Lawmakers face hard choices on taxing capital gains

The joint get-together of House Ways and Means and Senate Finance comes as many lawmakers are pointing toward 2013 as the year for tax reform, and as Democrats and Republicans are grappling with how to deal with the looming fiscal cliff. 

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If Washington doesn’t act, all of the Bush-era tax rates will expire at the end of the year, and the economy will also face automatic spending cuts arising from the failure of last year’s supercommittee.

The rate on capital gains has also played a big role in the presidential election, given its role in the 13.9 percent tax rate that the GOP nominee, Mitt Romney, paid in 2010. Democrats have tried to make hay of that rate and Romney’s private-equity experience, though that particular issue did not come up in Thursday’s hearing.

With lawmakers looking to next year for reform, David Brockway, a former chief of staff for the Joint Committee on Taxation (JCT), said lawmakers may need to look to the last overhaul of the tax code in 1986 for inspiration.

The 1986 reform taxed capital gains and regular income at the same 28 percent rate, with the top rate on income having come back to 35 percent in the ensuing quarter-century. Democrats have called for raising the top rate back to a Clinton-era 39.6 percent.

Brockway noted that raising the capital gains rate was a measure of last resort in 1986, and said that may be necessary again with Republicans looking to push the rate down to the mid- to upper 20s. 

“I would be very surprised if you would be able to design and enact a tax reform package with a top individual tax rate on ordinary income in the mid-20s without increasing the capital gains rate to the ordinary income rate,” Brockway, who was at the JCT during consideration of the 1986 reform, told lawmakers.

But David Verrill, representing so-called angel investors, noted that wealthier investors were already set to face an increase in capital gains taxes from the Democratic healthcare overhaul. Angel investors, generally speaking, invest in startup companies in exchange for some sort of stake in the business. 

“My argument is that we have found a rate that works,” Verrill said in his prepared remarks for the hearing. “At a time when small businesses and startups are still having trouble accessing capital, this is not the time to increase the capital gains rate for individual investors who take great risks in supporting job-creating businesses.”

The lawmakers themselves also pointed out some of the roadblocks to coming to an agreement on a capital gains rate. 

Rep. Sandy Levin (D-Mich.), the ranking Democrat at Ways and Means, said that most of the benefits of the lower capital gains rate go to those making more than $1 million a year. And Sen. Max Baucus (D-Mont.), the chairman of the Finance panel, added that most of the time capital gains is not subject to double taxation — one of the problems conservatives have with taxing investments.

“There is a real consequence from the preferential rate to the progressivity of our tax system,” Levin said. 

But Camp, in his opening remarks, said that the top rate on capital gains is in some cases more like 45 percent, because of double taxation. And Sen. Orrin Hatch (Utah), the ranking Republican on the Finance committee, countered that the U.S. already had a very progressive tax code and would become even more so by raising the capital gains rate.

“I don’t think there are any binary choices in tax reform,” Camp said after the hearing when asked if the capital gains rate may have to rise.