Floor Statement - Capital Formation Act of 1997

Statement by Sen. Orrin G. Hatch before the United States Senate

The Capital Formation Act Of 1997

Mr. President, I am pleased to be joined by Senators Lieberman, Grassley, and Breaux in introducing the Capital Formation Act of 1997.

Mr. President, reducing the high rate on capital gains has long been a priority of mine. During the last Congress, I joined my good friend, the chairman of the House Ways and Means Committee, Bill Archer, in sponsoring the Archer-Hatch capital gains bill. Then later in the session Senator Lieberman and I offered a bipartisan capital gains tax reduction bill. The Hatch/Lieberman bill, S. 959, contained the same 50 percent deduction for capital gains as well as an enhanced incentive for investments in newly issued stock of small corporations. This measure was supported by 45 senators, and we were pleased that its provisions were included in the Balanced Budget Act of 1995.

The bill we are introducing today is substantially the same. Our bill combines two important elements of capital gains relief with a broad based tax cut and a targeted incentive to give an extra push for newly formed or expanding small businesses. Like the capital gains measure that passed the House and Senate during the last Congress, our bill would allow individual taxpayers to deduct 50 percent of any net capital gain. This means that the top capital gains tax rate for individuals would be 19.8 percent. Also, it grants a 25 percent maximum capital gains tax rate for corporations. Our bill also includes an important provision that would allow homeowners who sell their personal residences at a loss to take a capital gains deduction.

A provision that is not in our bill is a provision for indexing assets. Many of our Senate colleagues have expressed concern that indexing capital assets would result in undue complexity and possibly lead to a resurgence of tax shelters. While I continue to support the concept of indexing capital assets to prevent the taxation of inflationary gains, I believe even more strongly that capital gains tax relief is essential for our long-term economic growth. Therefore, in an effort to streamline this bill and expedite its passage, we have omitted the indexing provisions. I hope that some form of indexing can be developed that will achieve the goals of indexing without adding undue complexity or to the potential for abuse.

In addition to the broad-based provisions listed above, our bill also includes some extra capital gains incentives targeted to individuals and corporations who are willing to invest in small businesses. We see this add-on as an inducement for investors to provide the capital needed to help small businesses get established and to expand.

Mr. President, this additional targeted incentive works as follows: If an investor buys newly issued stock of a qualified small business, which is defined as one with up to $100 million in assets, and holds that stock for three or more years, he or she can deduct 75 percent of the gain on the sale of that stock, rather than just the 50 percent deduction provided for other capital gains.

In addition, anytime after the end of the three-year period, if the investor decides to sell the stock of one qualified small business and invest in another qualified small business, he or she can completely defer the gain on the sale of the first stock and not pay taxes on the gain until the second stock is sold. In essence, the investor is allowed to roll over the gain into the new stock until he or she sells the stock and cashes out the assets. We think that this additional incentive will make a tremendous amount of capital available for new and expanding small businesses in this country.

In particular, these special incentives should really make a difference in the electronics, biotechnology, and other high tech industries that are so important to our economy and to our future. The software and medical device industries in Utah are perfect examples of how these industries have transformed our economy. While these provisions are not limited to high tech companies by any means, these are the types of businesses that are most likely to use them because it is so hard to attract capital for these higher risk ventures. In addition, many start-up companies have large research and development needs. With the uncertainty of the R&E tax credit, this bill will give investors an incentive to fund high risk research companies that may be a Novell or Thiokol of tomorrow.

Mr. President, our economy is becoming more connected to the global marketplace every day. And, it is vital for us to realize that capital flows across national boundaries very rapidly. Therefore, we need to be concerned with how our trading partners tax capital and investment income.

Unfortunately, the U.S. has the highest tax rate on individual capital gains of all of the G-7 nations, except the U.K. And, even in the U.K., individuals can take advantage of indexing to alleviate capital gains caused solely by inflation. For example, Germany totally exempts long-term capital gains on securities. In Japan, investors pay the lesser of 1 percent of the sales price or 20 percent of the net gain. I think it is no coincidence, Mr. President, that Germany's saving rate is twice ours, and Japan's is three times as high as ours. In order to stay competitive in the world, it is vital that our tax laws provide the proper incentive to attract the capital we need here in the U.S.

We are aware that some of the opponents of capital gains tax reductions have asserted that such changes would inordinately benefit the wealthy, leaving little or no tax relief for the lower and middle income classes. Nothing could be further from the truth. In fact, capital gains taxation affects every homeowner, every employee who participates in a stock purchase plan, or every senior citizen who relies on income from mutual funds for their basic needs during retirement. A capital gains tax cut is for everybody.

It is interesting to note how the current treatment of capital gains only gives preferential treatment to those taxpayers who incomes lie in the highest tax brackets. Under the Capital Formation Act of 1997, the benefits will tilt decidedly toward the middle-income taxpayer. A married couple with $30,000 in taxable income who sells a capital asset would, under our bill, pay only a 7.5 percent tax on the capital gain. Further, this bill would slash the taxes retired seniors pay when they sell the assets they have accumulated for income during retirement.

I also believe there is a misperception about the term "capital asset." We tend to think of capital assets as something only wealthy persons have. In fact, a capital asset is a savings account—which we should all have—a piece of land, a savings bond, some stock your grandmother gave you, a mutual fund share, your house, your farm, your 1964 Mustang convertible, or any number of things that have monetary worth. It is misleading to imply that only "the wealthy" would benefit from this bill.

I want to elaborate on this point, Mr. President. Current law already provides a sizeable differential between ordinary income tax rates and capital gains tax rates for upper income taxpayers. The wealthiest among us pay up to 39.6 percent on ordinary income but only 28 percent on capital gains. We certainly believe that income tax rates are too high. And, for middle income taxpayers in the 28 percent income tax bracket, there is no difference between their capital gains rate and their ordinary income rate. Thus, current law provides no tax incentive for middle income taxpayers to invest assets that may have capital gains. Our bill would correct this problem and give the largest percentage rate reduction to the lowest income taxpayers. For example, the rate for high income earners would change from 28 percent to 19.8 percent—a 8.2 percentage point reduction. Whereas, a middle income taxpayer—who is getting no benefit under current law—would be taxed at 14 percent—a 14 percentage point reduction.

Frankly, Mr. President, the introduction of a bipartisan capital gains bill couldn't come at a better time than now. Congress is in the midst of formulating a plan to balance the federal budget. The elements of this plan will have consequences far beyond this year or even beyond 2002 when we hope to achieve our balanced budget goal. Crucial to the achievement of a balanced budget is the underlying growth and strength of our economy. Small changes in the behavior of the economy can make or break our ability to put our fiscal house in order. Thus, especially now, we can ill afford to have our economy slow down and create an increased fear of future job insecurity. Both Republicans and Democrats alike can agree that the creation of new and secure jobs is imperative for a vibrant and growing economy.

This is where a reduction of the capital gains rate can be so important. By stimulating the economy and spurring job creation, a cut in the capital gains rate can stave off the downturn that may be on its way.

Many Americans have expressed concern about the wisdom of a tax reduction while we are trying to balance the budget. However, Mr. President, we see this bill as a change that will help us balance the budget. The evidence clearly shows that a cut in the capital gains tax rate will increase, not decrease, revenue to the Treasury. During the period from 1978 to 1985, the tax rate on capital gains was cut from almost 50 percent to 20 percent. Over this same period, however, tax receipts increased from $9.1 billion to $26.5 billion. The opposite occurred after the 1986 Tax Reform Act raised the capital gains tax rate. The higher rate resulted in less revenue.

Mr. President, the capital gains tax is really a tax on realizing the American dream. For those Americans who have planted seeds in small or large companies, family farms, or other investments, and who have been fortunate enough and worked hard enough to see them grow, the capital gains tax is a tax on success. It is an additional tax on the reward for taking risks. The American dream is not dead; it's just that we have been taxing it away.

I urge my colleagues on both sides of the aisle to take a close look at this bill. We believe it offers a solid plan to help us achieve our goal of a brighter future for our children and grandchildren. When it comes down to it, jobs, economic growth, and entrepreneurship are not partisan issues. They are American issues.

I ask unanimous consent that the text and a summary of the bill be entered into the Record following my remarks.