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Joint Hearing of the Senate Finance Committee and the House Ways and Means Committee - Tax Reform and the Tax Treatment of Capital Gains


Location: Unknown

The issue of how to tax capital gains will be one of the biggest and likely most controversial in tax reform. The reduced rate on long term capital gains is one of the largest individual tax expenditures, costing hundreds of billions of dollars over the next decade.

It is also a source of considerable complexity. I noted in reviewing the testimony for this hearing that by some estimates fully half of the tax code is devoted to defining the difference between capital gains and ordinary income. When there is a significant capital gain preference, there is a lot of pressure on these rules, because the greater the tax preference for capital gains, the greater the incentive to try to re-characterize ordinary income as capital gains -- that's what our carried interest fight is all about.

So it is useful for all of us to really understand the issues surrounding capital gains. That includes the history -- we have mostly had a preferential rate, but the 1986 tax reform eliminated it. And it includes the various arguments for why you might want a lower rate whether that is double taxation of corporate income, inflation, the so-called "lock-in" effect, an incentive to invest and others.

It is also important that we understand the evidence about these different rationales and how they hold up to reality. Most capital gains are realized by the highest earners. Some 71 percent of the benefit of the preferential rate on capital gains goes to those making more than $1 million a year according to the Joint Committee on Taxation. So there is a real consequence from the preferential rate to the progressivity of our tax system.

Both out committees will have to wrestle with these issues as tax reform moves forward, so I look forward to the testimony and hope it will help inform that process.

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