More on the Reagan Administration and Capital Gains Taxes – A Correction and More Detail

I generalized a bit too much in my previous post on Reagan and taxes about the Reagan Administration’s views on capital gains. Here is a correction and some more detail on this subject.

A tax lawyer who worked at Treasury in the mid-80s and was very involved in Treasury’s efforts to get tax reform enacted recently told me in reaction to my post that Treasury II (The President’s Tax Proposals to the Congress for Fairness, Simplicity, and Growth, May 1985) proposed a preferential rate for capital gains, which was later dropped for revenue reasons. As a consequence, I looked at both what Treasury I (Tax Reform for Fairness, Simplicity, and Economic Growth: The Treasury Department Report to the President, November 1984) and Treasury II said on this subject.

In fact, Treasury II did propose a top 17.5% long-term capital gains rate for individuals and non-corporate taxpayers. It reduced the exclusion rate for net long-term capital gains from 60% to 50% and the top propose rate was 35%. (See page 168 of Treasury II here.) The Administration though subsequently supported the legislation going through Congress that did away with capital gains preferences.

Treasury I did not propose an exclusion for capital gains but rather proposed indexing the basis of long-term holdings of capital asset to inflation. To avoid tax games, though, Treasury I also proposed eliminating the inflation compensation component of interest from both taxation and deductibility. This inflation indexation idea was dropped in the Treasury II proposal, which was developed when James Baker had replaced Don Regan as Treasury Secretary.

As for Treasury’s position on this, I remember listening to a speech by Charles McLure, who was Deputy Assistant Secretary for Tax Analysis from 1983 to1985. As I remember it, he argued that income does not come marked as to character and should all be taxed the same, whether the character was capital gains or ordinary income. It was this speech that I particularly remember on this subject.

Moreover, it should be noted that the Reagan Administration did find its way to supporting the elimination of the preferential treatment for capital gains. The elimination did not last long.