Tax Analysts Blog

Clinton Should Keep It Simple and Just Propose Repealing the Capital Gains Preference

Posted on Aug 6, 2015

Last month, Hillary Clinton released a not entirely novel plan for taxing capital gains. In an effort to encourage long-term thinking and check the rise of what she calls “quarterly capitalism,” she suggested a tax break targeting buy-and-hold investors. If investors are thinking long-term, corporate managers will, too.

Or at least that’s the theory. But as many observers have pointed out, the linkages between tax rates, asset holding periods, and managerial decision-making are complex. Nearly as complex, in fact, as the proposal Clinton advanced to manipulate all three.

Clinton’s plan – which features five rates keyed to various holding periods – would reserve maximum tax relief for those investors willing to wait the longest before cashing in. Taxpayers hoping to enjoy the same break currently on the books (20 percent for long-term gains) would have to hold their assets for at least six years.

Will Clinton’s plan work? Probably not. The tax system is full of “targeted” tax incentives designed to achieve particular goals with admirable precision. But many of these proposals either miss the mark or don’t really have any effect at all. When it comes to capital gains in particular, it’s not clear that investment decisions are really that sensitive (at least over the long term) to tax rates.

Experts are broadly skeptical of the Clinton plan. University of San Diego law professor Vic Fleischer called it “more show horse than workhorse.” In particular, Fleischer wrote, “it would do little to accomplish its stated goal of aiming at what Mrs. Clinton called 'the tyranny' of today’s earnings report."

Len Burman, director of the Urban-Brookings Tax Policy Center and a leading expert on capital gains, is also dubious. Even assuming that investor pressure for short-term gains is depriving companies of investment capital (an assumption that Burman doesn’t share), the plan is unlikely to change corporate behavior. “It’s not at all clear that Clinton’s tax-based prescription would cure the problem.” he said.

Ultimately, Clinton’s plan is too complicated for its own good. It’s true, as Neera Tanden of the Center for American Progress has observed, that much of that complexity will be relevant only to “filers who use slide rules” rather than computers to complete their returns. But complexity is a problem for everyone when it makes the tax system more opaque and less comprehensible. Complexity erodes tax morale, even when TurboTax streamlines the actual filing ritual.

In defending her capital gains plan, Clinton emphasized the need to encourage patience among investors and corporate managers. What she didn’t stress, however, is another element of her plan that certainly hasn’t gone unnoticed: It’s likely to raise the tax burden on the nation’s richest taxpayers.

But if that’s Clinton’s goal, there’s a much simpler and more direct route to the same destination -- simply abolish the capital gains preference entirely.

There are good arguments for keeping a preference in the law, as Alan Viard of the American Enterprise Institute has explained in an article on this “imperfect but useful” provision.

But there are even better reasons for getting rid of it. As Burman has pointed out:

      Lowering tax rates on capital gains alone (1) distorts work and investment decisions into activities that produce income taxed as capital gain instead of ordinary income, and (2) creates a giant loophole that can be exploited via tax shelters.
Rather than concocting new limitations on the preference for capital gains, Clinton should embrace her inner progressive and simply call for its abolition. And Burman has a plan for that, too: “The best option, in my view, would be to tax capital gains as ordinary income and use the revenue gained to lower individual and corporate income tax rates.”

Now that’s an appealing tax reform.

Read Comments (2)

edmund dantesAug 8, 2015

We tried sky-high taxes on capital gains during the Carter administration, and
that didn't work out well. We tried eliminating the preference for capital
gains under Reagan, and it worked out great. But then the top tax rate was
28%. That would be too low to satisfy liberals today.

Elimination of the preference today would not lead to lower rates, it would
lead to still more government spending, and to an economy even more stagnant
than what we've experienced the last 6 years.

AMTbuffAug 9, 2015

This would be fair if basis were indexed to inflation rather than taxing
phantom gains.

Perhaps a Republican president can allow indexing by executive order, the same
way as the current president did for Obamacare and immigration. Who needs a
Congress?

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