Money

By Andrew Tobias

The only truly good tax, of course, is a tax on someone else. Failing that, the best taxes are simple, fair and easy to collect, and -- perhaps most important -- they discourage the right things. (When you tax something, you discourage it.)

Take the existing federal gasoline tax. Anyone can understand it. At a flat 9.1 cents per gal., it's easy to collect and reasonably fair, since the more you use the roads, the more you pay for them. It also discourages things we want to discourage: dependence on foreign oil, the trade deficit, pollution and traffic. As taxes go, this one's a winner.

Last week the House passed a loser, but now the Senate will have an opportunity to ponder the same issues:

RAISING THE TOP BRACKET. Right now the top marginal tax rate rises to 33% for people earning roughly $50,000 to $200,000, then falls back down to 28%. It's hard to argue that this is fair, though I've loved every minute of it. If the top marginal rate stuck at 33% -- for the rich and not just the upper middle class -- it would raise billions that could be used to lower other taxes.

RESTORING AN IRA DEDUCTION. We spend more than we produce and fail to save nearly enough to remain competitive. Restoring the Individual Retirement Account incentive, as House Democrats proposed, would nudge the average family to spend a little less and save a little more -- just what the doctor ordered. More saving and less borrowing would also tend to lower interest rates, which would benefit rich and poor alike.

The Democrats' proposals to allow early IRA withdrawals to fund tuition or buy a first home, however, would complicate the now simple IRA, raise the potential for abuse and reduce the amount ultimately saved for retirement. Congress might better allow IRAs to be pledged as collateral on education loans and first-home mortgages. Any tinkering should focus on how to get people to put more into IRAs (perhaps by raising the $2,000 annual allowable contribution, even if the excess were not deductible) rather than on ways to let them take money out.

CUTTING CAPITAL GAINS. A broad tax break for capital gains, as the House approved and President Bush supports, would in the long run be expensive and dumb. Applying the break to investments we already own does nothing to encourage us to make new ones. Any tax break should be on future investments only.

But even there, restoring a two-tiered system -- with one income-tax rate for "ordinary" income and a lower one for capital gains -- would do little more than restore the incentive to concoct schemes to convert the former to the latter. We don't need more tax lawyers and tax-driven strategies to compete in the world marketplace; 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 real estate and stocks and fine art from the effects of inflation but not those without appreciable assets, whom inflation hits hardest. (Homeowners already have big tax breaks. They're allowed to roll gains tax-free from one home to the next and, at 55, avoid tax altogether on $125,000.) 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 across the board? To fuel real estate fever in Beverly Hills? To inspire construction of even more shopping centers? It would be far cheaper and more effective to pinpoint the tax break where it's most needed: to encourage formation of new companies and expansion and modernization of existing ones. Any capital-gains tax break should apply only to owners of "original" shares -- namely, company founders and venture capitalists -- and to purchasers of any new stock or bond offering. Investors who merely bought existing securities from each other should get no special break. (Neither should investors in real estate companies, lest thousands of them be set up simply to qualify for this tax break.) Brokerage confirmation slips already distinguish securities purchased in public offerings, so keeping track would be easy.

Finally, tying capital-gains tax breaks to a holding period of a year or more -- or even a day -- makes no sense. 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, so 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.

In short: let's raise taxes on the rich so they pay as much, on the margin, as the only fairly rich. Let's use that new cash to restore or even enhance the old IRA incentives. And let's offer a capital-gains tax break only to people who can really do the economy some good: those who found or fund private enterprise.

Too costly? Any shortfall in this package could easily be met by adding a few pennies to the gasoline tax.