The latest craze in conservative circles is to see who can heap the most praise on the tax reform plan that Republican Senators Mike Lee and Marco Rubio released earlier this month.
Bloomberg’s Ramesh Ponnuru called it “the most pro-growth tax reform since Calvin Coolidge’s presidency.” Veronique de Rugy gushed in the National Review that “it’s just about impossible not to be happy with the plan.” The Mercatus Center’s Scott Sumner even went so far as to argue that, if enacted, the Lee-Rubio plan would “easily be the best thing the Federal government has done since the civil rights laws of the 1960s.” And they were far from alone in their enthusiasm.
Insofar as those on the Right quibble with the plan at all, they object to the so-called “reformocon” elements of the proposal, like the increases in the child tax credit and the maintenance of graduated income tax rates (instead of flat rates or a national consumption tax).
Why such conservative love for Lee-Rubio? As de Rugy put it, the plan packages a variety of ideas that “the free-market movement has highlighted for years.” Lee-Rubio is the culmination of more than four decades of conservative assault on the taxation of capital income.
Though they’ve never wholly escaped taxation, throughout the history of modern federal tax policy capital gains have usually been taxed at lower rates than labor income. In the decades after World War II, however, many policymakers and tax experts viewed the capital gains preference as a flaw, rather than a virtue, of the federal tax code. When they spoke of capital gains tax “reform,” most meant eliminating this special privilege and instead taxing capital income at the same rates as ordinary income.
By the early 1970s, most mainstream political forces agreed that addressing the capital gains loophole had to be part of any significant revision of the federal tax code. President Nixon’s undersecretary of the treasury, Edwin S. Cohen, called the preferential treatment of capital gains “undoubtedly the single most important source of complexity in the law.” Philip Stern — the author of The Great Treasury Raid, a 1963 bestselling loophole exposé — spoke for many on the Left when he called the capital gains preference “the greatest single cause of both inequity and complexity in the American tax system.”
The Treasury Department put hard numbers behind these objections when it began publishing estimates of the federal tax expenditure budget in the early 1970s. This data demonstrated that the capital gains preference not only accounted for the single greatest revenue loss among all tax loopholes, but that it was the rich who reaped its benefits, with more than half of all capital gains accruing to those making more than $100,000 per year in 1972 (more than $550,000 in today’s dollars).
With the Treasury hemorrhaging revenue, the rich escaping taxation, and tax accountants expending needless energy devising complex schemes to convert their clients’ earned income into capital gains, few objective experts seemed to support the capital gains preference anymore. Harvard tax economist Richard Musgrave summarized the conventional wisdom of the early 1970s when he told Congress that there were “no valid grounds” for continuing to tax capital gains at lower rates than earned income.
When George McGovern challenged Nixon in the 1972 presidential election, he ran on an anti-capital gains preference platform, declaring, “money made by money should be taxed at the same rate as money made by men.” McGovern also linked the issue of tax loopholes to rising economic inequality, calling unapologetically for “redistribution of income” by closing federal tax loopholes and lowering taxes — not only at the federal, but also state and local levels — for low- and middle-income taxpayers.
Despite McGovern’s sweeping loss to Nixon, both Nixon’s internal polls and public surveys showed that tax reform was the only issue on which McGovern consistently bested Nixon, a fact pollster Louis Harris called “remarkable.”
Indeed, the erosion of the progressive federal income tax, combined with steep increases in regressive state and local taxes, had squeezed the pocketbooks of most Americans and stoked public resentment at the loophole-filled tax code. By the early 1970s, two-thirds of Americans agreed that the “tax laws were written to help the rich and not the average man.” As a result, many in the press predicted that the capital gains preference would meet its end by the mid-1970s.
But the rising consensus around eliminating the capital gains preference elicited a sharp backlash from the Right. This pushback fit within a larger movement in the 1970s by business and the Right to reassert their strength in politics, perhaps best exemplified by Lewis Powell’s famous memo, “Attack on American Free Enterprise System.”
Business, Powell argued, needed to “launch a counter-attack” against those on the Left who criticized pro-business provisions like loopholes. General Electric CEO Reginald Jones agreed, arguing in the Harvard Business Review that “antibusiness attitudes” were “rotting out the very foundations of our economy.” What the Right needed to do, Jones said, was challenge not only proposed hikes in capital gains taxation, but also the existing “discriminatory tax treatment” of capital income.
Newly founded or reinvigorated right-leaning, corporate-funded groups like the Heritage Foundation, Business Roundtable, the Cato Institute, and American Council for Capital Formation, among others, now called for cuts to — or the elimination of — capital gains taxes.
While reducing the taxation of capital income would disproportionately benefit the wealthy individuals funding these foundations — such as Richard Mellon Scaife, John Olin, Joseph Coors, and David and Charles Koch — proselytizers for the tax cuts cast them as both indirectly beneficial for average Americans and morally just.
By encouraging “capital formation” with capital gains cuts, those on the Right argued, inflation would fall, employment would rise, and prosperity would flow down the income ladder, benefitting the “poor as well as the rich, and labor as well as management,” as the Chamber of Commerce’s Walker Winter put it in 1973. The American Council of Capital Formation portrayed the idea of taxing capital income as an attack on the “American Dream” itself.
The upper-income taxpayers who received capital gains were not beneficiaries of loopholes, conservatives argued, but were instead victims of oppressive tax rates and inflation. Just weeks after being sworn in as chair of President Gerald Ford’s Council of Economics Advisers, Alan Greenspan elicited boos and catcalls from a crowd of grassroots groups when he argued that “Wall Street brokers” were “really hurt the most” by inflation — an assertion contradicted by a Joint Economic Committee study that had been released earlier that year.
These anti-tax conservatives finally found their political opening when California voters approved Proposition 13 in 1978. Prop 13 cut taxes on the only significant capital most Americans owned — their homes. However, many Republicans and right-leaning activists portrayed Prop 13 as a call for cuts to all taxes on capital.
Crisscrossing the country aboard a plane dubbed the “Tax Clipper,” Republicans from Greenspan to Ronald Reagan pitched a previously moribund capital gains tax-slashing bill authored by Wisconsin Rep. William Steiger. In speeches, Reagan argued that the Steiger bill, like Prop 13, embodied the public’s demand for low taxes and economic growth. A capital gains cut, Reagan added, would actually raise revenue, thanks to its stimulating effect.
Many, from Ralph Nader to the AFL-CIO, opposed the Steiger bill, and President Carter initially criticized it as “huge tax windfalls for millionaires and two bits for the average American.” However, rhetorically linking the Steiger proposal to Prop 13 proved to be a stroke of political genius by conservatives. Democrats quickly folded, giving the bill overwhelming majorities in the House and Senate and leaving Carter to reluctantly sign the bill.
This 1978 victory proved to be a watershed for anti-capital gains tax proponents. Mark Bloomfield, the current president of the American Council for Capital Formation, proudly displays in his K Street Office a comic book-style cartoon depicting the ACCF’s role in the passage of the Steiger bill. Indeed, with the temporary exception of the Tax Reform Act of 1986 — a compromise that taxed capital gains at the same rate as ordinary income in exchange for slashing the top income tax rate from 50 percent to 28 percent — the notion that capital gains deserve special tax treatment has rarely gone unchallenged.
Today, aside from Vermont Sen. Bernie Sanders, few policymakers advocate the older definition of capital gains “tax reform” — taxing gains the same as ordinary income. At most, some Democrats, like President Obama, support modest increases in capital gains rates.
The case for the old definition of reform remains strong, however. It has wide support among left-leaning economists like Paul Krugman, and numerous studies, both governmental and academic, have questioned whether low taxes on capital income either lead to significant job growth or bring about income gains that trickle down to low- and middle-income Americans.
In contrast, cuts to capital gains taxes undoubtedly have helped drive rising income inequality. Since the 1970s, capital income has become more concentrated. The top quintile of households now receive 90 percent of all capital gains and dividends, with the top 1 percent alone collecting nearly 70 percent.
Both the Congressional Budget Office and the Congressional Research Service have documented the outsized role that capital income has played in the soaring inequality evident in recent US history. Over the past decade, as the CBO put it, capital gains “accounted for about four-fifths of the total increase in [income] concentration.” The Right, however, remains undeterred in its push for zero capital gains taxes.
The Lee-Rubio proposal is the culmination of anti-capital gains tax arguments honed by conservatives since the 1970s. Echoing the “capital formation” claims of that decade, Lee and Rubio have touted their plan as eliminating the “bias against capital investment,” while the business-backed Tax Foundation has predicted that Lee-Rubio would super-charge growth and even pay for itself in the long run, despite the fact that more traditional estimates have found that it will cost the government trillions of dollars over the next decade.
What is certain, though, is that Lee-Rubio will tilt its benefits toward the richest taxpayers, just like the 1978 Steiger bill did. If it became law, Lee-Rubio would eliminate taxes on capital gains for the first time in the history of the modern US tax code. This would be not only a sweeping conservative policy victory, but also a redefinition the very meaning of “tax reform.”
The tides haven’t turned against taxing capital because there’s overwhelming evidence of its fairness or efficacy, but because the Right has gained more political power. The task for the Left is to organize to revive the older vision of “reform” as ending the preferential treatment of capital gains, shifting political power away from the wealthy and making at least some inroads against income inequality.