http://www.businessweek.com/stories/1995-11-12/a-capital-gains-cut-might-keep-the-economy-cooking

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A Capital Gains Cut Might Keep The Economy Cooking


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A CAPITAL-GAINS CUT MIGHT KEEP THE ECONOMY COOKING

Over the past several years, Corporate America's heavy spending on computers, machine tools, and other labor-savers has provided much of the fuel for economic expansion. But with growth in capital spending expected to fall off next year, concerns are growing about whether consumers will be able to pick up enough spending slack to keep the U.S. economy--and corporate profits--humming.

Those worries intensified late in October, after Sacramento's The Money Store Inc.--which provides mortgage loans to borrowers with poor credit histories--reported a sharp rise in delinquencies on loans. Already, consumer installment credit, which doesn't include auto leasing or home-equity loans, has shot up 30% in the past two years. Add in automobile leases, and consumer debt now tops 20% of disposable income, a record (chart). "The consumer is pretty stretched, and it wouldn't take much more to convince them to slow their spending," says Douglas Lee, chief economist at HSBC Washington Analysis.

Rising debt appears to be taking a toll. After growing 3.4% in 1995's second quarter, consumer spending increased just 2.9% last quarter. Economist Daniel Bachman of WEFA Group in Bala Cynwyd, Pa., believes it will grow 2.6% in the fourth quarter--well down from the red-hot 5.1% seen at the end of 1994--before leveling out at just 2.3% for full-year 1996. But some economists believe there's a wild card in the deck that could give a short-term kick to consumer spending: a cut in the capital-gains tax rate.

The White House and congressional Republicans remain bitterly divided over budget priorities. But the Clinton Administration appears willing to accept some cut in the effective 28% effective top rate on capital gains, although perhaps not to the 20% level the GOP has proposed. What's more, the Administration may try to ensure that most of the benefits go to middle-class taxpayers. Any change probably won't take effect until December or January, 1996.

But that could give the economy some juice just when it needs it. Economist David Hale of Kemper Financial Services Inc. argues that a capital-gains cut could prompt shareholders to cash in some of the paper profits earned in the market's 25% runup since January--a rally that has boosted household wealth by more than $1 trillion. After a similar capital-gains tax cut in 1982, tax receipts from the sale of stocks, bonds, and other assets soared to $763 billion from 1983 to 1986--double the revenues generated during the previous five years. "It would provide a positive shock to the economy," says Hale. And Norwest Corp. economist Sung Won Sohn adds that a cut would be particularly good for makers and merchants of such big-ticket items as autos, furniture, and durable goods.

CHRISTMAS GOOSE? The conventional wisdom holds that most of the windfall from a lower gains rate would be enjoyed by the wealthiest Americans, who hold a disproportionate share of stocks. But the boom in mutual funds and contributory pension plans means that the middle class holds far more equities than in the past. Today, more than a quarter of all U.S. households own shares in mutual funds, up from just 6% in 1980.

A cut in capital-gains taxes could also help push the market higher. So even if middle-class families don't cash out, economists believe that many will respond to an increase in the value of their assets by hiking spending. Between the direct effect of realized capital gains and the psychological boost from rising assets, consumers may be more cheerful than most pundits project. And that could be good news for an economy in need of a jump start early next year.By Dean Foust in Washington


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