Today’s Tax-Cut Arguments Show Concerns of a Wealthier America

A changed America was on view last week as measures to lower capital gains and inheritance taxes, while granting tax credits for education and child care, were introduced in Washington.

The tax proposals are important for what they say about the U.S. economy--especially in a week in which the stock market took yet another great leap upward. For the economy is tied more than ever to the stock market.

And the tax proposals respond to an American middle class richer and more concerned than ever with investments and even with wealth.

Don’t be fooled by last week’s raucous congressional bickering over who is rich and who is poor in America.

The reality is that a lot of people are building up wealth. Sixty-three million Americans, a number equal to 50% of all working people, own mutual funds. The proposed reduction in capital gains tax rates, to 20% from 28%, would cut the taxes fund owners pay on gains made by stocks sold during the year by their mutual fund managers.

A lower capital gains rate also appeals to elderly people waiting to sell houses that have risen in value as the economy has gone from post-Cold War recession to broad prosperity.

But most Americans support tax cuts less for such direct benefits than for the belief that their investments for retirement should be taxed at lower rates, or not taxed at all.

As more Americans have taken charge of their pension plans themselves, their views of finance have become more conservative.

That shift is behind the popularity of the measure to raise the inheritance tax exemption from $600,000 to $1 million. Critics are technically correct that only about 1,700 estates would qualify for such a tax exemption at present. But the measure reflects the larger reality that America has become a self-employed nation. By one estimate, there are now 22 million businesses owned by families or individuals. More income is being earned from stock options.

The shift in financial attitudes reflects the rapid buildup of wealth in 401(k) plans, which now total $675 billion and will pass $1.5 trillion in assets by 2000.

And more Americans have nest eggs. In this decade alone, the corporate equity assets of U.S. households have risen 70% to more than $5 trillion.

A generation ago, 1972 presidential candidate George McGovern scoffed at factory workers who protested his idea of taxing inheritance more heavily. “Do they think they’re going to have something to leave their kids?” asked the politically tone-deaf McGovern.

Today factory workers and many others do have something to leave their kids, or to enjoy in their own old age.

“We have become a nation of investors, and we’re even becoming a nation of owners,” says Lawrence Stone, tax partner at the Los Angeles law firm of Irell & Manella.

That is why for all the bickering, the tax proposals have bipartisan support. Other measures--tax credits for higher education and for child care, a necessity as both parents work--also reflect middle-class concerns in the new economy.

There are implications to the shift in attitudes toward taxes. It marks an end to the redistributive emphasis in tax policy that strove to narrow gaps in living standards by taxing the wealthier to fund benefits for the poorer in society. The impulse dates to the Depression 1930s, when everybody was broke and most people supported sharing the wealth.

But there is more to today’s emphasis than mere inattention to the poor, says economist John Cogan of the Hoover Institution at Stanford University. The tax-cut proposals represent an attempt to speed up economic growth. Tax cuts would spur transactions, move money around and allow the U.S. economy to grow faster than the 2% to 2.5% average of recent years.

Retirement, ultimately, is behind the concern for growth.

“The economy needs to grow faster if we are to afford Social Security and Medicare benefits in the next century,” Cogan says.

To be sure, tax cuts totaling $85 billion in value can’t really boost a $7-trillion economy. But the emphasis on lower taxes inspires confidence, and that’s important.

An example is the capital gains tax cut of 1978. In that inflationary time, middle-class people suddenly saw themselves owing higher taxes on assets that had risen in value. So they demanded a cut in capital gains rates.

And when bipartisan support in Congress gave it to them, the economy grew faster, recalls Philip Holthouse of Holthouse, Carlin & Van Trigt, a Los Angeles tax-accounting firm.

Today the middle class wants tax cuts to help preserve retirement nest eggs.

Success for the tax proposals is not yet assured. Spending cuts are a necessary part of the package to balance the budget. And attempts to trim Medicare will spark fierce opposition.

“At the end of this year, we’ll either have a big tax cut or a smaller package or everything will fall apart,” says Mark Bloomfield of the American Council for Capital Formation, a Washington think tank on taxes. “I think we’ll have some kind of tax package,” he adds.

Beyond taxes, the risks inherent in retirement hopes so dependent on the stock market are causing anxiety. “Are stocks overvalued?” investors ask. “Will there be a crash?”

In fact, stocks are not as overvalued as they are sometimes painted. As U.S. companies lead the transition to a global economy, there is a greater value to many businesses. How much greater is always the question, of course.

The real danger is what will happen when stocks do go down. If investors panic and dump their holdings, they could damage their long-term prosperity.

So the currently confident middle class should think about the time--certain to come--when something unexpected happens to upset the world economy.

Stocks will have a serious decline at some point. And the U.S. economy will have another recession.

That’s not predicting disaster. A 25% to 30% decline in the stock market would reduce aggregate wealth in the U.S. economy by only 3%. The resilient U.S. economy would regroup and come back.

However, a 25% decline in their individual stocks would frighten many investors. But there’s no reason to panic. The reality is that many Americans have already made the leap to handling their own pension money, to taking charge of their own retirement savings. They should understand that they can weather reversals and come back just like the economy at large.

Meanwhile, the market is up, the economy is strong and tax cuts are in the wind.