Congress is leaving a daunting list of tax questions unanswered until after the election. But lawmakers will debate one important and contentious issue, the tax treatment of capital gains, during a long-awaited hearing Thursday.
Like many features of the tax code, the current tax rate on capital gains is set to expire at the end of the year. Unless Congress and President Obama can agree on legislation, the nominal capital gains tax rate will jump from 15 percent to 20 percent, while the effective tax rate for individuals earning more than $200,000 will be still higher because they will have to pay a new 3.8 percent additional tax on investment income.
Although most attention has focused on the 2001 and 2003 income tax rates (PL 107-16, 108-27) expiring at the end of this year, taxation of investment income is a pressing matter for the business community, particularly Wall Street firms.
A rare joint hearing involving the House Ways and Means and the Senate Finance committees scheduled in June to consider the capital gains tax was delayed because the Supreme Court issued its health care ruling that day. With tax negotiations expected to be a major part of the post-election session, the rescheduled event Thursday will give members of both parties a chance to lay out their arguments and get more information about the impact of capital gains on the economy.
Republicans want to keep the capital gains tax as low as possible, arguing that any tax on investment activity impedes personal savings and economic growth. At their urging, the capital gains tax was reduced from 28 percent to 20 percent in 1997 and put on its current path in 2003.
The preferential treatment of capital gains income came under increased scrutiny this year when Mitt Romney released his 2010 and 2011 tax returns. Despite an adjusted gross income of more than $20 million, the Republican presidential nominee’s effective tax rate was 13.9 percent in 2010 and 15.4 percent in 2011 — largely because most of his earnings were capital gains and dividends.
But Republicans might now have to weigh their preference for low capital gains rates against other priorities, including lower tax rates on ordinary income. Although many Republicans favor a broad overhaul that would reduce tax rates while broadening the income subject to taxation, cutting ordinary income tax rates while keeping the capital gains tax rate low would almost certainly result in a large tax cut for upper-income individuals, according to tax experts.
Many Measures Expiring
Large portions of the tax system remain up in the air awaiting new legislation. Absent congressional action by the end of the year, the tax rate on dividends will increase from 15 percent to 39.6 percent. Ordinary income tax rates will rise for the majority of households, more middle-income taxpayers will be hit by the alternative minimum tax (AMT) and workers will see their share of the Social Security payroll tax increase.
Also in question is the fate of dozens of tax breaks known as “extenders” because they need to be renewed periodically.
Senate Finance advanced a tax extender package on a 21-5 vote shortly before the August recess. The $205 billion measure, which included AMT relief, has “a pretty good” chance of seeing floor action before the Senate begins its pre-election recess, Majority Leader Harry Reid, D-Nev., said Wednesday. However, a Republican aide said the Senate has run out of time to consider the legislation.
House Republicans have never seriously considered introducing a tax extenders package before the election. Their preference has been to consider extenders including the research and development tax credit along with the many other expiring tax provisions. It appears they will get their wish.