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Capital Gains Tax Cut Was Beneficial, Treasury Says

September 13, 1985

WASHINGTON (AP) _ The 1978 reduction in taxes on capital gains produced at least a temporary increase in revenues and modest economic growth, the Treasury Department said Friday.

The department said its seven-year study of capital gains ″supports a favorable evaluation″ of the reduction. However, the study stopped short of endorsing a further reduction, as President Reagan has recommended in his plan for overhauling the federal income tax.

″In considering further reductions in capital-gains taxes, one must weigh the benefits from increased incentives for private saving against the consequences of increasing the disparity in tax rates applied to different forms of income,″ the report said. ″Also, reductions in capital-gains tax rates at some point cause revenue from capital-gains taxes to fall.″

On the other hand, it said, ″increasing the tax rate on real capital gains above current levels in the context of the current tax system ... is unlikely to result in significant increases in revenue .... ″

In 1978, Congress was told that a better tax break on capital gains - which are profits from the sale of stocks and other investment property held more than a year - would stimulate the economy and produce enough new activity that the tax cut would pay for itself.

As a result, the lawmakers reduced from 50 percent to 40 percent the portion of capital gains of subject to income tax.

Since then, the preferential treatment has been made available to property owned more than six months. And as a result of across-the-board reductions in federal income tax rates, the maximum tax on capital gains has been slashed from 49.1 percent in 1978 to 20 percent.

In his tax-overhaul plan, Reagan proposed that the maximum rate be reduced again, to 17.5 percent.

The Treasury study found that the 1978 changes resulted in a substantial ″unlocking″ of unrealized gains; that is, the new law gave investors incentives to sell long-held assets.

Because of those sales, federal tax collections from capital gains rose by about $1 billion to $2 billion in 1979 and significantly less in subsequent years.

″The findings suggest that long-run annual revenue from capital gains taxes either increased or declined only slightly as a result of the capital gains tax reductions in the 1979″ act and the across-the-board tax cuts of 1981, Treasury reported.

″The reduction ... will over time cause the rate of investment, the capital stock, national income, labor productivity and the overall standard of living to be higher than if the tax treatment of capital gains had remained unchanged,″ the study said.

Ronald Pearlman, assistant secretary of the Treasury for tax policy, said the study again calls attention to the dramatic effects inflation has on the tax system.

Before 1978, the study noted, the combination of high tax rates and inflation produced ″extremely high real effective tax rates on the return to saving.″ Thus, the capital gains cut boosted savings incentives. But in today’s low inflation and the 1981 tax cuts have substantially reduced the effective rate of tax on appreciating property, Treasury said.

The study also pointed out the obvious: that a capital gains tax cut is of greatest benefit to upper-income people. In 1982, 53 percent of capital gains were collected by people with incomes above $100,000 a year.

Nevertheless, Treasury said, the lowest income groups also benefit because of overall economic growth and increases in labor productivity.

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