Capital Gains Under Fire

AN executive who earns $30,000 in salary this year could easily wind up paying $5,180 in federal income tax. His neighbor who also makes $30,000, but gets it entirely in the form of profit on the sale of stock, could pay less than half as much. Is that fair? To Richard Nixon's economists, the lower tax on the stock profit is both a just reward for capitalist risk taking and a necessary stimulant to investment. To George McGovern's followers, the preference is the biggest "loophole" in the tax code. Says McGovern: "Money made by money should be taxed at the same rate as money made by men. Tax justice demands equal treatment for Americans who earn their living with a shovel or a slide rule and Americans who live on stock market and property gains."

At issue is the tax on capital gains, which can apply to profits on the sale not only of securities but also of houses, co-op apartments, land, cattle, patents, unharvested pecans--almost any asset held more than six months. Since 1921 such profits have been taxed at low rates--in most cases only half as much as wage or salary income. There is a maximum tax rate on capital gains, which under Nixon has been raised from 25% to 35%--v. a top 50% on salary and wage income and 70% on dividends, interest and rent. The President proposes no further change. Last week he pledged not to ask for any increased federal income taxes during the remainder of his Administration.

McGovern would tax capital gains at the same rates that apply to wages, salaries, interest and dividends--up to a new maximum of 48% on all types of income. To soften the blow, he would permit anyone realizing an unusually large capital gain to average it for tax purposes over an as yet unspecified number of years. By 1975, he figures, the reform would raise $7 billion a year from individuals and $1 billion from corporations. Another $4 billion would come from taxing gains in the value of assets that remain unsold at the owner's death; at present such gains escape taxation altogether.

Ability to Pay. But is the capital gains preference really a loophole? One reason capital gains get special tax treatment is that they often represent the payoff from investments made at considerable risk of loss. They may take generations to accumulate--and, says Treasury Secretary George Shultz, over any long period inflation is likely to make the true value of a capital gain much smaller than the gross sum that seems impressive on paper. Such gains are usually reinvested to build up more capital. Supporters of the present capital gains tax rule argue in addition that the levy should be kept low because it is a form of double taxation; the money put into investments was originally earned--and taxed--as income.

McGovern insists that capital gains must be taxed as ordinary income in order to make the revenue system obey the cardinal principle of levying taxes in accordance with ability to pay. The Senator's supporters argue that the progressive nature of the federal-state tax system has been undermined by federal income tax rate cuts that have benefited the rich most of all, and by great increases in sales, property and Social Security taxes, which bear most heavily on the poor. Capital gains taxes, so the argument goes, must be raised in order to redress the balance.

Supporters of Nixon's position counter that raising capital gains taxes will discourage rich and middle-income people from investing their savings. Economist Pierre Rinfret, a Nixon spokesman, insists that the U.S. already has the highest capital gains taxes in the industrial world, and that stiffening them further will "penalize the capital formation without which we don't grow." David Grove, a nonpartisan member of TIME'S Board of Economists, worries that the rich will not only invest less but will not indulge in risky bankrolling of promising new companies and will instead stick to blue chips. Conservative economists also fear that hitting capital gains will prompt many investors simply to sit on stock or property in which they have large paper profits rather than selling, paying the tax and putting the money to work somewhere else.

Some McGovernites concede that investment may be reduced, but contend that the effect will be so small as to constitute a minor price to pay for greater tax equity. The impact, they say, will be largely offset by the Senator's proposal to change the top tax rate on all kinds of income to 48%; that will enable affluent people to keep more of their incomes, especially from rents, interest and dividends, and thus give them more cash to invest. Taxing capital gains at death will force into the marketplace much money now tied up in stocks and property that wealthy people plan to pass on to their heirs.

Joseph Pechman, a leading tax-reform authority who drafted much of McGovern's current program, argues forcefully that in the long run the level of investment depends not on tax rates but on the vigor of the economy. That contention illustrates a profound difference in philosophy: broadly speaking, Nixonians view investment as the most important force powering economic growth, while McGovernites give priority to consumer spending. McGovern himself has quoted John Kennedy's remark that "a rising tide lifts all the boats." But Treasury Secretary Shultz had a ready reply: "We must be careful we don't drill holes in the boats."

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