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A Tax Cut Nobody Needs

Cutting the federal deficit is a hot topic on Capitol Hill, and some kind of action seems certain. Congress is due to take up taxes for the first time in President Obama’s term (including the expiration of the Bush tax cuts), and a report from the president’s national debt commission is expected come December. Both bodies should take a hard look at ending a needless tax break; getting rid of it would raise billions, and make the Tax Code a touch fairer in the bargain.

This little-remarked giveaway is the write-off which the IRS allows every year for stock market losses: when net losses exceed gains, taxable income can be reduced by up to $3,000. This is “I-want-it-now” tax law, and it turns a private loss into a hurry-up claim on the public purse. With the deficit soaring, it richly deserves repeal.

The same as now, capital losses could be written off dollar-for-dollar against capital gains. The same as now, losses could be carried forward indefinitely until they were wiped out. What the repeal would disallow is writing off stock market losses against ordinary income (which, as we shall see, was poor policy in the first place).

Let’s quickly take a look at who gains from this special write-off, and who pays for it. Then let’s look at the hefty inflow to the Treasury if the write-off were written off for good.

Roughly half of all Americans own no stocks, so losses in the market offer no tax advantages to them. While it’s true that more people than ever do own stocks, most have their holdings in tax-sheltered retirement accounts; the write-off doesn’t help them, either. It turns out that the benefits flow entirely to a privileged minority: those well-off enough to have non-retirement investment portfolios. There’s no defense for a tax break so skewed toward the affluent, especially one as gratuitous as this.

And who picks up the tab? Like any other tax deduction, it’s paid for by taxpayers in the aggregate; in this case, the many pony up to benefit the few. Far better for the Treasury, and better for tax fairness, if Congress shows some spine and calls a halt.

The result would be an annual drop in tax expenditures (the revenue the government foregoes via the tax breaks it hands out), and a corresponding uptick in Treasury receipts. Year after year, the deficit would be that much less. Nobody can predict Wall Street’s ups and downs, or individual investors’ either, so the actual numbers could vary widely. All the same, the market’s slump in 2008 and the first half of this year have almost certainly front-loaded the benefits of a repeal.

Portfolio values sank by hundreds of billions during the major sell-off; one estimate put total losses at north of $2 trillion. Of course not all the losses were realized, and stocks went on to rally sharply for most of 2009. But by mid-year 2010 the markets had once again soured, and the major indices were nowhere near their former levels. So while it’s impossible to know hard numbers, it’s a safe bet that on-the-books losses hover near a record high.

Which means it’s an opportune time to disallow writing off those losses against ordinary income. It serves no purpose, the money goes to people who scarcely need it, and it’s an annual drag on the Treasury; the sooner it’s repealed the better for the federal deficit.

And everybody cares about cutting the deficit, right?

GERALD E. SCORSE helped pass a bill that tightens the rules for reporting capital gains.

 

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