Lawmakers Grapple With Capital Gains Tax Overhaul

Rep. Levin: the treatment of capital gains will be ‘the major and most controversial issue’ in reforming the tax code

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As Congress tackles broad tax reform, where to set the rates on capital gains will be the most controversial and complex issue lawmakers must tackle, a lawmaker said.

During a joint hearing held Thursday by the Senate Finance and House Ways and Means committees on the treatment of capital gains, Rep. Sander Levin, D-Mich., ranking member on the Ways and Means Committee, said the treatment of capital gains will be “the major and most controversial issue” in reforming the tax code.

“We need to be optimistic but realistic,” Levin said, with “much less talk about targets and more about tradeoffs.”

The lawmakers held the joint hearing a day before they broke for recess until after the election.

Senate Finance Committee Chairman Max Baucus, D-Mont., said during the hearing that a comprehensive review of the rates on capital gains must be taken to find a level that “sparks broad-based growth, creates jobs and strengthens the economy.” He added that the reform process needs to consider the capital gains rate in conjunction with those on individual wage income, corporate income and dividends.

“In order to get tax reform done, we’ll need members of both parties and both chambers willing to tackle the tough issues,” Baucus said.

As it stands now the maximum capital gains tax rate is 15%, as compared to the maximum individual ordinary income tax rate of 35%.

Baucus questioned at the hearing whether it is feasible to “lower wage income tax rates substantially without an increase in the capital gains rate to maintain revenue.” He also noted the fact that capital gains taxes are a major driver of the tax code’s complexity. Because of that complexity, he said, “and because the capital gains rate is lower than the standard income tax rate, many people try to skirt their tax responsibilities and game the system.”

Ways and Means Committee Chairman Dave Camp, R-Mich., explained during the hearing that absent congressional action to stop the impending tax hikes at year-end, the maximum capital gains rate will increase to 25% and the maximum individual ordinary income tax rate will increase to “40.8% when certain hidden marginal tax rate increases are factored in.”

The potential tax increases that we face next year, Camp said, “would have a devastating effect on the economy.” He cited a Joint Committee on Taxation (JCT) report that found that “failure to enact a one-year extension of the low-tax policies first enacted in 2001 and 2003—including an Alternative Minimum Tax (AMT) patch—would result in a $384 billion tax increase.” 

Camp went on to say that as lawmakers consider the economic impact of the tax burden associated with capital gains, “it is critical that we focus on the total integrated rate,” which he said was nearly 45%, not just the statutory rate of 15%.

“The capital gains tax is often, though not always, a double layer of taxation,” he said. “For example, in the case of shares of stock, a company’s income is first taxed at the corporate rate. Then, when shareholders of the company later decide to sell their stock, they are subject to capital gains tax on the sale. But the value of the stock they sell already has been reduced by the fact that the corporation previously paid out a portion of its earnings as taxes.”

So, Camp continued, even if the current policies are made permanent, the top bracket still faces “a 35% first layer of tax and a 15% capital gains tax. If we allow current low-tax policies to expire, the top integrated rate on capital gains will exceed 50%.”

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