The Contract with America: The New Majority in Congress Sets out to Prove Fewer Taxes Are the Cornerstone of Economic Prosperity

The Republican Party has emerged from exile and is geared up to take on the task of improving the economy. Their strategy is grounded in the party's traditional stance that less government and fewer taxes are the cornerstone of economic prosperity. Accordingly, Republicans feel the "Contract With America" is truly a mandate from the people and that they have both the momentum and, more important, the votes to make the transformation from rhetoric to law. The contract contains myriad proposals that are pleasing to the ear, including a capital gains tax rate reduction, indexing the basis of capital and selected other assets, a "neutral cost recovery system" for depreciating business assets, a higher expensing limit for small business equipment, liberalization of the home office deduction rules, family tax credits, "marriage penalty" relief, "American Dream" savings (ADS) accounts, changes to the Social Security earnings limit and the amount of benefits subject to tax as well as tax breaks for long-term care insurance and employee benefits. Passage of all of these cuts depends on offsetting spending cuts, especially if the proposed balanced budget amendment becomes law. (For details of the American Institute of CPAs testimony on the contract before the House Ways and Means Committee, see "AICPA Testifies on Tax ) CAPITAL GAINS The proposed capital gains cut--the contract's focal point--generally goes back to pre-1987 law. A 50% deduction for individual or corporate taxpayers' "net capital gains" (the excess of net long-term capital gains over net short-term capital losses) would be available for sales of capital assets on or after January 1, 1995. Installment payments on sales executed before 1995 but received on or after January 1 1995, also would be eligible. This deduction would effectively cut the capital gains tax rate to half that imposed on ordinary income. And the deduction amount would not constitute a preference item for purposes of calculating the alternative minimum tax. So-called pass-through entities, including partnerships, S corporations, mutual funds and real estate investment trusts, would determine the eligible gain at the entity level; the deduction effectively would flow through to shareholders. Taxpayers will benefit even further because the capital gains deduction is part of the adjusted gross income (AGI) calculation. Thus, taxpayers will be less susceptible to the phaseout of itemized deductions and personal exemptions because they will take effect when AGI exceeds specified levels. Conversely, for purposes of the 50% deduction, eligible net capital gains must be reduced by the amount a taxpayer elects to treat as "investment income." In 1993, net long-term capital gains were removed from the investment interest definition unless the taxpayer elected not to subject them to the 28% maximum tax. For this purpose, net capital gains are investment income only if a taxpayer forgoes the 50% deduction. This provision also would repeal recently enacted Internal Revenue Code section 1202, which allows noncorporate shareholders to exclude 50% of the gain on the sale of "qualified small business stock" held more than five years. The contract's 50% deduction provides more favorable treatment for investments than the rules being repealed. Currently, taxpayers can deduct net capital losses against up to $3,000 of ordinary income. Before 1987, it took $2 of net long-term loss to offset $1 of ordinary income. The contract returns to this system: Capital losses are allowed as deductions to the extent of capital gains, dollar for dollar, plus the lesser of $3,000 or the sum of net short-term losses plus half of net long-term losses. For example, under the contract a taxpayer with net long-term losses of $4,000 can offset only $2,000 of ordinary income. In contrast, if the same taxpayer has net short-term losses of $4,000, he or she can offset $3,000 of ordinary income with the unused loss carried forward to succeeding years. …

Field of study: Business