is all about politics.

_______

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

The President's Speech and Private Investment

In his September 8 speech on the economy, President Barack Obama made the following bold claim about his plan: "It will provide a jolt to an economy that has stalled, and give companies confidence that if they invest and if they hire, there will be customers for their products and services."

If only that were the case.

Instead, the agenda laid out by the President not only provides little to enhance the incentives and ability to accelerate entrepreneurship and investment, but actually includes measures that work against such critical risk taking.

It is important to grasp that what our economy has been long experiencing is a dearth of economic growth. In turn, growth comes from private sector risk taking, in particular, from starting up, building and investing in businesses. Quite simply, entrepreneurs and investors need the incentives, resources and certainty to undertake the ventures that will spur the economy forward.

The only positive for business investment in the President's plan is extending the ability to expense capital expenditures into 2012. However, the effectiveness of this measure is limited due to its temporary nature. At best, such temporary measures shift the timing of investment, but do not enhance overall investment.

But in this case, the temporary ability to expense investment has been further limited in its effectiveness due to a wide array of other policy initiatives that overwhelmingly work against private risk taking. Those measures include increased regulation of financial firms; a combination of more regulation, higher taxes and increased government spending via ObamaCare; and the threat of ever-increasing taxes due to the historic explosion of federal spending and debt in recent years.

And then there are the tax increases that President Obama actually called for, again, in his speech on the economy. Mr. Obama declared: "Should we keep tax breaks for millionaires and billionaires? Or should we put teachers back to work so our kids can graduate ready for college and good jobs?" That's a glaring example of shameless and ignorant class warfare politics, as opposed to sound economics. The president actually has called for increased personal income, capital gains, and dividends taxes on those earning more than $250,000 annually.

But while President Obama gives lip service to small business owners, and to the need for more investment and job creation, at the same time, he calls for increased taxes on the entrepreneurs and investors with the ability and resources to make more investment and jobs a reality.

The President claimed in his speech, "This isn't political grandstanding. This isn't class warfare." In reality, of course, that's exactly what this is. Unfortunately, class warfare always makes for bad economics.

There's no secret about what's needed to get entrepreneurship, investment and the economy re-ignited, and along with them, boosting job creation. Deep, substantive tax relief, deregulation, free trade, smaller government, and sound monetary policy focused on price stability work together to get incentives right, to allow the private sector to spend and invest resources, and to provide a degree of certainty that public policy is pointed in the right direction. This is what, to quote Mr. Obama, will "provide a jolt to an economy that has stalled, and give companies confidence that if they invest and if they hire, there will be customers for their products and services."

President Obama keeps claiming that he wants to help small businesses, investment, and job creation, yet he keeps pushing policies that do the exact opposite.

_______

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Taxing Risk-Taking, Investment and Innovation

Why are so many leading politicians, including President Obama, ready to increase one of the most destructive taxes known to man?

The current top individual capital gains tax rate stands at 15 percent, and is scheduled to increase to 20 percent at the end of next year. For good measure, starting in 2013 under ObamaCare, upper-income earners will face a capital gains tax rate of 23.8 percent.

But one has to factor inflation into the equation as well. With CPI inflation, for example, moving higher, running at 3.6 percent over the past year, the real capital gains tax rate rises as well since gains are not indexed for inflation. For example, in the case of a one-year investment returning 7 percent with a 3.6 percent inflation rate, the real capital gains tax rate turns out to be 31 percent – more than double the nominal 15 percent rate.

But it’s not just the President’s tax proposals that are troubling. The so-called Gang of Six proposal on the debt ceiling has received a great deal of attention, despite its stunning lack of details and the House Budget Committee noting that given the current policy situation, the Gang of Six are serving up a 10-year $2.8 trillion tax increase.

At first glance, the Gang of Six plan is alluring due to talk that it would actually reduce income tax rates, with the top personal and corporate income tax rates being reduced to the 23 percent to 29 percent range. That obviously would be an improvement over current and scheduled future tax rates. But the question is: How do you reduce rates while also jacking up taxes so substantially? Obviously, deductions and credits must be eliminated, and other taxes increased.

As for taxes on investment, Bloomberg News reported the following on July 21: “The bipartisan deficit-reduction plan gaining momentum in the U.S. Senate would likely require lawmakers to curtail or end the preferential tax treatment of capital gains and dividends. The proposal from the so-called Gang of Six doesn’t mention capital gains and dividends. The plan’s goals for income tax rates, federal revenue and progressivity would likely require Congress to raise tax rates on investment income, said tax analysts who favor and oppose preferential tax rates on capital gains and dividends.”

If so, that would mean a substantial capital gains tax hike – even much higher than the President prefers under is budget plan. Throw in inflation, and the real rate would go even higher.

This is economic madness.

The capital gains tax ranks among the most destructive because it is a levy on the returns on risk taking, that is, on the investment and entrepreneurship that drive innovation and growth. The higher the capital gains tax, the greater the disincentive to start up, expand and invest in businesses.

In the current poor economic climate, our elected officials should be focused on reducing, or preferably eliminating, capital gains taxes. At the very least, the current individual 15 percent capital gains tax rate should be made permanent and the corporate capital gains tax (currently 35 percent) reduced to the same level, along with indexing all gains for inflation.

Instead, policymakers are talking about raising the capital gains tax. If the objective is to restrain entrepreneurship, angel and venture capital investment, technological innovation, U.S. competitiveness, and economic and employment growth, then raising the capital gains tax makes perfect sense.

_______________

Raymond J. Keating serves as chief economist for the Small Business & Entrepreneurship Council.

President Obama’s Zero Capital Gains Tax: Only C corporations qualify

President Obama along with other members of his Administration landed in Cleveland Ohio on February 22 to listen to small business owners. This issue of “access to capital” came up quite frequently.

In response to one business owner’s idea that tax policy should be changed to encourage investments in small business – specifically a zero capital gains tax for investments in small businesses – President Obama said, “That is such a good idea, that we implemented it last year.”

True, the President did sign this policy measure as part of the Small Business Jobs Act last year. It was then extended for 2011. But there is a serious flaw in the policy – it only applies to C corporations (with assets of less than $50 million).
Most small businesses are not structured in this way. Most are structured as partnerships, S corps or LLCs, or have no formal structure at all.

In addition, certain field or industries – like farming, restaurant/hotel operations, accounting, law, banking and financing – do not qualify for this specific zero capital gains tax incentive.

Those “anchors of Main Street” in Cleveland that President Obama referred to in his remarks continued to bring up “access to capital” as a serious challenge throughout the forum because more broad-based measures and incentives are needed.

How about zeroing out capital gains taxes period, rather than raising these taxes in 2012 as President Obama proposes to do in his budget?

Karen Kerrigan, President & CEO

SBE Council Signs Letter to Freeze Capgains and Dividends Tax Rates

The Small Business & Entrepreneurship Council (SBE Council) signed a coalition letter thanking U.S. Senator Jim DeMint (R-SC) for his efforts to stop the looming increases in capital gains and dividends tax rates scheduled for the end of this year.

The letter says:

We are writing to express our appreciation for your efforts to protect Americans from tax increases that would take effect at the end of the year. In particular, we applaud your work to keep the capital gains tax rate at 15 percent. Allowing the rate to climb to 20 percent, as the President proposes, would negatively impact the economy, national competitiveness, and the well-being of all Americans.

A higher capital gains rate discourages risk-taking and productive capital formation, which would mean less economic growth and job creation. Moreover, it is quite likely that a higher rate actually reduces tax revenue - especially in the long run. Taxes on capital gains also violate basic principles of fairness. It is a form of double taxation since people buy assets with income that already has been taxed. This is why every pro-growth tax reform plan eliminates the tax. Moreover, since the capital gains tax is not indexed to inflation, it often amounts to a tax on imaginary gains.

For many reasons, the capital gains tax should be abolished. The perfect should not be the enemy of the good, however, so we also recognize that a lower rate is better than a higher one. And we certainly do not want to see American competitiveness undermined by a higher tax rate.

Thankfully, we can count on your leadership on this issue. The undersigned applaud and support your efforts.

The full letter and list of signers is available here.

Indexing Capital Gains for Inflation

The latest information from the Bureau of Labor Statistics put consumer price index inflation at 0.2 percent in January. Over the past year (January to January), CPI inflation ran at 2.6 percent.

Meanwhile, the Federal Reserve just announced an inching up in the discount rate (from 0.5 percent to 0.75 percent). Is this a sign that the Fed is ready to start some tightening after its unprecedented loose monetary policy? Well, not according to the Fed. The Fed effectively is saying that it is keeping its foot on the money growth accelerator for the foreseeable future. Any true tightening would require a dramatic reining in of the monetary base - and no one is talking about that.

So, given the dramatic increase in the monetary base, the risk of an inflation flare up persists. In addition, it must be noted that CPI inflation already has started the process of creeping higher. For example, nonexistent inflation over the period of December 2007 to December 2008, shifted to 2.7 percent CPI inflation from December 2008 to December 2009.

From an entrepreneur's perspective looking to fund the start up or expansion of a business, it also must be kept in mind that inflation and inflation expectations not only affect interest rates, but also impact the real capital gains tax rate...

Read the rest of the SBE Council Capital & Credit analysis here.

Raymond J. Keating

Chief Economist

Small Business & Entrepreneurship Council

Small Biz Health Care Daily: Taxing Investment = Taxing Small Business

The January 12 Wall Street Journal included a news story noting that U.S. House of Representatives and Senate negotiators are considering an increase in the tax rate on investment income to help pay for big government health care.

The Senate bill included a hike in the Medicare income tax for individuals earning more than $200,000 and couples earning more than $250,000 from a total rate of 2.9% to 3.8%. This tax increase on wages would be ill-advised for a variety of reasons, including raising the cost of working and risk taking, as well as shifting resources from more productive private sector ventures and funneling those resources into the hands of wasteful, inefficient government.

And keep in mind that, combined with the tax increase looming at the end of this year, the top personal income tax rate would increase from 35% to 43.4%. Of course, most businesses (better than 90%) pay the personal income tax, rather than the corporate income tax.

But the Journal story shows that negotiators are considering making this ugly tax increase even worse by applying it to investment income, for example, capital gains and dividends.

Combine this with what’s already slated to occur at the end of this year, and the capital gains tax paid by individuals would jump by 59 percent – from 15% to 23.8%.

Make no mistake, this tax increase would hit investors and entrepreneurs. And how can raising taxes on investment and entrepreneurship possibly be good for the economy, business formation and job creation? It can’t.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Georgia Governor to Veto Capital Gains Tax Cut

There seem to be a lot of state elected officials around – from California to New York – who remain oblivious to the economic effects of policymaking. As a result, we’ve seen a wide array of tax increases in various states during this recession.

These lawmakers are intent on taking a very bad economic situation and making it worse.

But state legislators in Georgia actually did the right thing. They passed a measure featuring a 50 percent cut in the state’s individual and corporate capital gains tax rates.

This is exactly the kind of legislation the economy needs right now. Reduce the costs of and boost the incentives for investment and entrepreneurship in order to enhance innovation, economic growth and job creation.

Unfortunately, according to a May 11 report by the Atlanta Journal-Constitution, Georgia Governor Sonny Perdue, a Republican, has promised to veto the measure, citing budget deficit concerns. Of course, if deficit concerns are legitimate, then they should be dealt with on the spending side of the state budget equation.

Governor Perdue had the chance to be a leader on the national stage in terms of taking a bad economic situation and working to make it better, and he simply blew it.

Let’s hope that state legislators move to override this misguided veto.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

The Capital Gains Tax Question

There’s lots of garbage being jammed into the so-called economic stimulus package that will do nothing to help the economy in the short run or long run.

Of course, there were some ideas proposed during the 2008 campaign that would provide some help.

The Wall Street Journal on February 10 asks a very important question:

One question we wish someone had asked President Obama at last night's press conference is this: Why doesn't his economic stimulus bill include his own campaign proposal to eliminate the capital-gains tax for small businesses? The House bill omits it entirely, and the Senate version offers a rate reduction to 7% from the current 14%, but only on investments made in the next two years. That lower rate would apply to less than 2% of all capital gains…

We'd prefer an across-the-board capital gains cut rather than a targeted reduction. But the proposal would at least signal some Democratic interest in encouraging businesses to take risks again -- the only way the economy is going to recover. So what happened?

Good points and good questions.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

A Stimulus Alternative

Outside of government, it’s hard to find a serious economist who is really jazzed about the “economic stimulus” package passed and signed into law earlier this month. And I mean really hard.

I was on panel at Dowling College on February 15 with two other economists. I was the supply-side economist. There also was a pretty hard-core Keynesian. And the other economist seemed to come down in between the two of us. None of us viewed the stimulus package as being substantive for the economy.

In an article for today’s Newsday, I noted the following regarding stimulus package, as well as the push for the Federal Reserve to act as the economy’s savior:

Government checks dropping from the sky is merely a case of income redistribution; in effect, a handout. Tax rebates didn't work in the mid-1970s or in 2001, and they won't this time. Meanwhile, the impact of the investment tax breaks for business will be severely limited because they're only temporary. At best, the timing of some investments will shift.

 Beyond the stimulus, many on both sides of the political aisle, along with various TV talking heads, also agree that the Federal Reserve should be trying to juice up the economy through interest rate cuts and added liquidity.

 But the purpose of monetary policy is to keep inflation low. It is not a magical means for manipulating economic growth. And since consumer price inflation during the past three months has been running at a red-hot annualized rate of 6.8 percent, the Fed needs to get refocused on getting inflation under control. Low inflation, of course, helps consumers and investors.

So, is there an alternative to this misguided policymaking? Yes, there is:

How about the Fair and Simple Tax Act proposed late last month by Rep. David Dreier (R-Calif.)? Rep. Peter King is one of the original co-sponsors.

 The bill would simplify the personal income tax by reducing six brackets to three, with the top rate cut from 35 percent to 30 percent. 

The capital gains tax rate would fall from 15 percent to 10 percent, with gains indexed for inflation. And the corporate tax rate would drop from 35 percent - one of the highest rates among developed nations - to 25 percent. In addition, the death tax would be thrown out, and the alternative minimum tax exemption would be adjusted for inflation and made permanent. 

This is sound tax policy that clearly would benefit the economy. The returns on starting up, expanding and investing in businesses would be enhanced. When business invests, production expands and jobs are created. In turn, individuals and families are confident and keep spending their consumer dollars.

The right policy mix is no mystery: The Fed works to keep inflation low, while Congress and the White House permanently and substantively reduce tax and regulatory burdens that hamper economic growth.

Wisconsin and Capital Gains Taxes

Wisconsin entrepreneurs and that state’s economy benefit from a capital gains tax rate that is lower than the personal income tax rate. Wisconsin’s top personal income tax rate is 6.75%, while the top capital gains tax rate is 2.7%.

But now Governor Jim Doyle has a proposal to push the capital gains tax rate to 0% under certain circumstances.

In a January 7 report, the Milwaukee Journal Sentinel explained:

Some Wisconsin investors should be allowed to avoid paying taxes on capital gains if they reinvest the money in emerging state companies, Gov. Jim Doyle said Monday…

Doyle proposes to allow individuals, partnerships and limited liability companies to avoid paying tax on as much as $10 million of their capital gains if they use them to fund qualifying young businesses in the state…

"This capital gains proposal is extraordinary, and I think he's courageous to propose it. Generally the Democrats have not been proponents of capital gains tax relief for economic development and job creation," said Mark Bugher, director of Madison's University Research Park. Bugher was secretary of the state departments of revenue and administration when Republican Tommy Thompson was governor.

This is a positive, pro-growth proposal. It would be even better without any restrictions whatsoever. Kill capital gains taxes altogether – on both individuals and corporations – and the state will become a magnet for investment and entrepreneurship.