HOW TO BENEFIT THE PROSPERITY OF A FREE SOCIETY

Joe Domian is an investment representative at Edward D. Jones and Company.

Today we hear much about the fairness question regarding the taxation of long term capital gains at a preferred rate. Besides the fairness question, I believe it is important that we also explore the economics of the question and how it benefits the prosperity of a free society.

Let us start with an example: In 1961 Peter and Martha Schmidt had saved enough money to make a down payment on a farm in rural Cape Girardeau. With a loan from the bank, they bought a 150 acre farm for $75,000. In 1991, after 30 years of long, hard work in good years and in bad, they sold the farm for $150,000 and retired.

The Schmidts thought they could live comfortably with the profit from the sale of the farm and some money they had managed to save over the years. It came as quite a shock to the Schmidts when they learned from their accountant that they would have to pay $21,000 in capital gains tax from the sale of their farm.

The Schmidts were upset, of course, and heart broken to see so much of what they had labored for being taken from them in taxes. The Schmidts had never thought of themselves as wealthy. They had always thought of themselves as hard-working, middle-class people.

The Schmidts, in fact, are typical. I.R.S. data indicates that a majority of people with capital gains in 1985 had ordinary annual incomes under $50,000 and nearly 75 percent had ordinary incomes under $75,OOO.

Since 1961, inflation has eroded the value of a dollar to 22 cents. Put another way, the farm would have had to increase to $340,000 just to keep pace with inflation! Hence, the farm as an investment, although doubling in value, lost real value. This loss was made all the more severe as a result of a tax on profits, when in fact, there were no real profits.

The Schmidts are a composite example of many people I have known over the years. They are the hard working entrepreneurs that drive our economy. An entrepreneur may be a farmer, a business owner, or a woman who starts a beauty shop in her basement and expands it to own several beauty parlors. An entrepreneur may be the store owner on Broadway or the husband and wife plumbing/heating company. These are the people that put their livelihood and life savings on the line all the time. They provide jobs and services, and they pay taxes. Their risk-taking and hard work should be rewarded and encouraged rather than discouraged and punished.

Currently in the United States most new jobs are being created by companies that employ fewer than 100 people. This is where our country's growth lies, and it should not be hindered by undue taxation. A recent study by economist Dr. Allen Sinai concluded that reducing capital gains taxes to 15~ percent would increase GNP by nearly 3~ percent, jobs by 2.5 million, and federal revenues by $30-$40 billion. It would also reduce capital costs by 4~ percent over 6 years.

Capital (think "money") is a tool. A tool that all businesses use and need. Like any other tool, it has its cost, either through interest charged for loaning the tool (i.e. bank loans or bonds) or by sharing in the ownership of the company in the form of capital in exchange for shares (i.e. stock).

The United States Government has added to the cost of capital by taxing the gain irrespective of inflation. Thus businesses in the U. S. pay dearer for capital and have among the highest taxed capital gains rates in the industrialized world.

The Declaration of Independence addresses the right to the "Pursuit of Happiness". As we strive to be industrious, to improve our lives, and to pursue our own happiness, it is the wiser government that allows and encourages its citizens to use their tools, rather than cripples its citizens by imposing an excessively "unfair" tax.

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