Facing their toughest lobbying battle in decades, supporters of low tax rates on capital gains are divided, unsure and off balance.
In the past, the struggle has been to persuade Congress to reduce the effective rate on capital gains -- the profits on the sale of an asset such as securities, real estate and other tangible property. Now, the Senate Finance Committee has proposed taxing capital gains at the same rate as wage income, an effective increase even though tax rates generally would be reduced in the tax revision bill.
The change is one of the most profound alterations of the tax code in the sweeping package. Yet it has been the subject of less public discussion than such narrower proposals as one to crack down on tax shelters by limiting "paper" losses.
An amendment to restore low tax rates on capital gains -- 60 percent of gains are not now taxed, resulting in an effective top rate of 20 percent -- is expected to be offered on the floor by Sens. Alan Cranston (D-Calif.) and Rudy Boschwitz (R-Minn.) and perhaps others. But it is not given good chances of passage.
Sen. Lloyd Bentsen (D-Tex.), for example, said he has supported reducing capital-gains rates in the past, but now is willing to trade that preference for lower tax rates overall. The Senate Finance Committee bill, which is expected to be considered by the full Senate beginning in early June, would cut the top tax rate for individuals nearly in half, to 27 percent, while reducing the corporate rate by one-third, to 33 percent.
Sen. John Heinz (R-Pa.) said there is "no sentiment" in the Senate for restoring a special low rate for capital gains as long as the top tax rate remains set at 27 percent. "If the 27 percent rate is changed, all bets are off on what might happen to capital gains," Heinz said.
Lobbyists say their poor chances of success stem from several factors: Even some industries heavily dependent on lower capital-gains rates, such as high-tech firms, favor other elements of the bill and do not want to see it fail. Any amendment to restore low capital-gains rates must be accompanied by offsetting tax increases in other areas to restore lost revenue. Such an amendment would disproportionately benefit wealthy taxpayers, destroying the balance in the bill that allocates the tax cut more to lower-income taxpayers.
Even President Reagan, who in his own plan proposed reducing the top effective capital-gains rate to 17.5 percent -- half of his proposed top rate of 35 percent -- can live with taxing gains as ordinary income, his aides say.
"The president believes strongly in incentives, in encouraging the entrepreneurial spirit . . . but the importance of the differential between capital gains and ordinary income is far less when the disparity is only seven" percentage points, said Treasury Secretary James A. Baker III.
"When you consider the fact that we will be freeing up a substantial amount of capital for productive investment that has heretofore been going into shelters, there will be plenty of incentives, we think, for investment and entrepreneurship."
Representatives of venture-capital firms, which inject money into new companies partly through the lure of low capital-gains rates, don't see it that way. They say successive reductions in the capital-gains rate in 1978 and 1981 led to a wave of technological innovation and the creation of companies.
Proponents of low capital-gains rates encourage managers to leave their firms and start new ones with the promise that their payoff, in the form of equity, will be rewarded with low taxes when sold. Just as important, low capital-gains rates help new firms recruit more managers even though they can't compete on the basis of salary, proponents say.
"The rate is not the important thing. What's important is the differential between the capital-gains rate and taxation of ordinary income," said Stanley E. Pratt, chairman of Venture Economics Inc. of Wellesley Hills, Mass., a research and consulting company. "Entrepreneurs act on perception more than reality. What they tell me is, 'We want an unequal advantage.' "
The extent to which that advantage attracts investment funds, however, is open to question. According to Venture Capital Journal, 33 percent of the funds committed to independent, private venture-capital firms in 1985 came from pension funds, which are tax exempt. Another 23 percent came from foreign interests, also not influenced by the capital-gains rate, and another 8 percent came from tax-exempt foundations.
Venture capitalists say in response that tax-exempt investors tend to follow the pattern set by private sources of funds, so that the capital-gains tax serves to influence the market leaders.
In any case, members of the Senate Finance Committee apparently gave little attention to these arguments during the week in early May when they put together the outlines of a tax-revision bill behind closed doors. Few of the members fought hard for retention of low capital-gains rates, according to some of those present.
And relatively few lobbyists were hovering outside the committee room door, grabbing elbows and whispering in ears to ask for preservation of the capital-gains preference. Mark Bloomfield of the American Council on Capital Formation, part of a coalition supporting a capital-gains amendment on the floor, said those groups suffered from "pressures on priorities."
That pressure caused a split in the coalition last week: The American Electronics Association pulled out when it became apparent that a floor amendment on capital gains would be offered. The association's members like several portions of the bill, including low tax rates and the retention of the research and development credit, and they fear the consequences of a floor amendment, according to Kenneth C. O. Hagerty, vice president for government operations.
"We are having to sit this dance out even though they're playing our song," Hagerty said. The AEA officially endorsed the Finance Committee bill Friday.
Securities dealers hope that more stock trading will result from lower tax rates on short-term capital gains. Gains realized in less than six months are now taxed as ordinary income, thus would be subject under the plan to a top rate of 27 percent. They also would like relief from the high tax rates they now pay.
"We don't have depletion and depreciation and things like that," said Raymond A. Mason, president of Legg Mason Inc. of Baltimore. He added, however, that he and the Securities Industry Association favor a floor amendment to restore a capital-gains differential.
Official figures have not yet been released on how much offsetting revenue would have to be raised to pay for such an amendment. Estimates generally range from $12 billion to $22 billion over five years.
But revenue is not the worst problem facing proponents of an amendment. Capital gains overwhelmingly accrue to upper-income taxpayers. According to the Treasury Department, they account for 41 percent of adjusted gross income for those earning between $500,000 and $1 million, but only 5.3 percent of AGI for those earning between $50,000 and $100,000.
"The way the bill has been constructed makes capital gains a load-bearing wall of the distribution of the tax burden," said AEA's Hagerty.