Political Diary: Tax Reform in 2013?

Published in Wall Street Journal

It was overshadowed by the presidential race tug-of-war, but on Thursday the House and Senate held a rare joint hearing on tax reform. There was the usual partisan wrangling over who should pay how much, but there was some bipartisan agreement as well. It now appears both parties want tax reform in 2013—and recognize that the current tax system is a cancer cell invading the economy.

A key figure in the tax debate next year is Senate Finance Committee chairman Max Baucus, the Montana Democrat. Mr. Baucus appears to want tax reform to be his legacy issue, but he did stress that if Republicans want lower personal income and business tax rates, they will have to accept a higher capital gains tax rate. “Capital gains is one of the most difficult issues we face” in getting an agreement, he said.

Democrats are fairly unified that capital gains taxes should be taxed at the ordinary income tax rate. This was the deal in 1986 when the top income tax rate fell from to 28% from 50%, but the capital gains tax was raised to 28% from 20%. As Mr. Baucus put it, “low capital gains tax rates are the main reason why many wealthy individuals pay lower tax rates than the middle class.” But that doesn’t take into account the tax paid by corporations as a second tier of tax on capital gains income. Democrats are clearly obsessed with the issue of the effective tax rates paid by wealthy people like Mitt Romney and Warren Buffett.

Republican Dave Camp, the House Ways and Means Committee chairman, says “there’s generally strong agreement on the Republican side of the aisle. “We want to get rates down to 25%, and we want to keep taxes on saving and investment low to create jobs,” he said. He thinks tax reform is coming in 2013 “no matter who is elected president, but it’s easier with a President Romney.”

One Democrat who seemed to want to bridge the differences between the two parties was Sen. Ron Wyden of Oregon, who suggested taxing capital gains and ordinary income at the same rate but allowing an exemption of as much as 50%. This creates the impression of a unified rate on ordinary income and capital gains and allows for a progressive capital gains tax. Another idea discussed: tax at a different rate for capital investment (i.e., investing in stocks or start-up businesses) versus land or collectibles (such as paintings).

“We’re hearing exactly the debate we heard in 1978 and 1986,” says Mark Bloomfield of the American Council for Capital Formation and a man that has been dubbed “Mr. Capital Gains” in Washington. “These same debates about fairness and growth have been going on for fifty years. But I was happy that almost everyone agreed we need more investment savings and entrepreneurship, and the tax code is discouraging that. This hearing was a step forward for tax reform.”

Download