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The Capital Gains 'Sieve' and the 'Farce' of Progressivity 1921-1986

Posted: 9 May 2005  

John W. Lee

William & Mary Law School

Abstract

From the Revenue Act of 1921's introduction of an individual capital gains preference until the Tax Reform Act of 1986's repeal by making the maximum individual permanent ordinary income rate and capital gains rate the same 28 percent, the capital gains preference reduced the average high income individuals' effective income tax rate substantially below the top nominal progressive income tax rates - dipping deeply in large incomes with a sieve as Henry Simon put it. This made progressivity 'a farce' for most taxpayers, because generally 80 percent of the tax benefits of capital gains preference are garnered by about three quarters of the top 2 to 3% of individual taxpayers by household economic income. The article examines the evolution of this preference 1921-1986 through detailed chronology and analysis of its legislative history. It further explores shaping of the preference by political interests. Processes such as 'cloaking' in the capital gains debate are documented, e.g., in 1921 the preference was sold in part as helping to break up large farms; in 1978 a brokerage house witness caught arguing for the little investor (when his real interest was big investors) shifted to private firms selling out. In this same vein, Representative George H.W. Bush argued in 1969 that the predecessor to the AMT would impact heavily on the small black businessman with an SBA loan (80% of the original individual preferences consisted of the then 50% capital gains deduction).

Suggested Citation

Lee, John W., The Capital Gains 'Sieve' and the 'Farce' of Progressivity 1921-1986. Hastings Business Law Journal, Vol. 1, No. 1, May 25, 2005. Available at SSRN: https://ssrn.com/abstract=721044

John W. Lee (Contact Author)

William & Mary Law School ( email )

South Henry Street
P.O. Box 8795
Williamsburg, VA 23187-8795
United States
(757) 221-3838 (Phone)

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