The House GOP Alternative

The House Republican alternative to the Senate compromise plan (I say this because the Paulson plan is, at this point, dead) is to be unveiled at noon today, so I’ll be interested to see what it contains. However, I can tell you that there’s at least one aspect unveiled so far that simply doesn’t make sense at all.

The RSC plan, which will be unveiled at noon, calls for a two-year suspension of the capital gains tax.

“By encouraging corporations to sell unwanted assets, this provision would unleash funds and materials with which to create jobs and grow the economy,” an outline of the proposal said. “After the two-year suspension, capital gains rates would return to present levels but assets would be indexed permanently for any inflationary gains.”

How does this help? The problem we’re facing is the crash in the housing market, which has caused mortgage-debt related instruments to decline in value. We’re not sure how much, but we know that it’s been a steep decline and that at present, the assets aren’t worth that much.

So how is a capital gains tax suspension going to help, exactly? In order for the tax to apply in the first place, there have to be capital gains. The crisis we face is one of steep capital losses. This doesn’t address any aspect of the problem at all.

Now, I understand that this capital gains tax suspension isn’t the end-all, be-all of the House GOP plan, but the very fact that it’s in there at all is just bizarre.

FILED UNDER: Economics and Business, US Politics, ,
Alex Knapp
About Alex Knapp
Alex Knapp is Associate Editor at Forbes for science and games. He was a longtime blogger elsewhere before joining the OTB team in June 2005 and contributed some 700 posts through January 2013. Follow him on Twitter @TheAlexKnapp.

Comments

  1. Bithead says:

    How does this help? The problem we’re facing is the crash in the housing market, which has caused mortgage-debt related instruments to decline in value. We’re not sure how much, but we know that it’s been a steep decline and that at present, the assets aren’t worth that much.

    So how is a capital gains tax suspension going to help, exactly?

    Even with all the demonstrable corruption going on with F&F, and with the way “Affordable Housing” was dealt with, we’d still not have had a problem had economic growth been larger. What this would do would be to spur the growth of the economy, and spur, in turn capital, which would in turn open up the housing maket again.

    Hardly bizzare; they’re about removing obsticles to economic growth.

  2. Alex Knapp says:

    Capital won’t move if banks won’t loan money to each other. That’s the crisis we face, and this doesn’t address that harm at all.

  3. Derrick says:

    How does this help?

    The answer is that it doesn’t. I think it was Milton Friedman who said something along the lines “that in a crisis, the action taken is based on the ideas lying around”. Here you have a capital gains tax cut, which conservative members have been trying to make the centerpiece of any economic package, lying around. What the hell, let’s just add it to to the Credit Crisis bill.

    I think David Brooks was right when he talked about the lack of ideas on the right at this moment. I’m one who is actually open to some conservative policies on fiscal matters, but I seriously doubt that where going to hear much except for renewing the Bush tax cuts, capital gains taxes, and what about another tax cut for business and the wealthy.

  4. Rick Almeida says:

    “What this would do would be to spur the growth of the economy, and spur, in turn capital, which would in turn open up the housing maket again.”

    But again, the problem is that many large, institutional investors are facing huge capital losses, not gains.

    Or are you saying that investors want to sell profitable investments to free up liquidity to buy far riskier ones?

  5. Bithead says:

    Guys, look; What I’m suggesting is that the losses incurred, going forward, are due to the lower market value of the housing. That in part is being fed by the economic instability. A growing economy would smooth that rough patch out. A growing economy helps get real estate prices rising, which would remove a lot of pressure from lenders, who would use the income at this point.

    And Alex, to your point, that also gets banks loaning each other money again, for example the Chinese, because they will see less risk in a growing economy.

    It’s all intertwined…

  6. Bystander says:

    ‘Capital’ Hill is addicted to earmarks. They just can’t help themselves. The Liberals are very sensitive to the fact that dope addicts and alcoholics are not really to blame for their condition, so we should not judge them. Well, here is another case of addiction and substance abuse. Let’s not be so quick to judge them either.

  7. M1EK says:

    When all you have is a hammer…

  8. Rick Almeida says:

    A growing economy helps get real estate prices rising, which would remove a lot of pressure from lenders, who would use the income at this point.

    Can you explain why a capital gains tax cut would do this more effectively than, say, a demand-side solution?

  9. Alex Knapp says:

    What I’m suggesting is that the losses incurred, going forward, are due to the lower market value of the housing. That in part is being fed by the economic instability. A growing economy would smooth that rough patch out.

    Bithead, while I understand your point, the problem with this analysis is that economic growth is contingent upon liquid capital markets, not the other way around. If banks don’t loan to each other, they’re also not loaning to businesses. Without those loans, or the ability of banks to inject capital into businesses, there can’t BE economic growth. THIS is the problem we face. Without a credit market, you’re going to be looking at a severe contraction of growth as businesses are unable to expand for lack of capital, especially because consumer spending is contracting because some of the easy credit markets the economy has relied on for the last 20 years are tightening up substantially.

  10. gawaine says:

    Trying to find some kind of reason: Wouldn’t this work into the analysis of the payoff of any bet on an investment? In other words, if you’re considering purchasing an asset as a short term investment, expecting to resell within the next two years, wouldn’t a lower tax rate make you more likely to consider buying – because it makes the upside so much more attractive?

    What I really think would happen, though, at the consumer level: If you tell me that I don’t have to pay any capital gains if I sell my assets right now, my investment account is going to roll over. I’ll sell everything now (or at the end of the two year period), realize the gain, and reset the tax basis. This is potentially good for the investment banks, since they’ll make money on the commissions, and possibly be able to push me into investments that benefit them. It’s potentially bad for the investment banks, the economy, and everyone else, if it causes a death spiral in the midst of everyone selling their assets at the same time.

  11. Patrick T. McGuire says:

    How does this help?

    It prompts private investment in the financial sector instead of the gov’t printing money. Private investors, like Warren Buffet, would see an opportunity to make tax free money and would inject their own funds into the system rather than the government adding $1 trillion to the national debt.

  12. Billy says:

    It prompts private investment in the financial sector instead of the gov’t printing money. Private investors, like Warren Buffet, would see an opportunity to make tax free money and would inject their own funds into the system rather than the government adding $1 trillion to the national debt.

    It will never cease to amaze me that despite the fact that we are currently wallowing in the unequivocally demonstrable results of the implimentation this philosophy, its advocates will never go off-message.

    What’s that I once heard about doing the same thing twice and expecting a different result?

    Oh – Bithead: you’re not smart.

  13. Bithead says:

    Can you explain why a capital gains tax cut would do this more effectively than, say, a demand-side solution?

    Supply side solutions always work better.

    Bithead, while I understand your point, the problem with this analysis is that economic growth is contingent upon liquid capital markets, not the other way around.

    Well, they tend rather to feed each other.

    It will never cease to amaze me that despite the fact that we are currently wallowing in the unequivocally demonstrable results of the implimentation this philosophy, its advocates will never go off-message.

    Hmmm…. is that anything like constantly promoting more government as the solution, when in fact government is the problem?

    Oh – Bithead: you’re not smart.

    I’ll consider the source here, and take it as the best indicator I could ever have that my comments are on track.

  14. Bithead says:

    Without a credit market, you’re going to be looking at a severe contraction of growth as businesses are unable to expand for lack of capital, especially because consumer spending is contracting because some of the easy credit markets the economy has relied on for the last 20 years are tightening up substantially.

    Alex; Roughly:

    Less taxes=(More investment+more capital)= More available consumer and business credit $$$ available.

  15. JT says:

    Part of the problem both parties are having is communicating to a very jaded American public that this bailout will help the average person, not just Wall Street. People are watching banks fail, but they’re also watching people lose their homes and jobs. If the government did a bit better job showing the benefits to the average man/woman, they would gain quite a bit of ground support.

  16. Steve Verdon says:

    But again, the problem is that many large, institutional investors are facing huge capital losses, not gains.

    In part yes. This view is from to high a level, IMO.

    Financial institutions have assets and liabilities. Right now the problem is that some of the assets are deemed toxic so that their actual price is most likely less, maybe even far less, than what the insitutions have them listed on their books. The rest of the assets are fine. So right now we have a situation that could be like,

    Good Assets + Toxic Assets (Book Value) = Liabilities

    Such an institution is technically sound. But what everyone is fearing is that the reality is,

    Good Assets + Toxic Assets (Real Value) Liabilities.

    Then we could see a situation like Patrick describes. This would drive up the stock price of these institutions and send a signal that all is well with that institution and also such institutions will once again loan money.

  17. Alex Knapp says:

    Bithead,

    The capital gains tax only comes into play when people sell their assets. You can only sell your assets if there are buyers, and the problem right now is that there aren’t any. Why? Because of the credit freeze? Why? Because of the housing market collapse. How? Because now nobody knows what mortage-debt paper is worth right now.

    A capital gains tax suspension does ZERO to address the underlying problems. In other situations, it might be a good boost to investment. In this environment, it’s totally irrelevent.

  18. Alex Knapp says:

    Steve,

    I don’t think that a cap gains tax is sufficient to overcome the uncertainty of the value of the mortgage related debt. I see such a suspension as being more part of a plan a year down the road to help the markets recover. I don’t see how it helps right now.

  19. Steve Verdon says:

    People are watching banks fail, but they’re also watching people lose their homes and jobs. If the government did a bit better job showing the benefits to the average man/woman, they would gain quite a bit of ground support.

    Unemployment has gone up, but it is by no means at a worrisome level. As for people losing their homes yeah, it is bad, but people also behaved irresponsibly. We don’t want to reward that sort of behavior.

    Yes, this applies in spades to the current situation on Wall Street but there is the added problem that if you let Wall Street collapse then there will be a credit crunch and that could trigger a recession, maybe a severe one, where unemployment goes up considerably and even people who behaved responsibly lose their homes. This is why the government is looking to intervene. The problem is that it also limits the downside for those in charge of these Wall Street/Financial institutions.

    Oh, and bailing out the homeowner directly however wont solve the problem of a credit crunch. That and voters don’t have as much lobbying clout as large Wall Street firms.

    Welcome to democracy in action.

  20. Steve Verdon says:

    I don’t think that a cap gains tax is sufficient to overcome the uncertainty of the value of the mortgage related debt. I see such a suspension as being more part of a plan a year down the road to help the markets recover. I don’t see how it helps right now.

    If you are looking for certainty then give up right now and move on to another topic. Nobobdy knows how to value these toxic assets which is part of the problem.

    Such a measure by itself might return some banks to sound basis which would mitigate the size of the problem and any impending credit crunch. That in turn would limit the severity and possibly the length of the following recession.

    Note: I’m not advocating this plan, just laying out how I see it working.

  21. Steve Verdon says:

    Crap my initial comment got all messed up, must be the greater than and less than symbols.

    Sigh

    Let me see if the code thingy works….

    Okay here we go again, a financial institution that has the following,

    Good Assets + Toxic Assets (Book Value) = Liabilities

    Is considered sound. The problem is that people seem to think reality is,

    Good Assets + Toxic Assets (Real Value) < Liabilities

    Such an institution would be in trouble, might even fail.

    Now, with a capital gains tax set to zero we might have some institutions that are in trouble switching to,

    Good Assets(No Cap Gains Tax) + Toxic Assets (Real Value) = Liabilities

    Thus restoring the insitution to a healthy status. If it turns out that we have,

    Good Assets(No Cap Gains Tax) + Toxic Assets (Real Value) > Liabilities

    Then as Patrick noted people like Warren Buffet (and smaller) would see a good investment opportunity buying up the stock and sending the price higher. Thus reassuring people such an institution is indeed sound and to not worry, at least about that insitution. Oh, and these institutions would then start lending money again.

  22. I don’t usually agree with Alex, but I see his point on this. I also see Bitheads point.

    I think what may make more sense is to allow capital gain losses offset standard taxes. This would allow people to sell sub-prime mortgage securities and take the loss out of their taxes. The securities would be properly valued by the market then which should clean up a great deal of the issue. The government isn’t paying out, rather it is not taking in (a delicate distinction I admit, especially depending on what they do with the resulting shortfall). Then you can look to economic stimulus ideas to grow the economy like capital gains tax reductions.

  23. Rick Almeida says:

    Supply side solutions always work better.

    That’s a religious argument. Very few outcomes “always” obtain. The empirical data show far less, but nonzero, support for supply side economics.

    Michael Ettlinger and John Irons provide a pretty rigorous but not apolitical long-term study.

    If supply side economics came even remotely close to “always” working, its proponents could at least point to the functional form of the Laffer curve.

  24. Fence says:

    A short term suspension of what is left of the cap gains tax would cause me to sell some securities on which I have gained before the tax is restored. Giving people greater incentive to sell in the short term doesn’t seem like a good idea right now.

    What would seem to make more sense is an increase in the $3K limit on deducting capital losses from your taxable income. When was that last changed?

    I’m all for cutting taxes, but cuts to the cap gains tax by itself just means greater reliance on taxing work.

  25. Dave Schuler says:

    This is where the suggestion mentioned by Arnold Kling, Stephen Bainbridge, and others comes in: get rid of mark-to-market accounting. Following Steve V.’s observations on good assets and toxic paper, this would enable the affected institutions to write down the toxic paper without a cash infusion.

  26. bains says:

    Capital won’t move if banks won’t loan money to each other.

    And just where do banks get the money from?

  27. Moonbat Boy says:

    It’s intention is to spur economic activity in the housing sector by allowing people to liquidate other assets and invest them in distressed properties. I’d think that was pretty obvious.

  28. Rick Almeida says:

    It’s intention is to spur economic activity in the housing sector by allowing people to liquidate other assets and invest them in distressed properties. I’d think that was pretty obvious.

    What’s less obvious is who would do this, and why?

    That would require liquidating profitable assets (which are the only kind that incur cap gains) and investing them in risky ones.

  29. Steve Verdon says:

    Rick,

    Moonbat Boy is working off of a faulty premise, your attempts to counter such an argument also do not work either.

    Lowering the capital gains tax isn’t to induce people to sell their homes, but is geared towards financial institutions. It will also impact other investors, but that isn’t the main thrust. It is to allow financial institutions to write down the toxic paper without a cash infusion.

    Or are you really in favor of the government buying that crappy paper?

  30. Rick Almeida says:

    Hi Steve,

    I am not in favor of buying that crappy paper. I would, however, consider using taxpayer money to buy some amount of solid, let illiquid, investments to recapitalize credit markets.

    You folks here at OTB have really led the league in discussing this stuff – I appreciate it very much.