Revision of Federal Tax on Capital Gains

Report Outline
Action on Taxes in the Next Congress
Treatment of Gains and Losses Prior to 1934
Revision of the Capital-Gains Tax in 1934
Capital-Gains Tax and Economic Recovery
Special Focus

Action on Taxes in the Next Congress

President Roosevelt in campaign speeches at Pittsburgh on October 1 and at Worcester on October 21 declared that rising receipts would enable the federal government to balance its budget within a year or two without imposing new or increased taxes. Secretary of the Treasury Morgenthau made a similar statement in an address in New York City, October 23, and Senator Harrison (D., Miss.), chairman of the Senate Finance Committee, concurred with these views at a press conference upon his return to Washington, November 20. Barring unforeseen emergencies, therefore, no major tax legislation is to be anticipated at the coming session of Congress. Harrison predicted that the tax on undistributed corporate profits would be left unchanged, except for minor revisions to correct inequalities. He indicated that most of the nuisance taxes due to expire June 30, 1937, would be continued for another year, since “every possible revenue should be had by the government and every saving made so that we may approach a balanced budget in two more years.” Although the Finance Committee chairman made no mention of the subject, it has been reported that the administration may suggest modification of the present income-tax provisions relating to capital gains and losses if it is found that such action can be taken without large losses of revenue. It is understood that studies of the question have been initiated to provide information for the guidance of the President in determining whether or not to recommend this change.

Capital-Gains Tax and a New Stock-Market Boom

Recent indications of an incipient boom in the stock market are believed to be responsible for the attention now directed to the capital-gains tax. It is well known that the administration, while seeking to promote economic recovery, desires that prosperity should return gradually and upon a sound basis. A runaway stock market would be regarded as an omen of future disaster. Numerous economists contend that one element contributing to the enormous rise of stock prices in 1928 and 1929 was the fact that the market was not restrained by the natural check that would have been imposed if holders of stocks whose prices had greatly appreciated had been able to sell without paying a substantial share of their profits to the government in the form of gains taxes. The unwillingness of many persons to sell under those circumstances, it is asserted, tended to intensify a scarcity condition and hence to force prices still higher toward the inevitable brink. According to this theory, if gains had been taxed more moderately or completely exempted from taxation, profit-taking sales would have occurred in greater volume and acted as a balancing force to keep prices more closely in line with true values.

Regardless of whatever influence the government's tax policy may have had upon the stock market, capital gains were a fruitful source of federal revenue during the boom years. Appeals to Congress to adopt the British system of exempting such gains from taxation consequently fell upon deaf ears. After the market collapsed, however, federal revenues suffered severely, not only from a precipitate drop in the yield of the capital-gains tax but from a sharp reduction in the yield of the regular income tax owing to the offsetting of capital losses against ordinary income. Congress then took steps to restrict use of losses in this manner, and in 1934 it introduced a radical change in the method of taxing gains. While the latter change was intended to ease the tax burden on capital gains, maximum relief was made available only in the case of assets held more than 10 years. The new law thus could not be expected to encourage profit-taking in a future boom. On the contrary, it might tend to defer such action.