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Politics Mondays: BEC Strategy Memo # 2: How The Democrats Can Win With The Capital Gains Tax (June 2006)


Today we continue with a second installment of our strategy memos. This piece was written in the same spirit as our initial writing on how the Republican Party could win by supporting the minimum wage issue.

These two pieces, written for Polyconomics, Inc. two months ago, reflect a strategy known in warfare as 'outflanking' your enemy. Basically, this approach is characterized by an opponent taking a strength of their enemy and attacking them where they least expect it or from where they aren't likely to perceive it. It is risking, however, in that it requires an army to execute something that they do not regularly do. Therefore it should be used sparingly. But if effective, it is absolutely devastating.

There is a lot more science to this than we can get into here. To whet your appetite however, and to think through the implication of these kind of things and what they mean for the Black electorate, political realignment, wedge issues, and triangulation read my exclusive interview with miltary historian Bevin Alexander from 2003.

I hope that you all will continue to ride and play chess with me as we think creatively and critically about issues, interests, alliances, voting blocs, campaigns, and elections that should be part of a strategy to obtain the self-enlightened interests of the global Black electorate.

Cedric Muhammad
August 21, 2006


How The Democrats Can Win With The Capital Gains Tax

There was something missing from the six priorities discussed by Senate Democratic Leader Harry Reid, House Democratic Leader Nancy Pelosi, Assistant Senate Democratic Leader Dick Durbin, and House Democratic Whip Steny Hoyer at last Friday’s press conference held to announce the Democratic Party’s “A New Direction” initiative.

The pro-growth legacy of President Bill Clinton.

While the ‘Clinton Boom’ is most frequently defined in terms of labor - the impressive job growth that took place during the eight-year reign of the last Democratic President of this country – it is the effect that his policies had on capital formation that are most revealing, and possibly most important.

When President Clinton signed the 1997 Taxpayer Relief Act, few in his party appear to have realized that he laid the base for a political realignment on the issue of capital gains. The law’s key provision – that anyone can sell their primary residence and make up to $250,000 in profit if they are single, and twice that if married, and not owe any capital gains taxes – is the variable most responsible for the ‘housing boom’ we all read about, nearly ten years later. Before May 7, 1997, the only way you could avoid paying taxes on your home-sale profit was to use the money to buy another, more-expensive house within two years. Sellers age 55 or older could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. In every case, there was tax Form 2119 to complete. But after that historic date, nine years ago, the only paperwork required is the counting of your cash, tax free.

The result of wealth creation made possible as a result of home ownership and investment is apparent to a significant portion of the electorate. Ownership rates and investment income from the sale of homes are at all time highs, especially among those groups at the lower end of the economic ladder. But the issue’s salience and potential remains untapped and unrealized as a result of the two-party system’s management of the economic growth – wealth distribution tug of war. The Republicans are content to market the benefits of capital gains to a narrowly defined investor class while Democrats are satisfied with a focus on job security and wage levels for the working class. A key element of President Clinton’s legacy is that he was able to work on both sides of the capital to labor ratio, simultaneously. In 1997, for example, he presided over an increase in the minimum wage and a reduction of the capital gains tax. Few politicians are so adept at divining what the electorate wants on economic matters. And the electorate wants politicians to understand that it knows that the only way a worker can get a capital gain is by putting his or her after-tax labor income at risk. Such income constitutes wealth, and can be consumed, saved, or invested. It is on the third of these three fronts – investment – where workers, not as acquainted with capital markets as Wall St. professionals, want barriers reduced to wealth creation.

In 2006 it appears the time is ripe for movement on this issue. But from angles few might expect. Just as we mentioned there is an opportunity for the GOP to find electoral success by absorbing the minimum wage issue, we similarly feel the landscape would warmly receive – and is even calling for – a pro-growth Democrat to broaden the appeal of the supply-side revolution. By showing the relevance of capital gains to wealth creation, as evidenced by its impact on real estate investment, the Left can go where the Right is unable or unwilling, for whatever reason. After all, look at how hard it was to get supposedly pro-growth Republicans to finally extend the 2003 cuts to the tax rates on dividends and capital gains, and continue tax breaks for small-business investment. The GOP, intent on lowering rates only, does not show the flexibility, creativity and sensitivity the issue now requires if further traction is to be gained en masse on the issue.

Maintaining the status quo on the capital gain tax might be all we can expect from the GOP. But change, on the margin, is the job of a Democrat who can:

Continue To Redefine ‘Capital Gains’. A major contribution of President Clinton was that his 1997 Taxpayer Relief Act applied capital gains elimination to the asset that most Americans recognize and understand. Not stock ownership but home ownership. By connecting the dots of wealth creation to the elimination of the cap gains tax in terms that they can understand, the investor class is now poised to include the first time home buyer and part-time real estate investor among their ranks. This is especially important among minority groups who own homes but still are relatively speaking, intimidated by the stock market. In 2003 an Ariel-Schwab survey revealed that 76% of Blacks surveyed viewed investments in home improvement as preferable to stocks. This was 15% higher than the view held by White Americans. By making the house the prism through which taxation on capital is viewed - all taxes, fees, and gains which bear on the home can be considered at once, linking capital gains with the mortgage interest rate deduction and property tax discussions. This increases the likelihood that the electorate will be able to communicate to any politician who will listen, its understandings of the relation between wealth creation and the tax burden. Just a few days ago a Quinnipiac University poll implied this possibility. When asked, "What do you think is the most important problem facing New Jersey today?" 46 percent replied taxes -- a percentage that was higher than any problem listed in any previous Quinnipiac statewide or national poll, the survey group said. The 46 percent included 19 percent who complained about all taxes, 26 percent who said property taxes, and 1 percent who said gas taxes. The home not financial markets is the epicenter of all taxation debates. In addition to this important shift, more discussions on the issue should include the capital gains tax burden carried by a small business. If you realized a gain from qualified small business stock that you held more than five years, you generally can exclude one-half of your gain from income. But the remainder is taxed at a 28 percent rate – 13 percentage points higher than the rate paid on long term capital gains.

Advocate For Retroactive Capital Gains Tax Indexation. Inflation eats away at capital like termites do a home’s foundation. For one, it causes bracket creep, by pushing individuals and businesses into higher tax brackets, and secondly, over time, it can totally erode the capital gain of an asset that has appreciated but which has not been enjoyed through the sale of that asset. Protecting capital gains from this insidious force by allowing owners to adjust for inflation enables vast amounts of capital still locked in the economy to be unleashed. If this had been done last decade, tax liabilities of $7 trillion in inflated values would have instantly been wiped away, liquefying this amount of capital.

Shorten Holding Periods For Favorable Capital Gains Tax Treatment. Across the spectrum – whether for a home, business or stock – the length of time necessary to hold an asset in order to qualify for the lowest possible cap gains rate is too long. In order for a home owner to qualify for capital gains tax elimination on the property sale, they actually have to live in it for two out of the previous five years. And if that weren’t enough that person must wait two years in between home sales in order to qualify for that exemption again. For businesses operating in distressed rural and urban areas that pay zero capital gains, the ownership must be held for 5 years in order to qualify. And to qualify for the long-term capital gains tax rate, one must hold, for example, the stock they are selling, for 1 year. If these ‘holding periods’ were reduced to 1 year of residence and one year in between exemptions for homes; 1 year for businesses in distressed urban and rural areas; and 6 months for long-term capital gains, one would see capital formation and wealth creation as never before.

Frame Capital Gains In A Populist Context. A clear case must be made that individual laborers, small businesses, and first-time homeowners are those who truly benefit the most from the elimination of barriers to capital formation with real examples and not just rhetoric (as has frequently been a GOP imperfection.) By doing so the stage is set, for the politician most sensitive, to effectively demonize – in an electoral context – those individuals and institutions most responsible for keeping some Americans from creating wealth. Such an appeal would effectively manage and even merge the electorate’s desire for both economic growth and the redistribution of wealth, in other words, its impulse for freedom and equality. That would represent the best of the populist worldview as defined by Jim Hightower, Commissioner of Agriculture of Texas, in 1986, when he said, “Populism addresses the problem that too few people have too much money and power....It doesn’t seek a liberal solution, to give welfare to the farmer who’s been forced off his land, or a conservative solution, which is to say ‘I got mine, so long sucker.’ The idea is to put the tools of self-help in people’s hands, to free up their enterprise so that prosperity doesn’t trickle down, it percolates up.”

***

The Democratic Party’s embrace of the capital gains tax issue would mark a departure for the party that has so rigidly focused on the redistribution of wealth, that it has ignored the paradigm-shifting economic growth break through of President Clinton’s 1997 Taxpayer Relief Act. But that reticence does not mean that the electorate does not have confidence in a singular Democrat’s embrace of the issue. In a CNN/USA Today Gallup poll released in February 1997,months before the historic law was passed, in response to the question, “Who Do You Have More Confidence In?”, on the issue of capital gains, 34% of the electorate said that it trusted the Democrat, President Clinton, more than it did Republicans.

All that the Party of Roosevelt needs to do, in order to become the Party of Clinton, is to find the right environment and the right politician in which to champion the capital gains tax issue in terms of populism and wealth creation. With a Federal Reserve intent on raising interest rates in the foreseeable future, and Labor Department’s “owner’s equivalent rent of primary residence” showing that more and more Americans are renting rather than purchasing homes – reversing the shift to ownership - the electorate understands that the housing market gains of the ‘Clinton boom’ are in jeopardy. All that they await is a politician through whom they can communicate this.

Most likely, they will find him or her, to the Left.


Cedric Muhammad

Monday, August 21, 2006

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