After The Fall: Saving Capitalism From Wall Street—and Washington

by Nicole Gelinas

Former Massachusetts governor Mitt Romney made a respectable showing in Tuesday’s Florida primary, and that’s good news for Americans worried about both the home-mortgage meltdown and their tax bills. Unlike Washington politicians, vying to outdo one another printing money to rescue Americans from falling home prices, Romney has proposed a bold long-term tax policy that would encourage Americans to choose their investments, both housing and otherwise, more wisely.

For the past two weeks, what’s passed for a debate in Washington over taxes and the mortgage crisis is an inane frenzy over a “stimulus” package, which means supposedly free money: $100 billion or so in taxpayer “rebates” to be mailed out this year, once Congress and the president work out the details. The rebates are supposed to avert a recession. If five-figure-earning American families have an extra $300 to $2,100 to spend, the thinking goes, they won’t pinch pennies as home values plummet. But this form of stimulus is unlikely to work, as plenty of smart observers have already pointed out. A one-time cash payment won’t change most people’s spending behavior; the reason they felt comfortable spending so freely before was that they figured that they could tap their rising home equity for extra cash regularly, not just once. Besides, the stimulus comes at the cost of further debasing the dollar over the long term, since the Treasury Department doesn’t have extra money lying around to pay for it.

Both Romney and John McCain deserve credit for mostly staying out of this frenzy, but Romney’s tax plan seems particularly fresh and intelligent in such a foolish atmosphere. Romney seems to believe that Americans are smart enough to plan for the long term rather than salivate over a one-shot check. His audacious plan would cut the tax rate on capital gains, interest, and dividends for any taxpayer making less than $200,000 annually to “absolutely zero.” This elegantly simple proposal would invite Americans to save and invest as much as they can or wish to without worrying about mind-numbingly complicated tax calculations.

But just as important, the plan would encourage people to diversify their investments without fear of poking the hornet’s nest of tax liability. Right now, a middle-aged American who has spent a few decades building up an investment portfolio outside his tax-favored IRA faces constraints if, like any wise investor, he wants to rebalance and update that portfolio periodically. If he was smart enough to invest in John Deere a few years back, for example, and wants to lock in some of his hefty profits today and rebalance his portfolio by selling some shares, he has to pause and consider the tax consequences, not to mention the annoyance of the whole process. Even if he already uses an accountant, he must dig up a trade confirmation from years ago as proof of what he paid for his stock in the first place. Under Romney’s plan, investment decisions would become simply investment decisions—and the investor would no longer have to ask himself, “Do I really want to go through all these tax calculations?”

Romney’s plan would accomplish another important goal: getting Americans to invest in something besides their homes. Even as capital-gains taxes have discouraged investing in stocks, the tax code has long encouraged people to invest in bigger houses—even if those houses are overpriced by any rational measure—because Americans know that they can deduct the interest that they pay on their mortgages from their IRS bills every year and, in many cases, get tax breaks when they sell their homes at a profit. Romney’s new incentive for market investing would serve as a counterweight to this lopsided code—which was meant to encourage Americans to own their homes rather than rent, but which has also led them to put far too much of their wealth in one large asset.

Romney would also enact permanent tax cuts for businesses and make permanent the Bush personal income-tax cuts, including dividend and capital gains reductions and rate cuts for top earners. He’d reduce the lowest tax rate, again permanently, from 10 percent to 7.5 percent, adding up to an average annual savings of $400 for working-class families as well as a one-time retroactive check. This move would make continued tax cuts for upper-income earners more politically palatable, and it’s far superior to the rebate plan that Congress and the White House are discussing because families could count on the savings every year.

McCain, Romney’s chief rival for the Republican nomination, has likewise pledged to keep the Bush tax cuts permanent, including keeping the current rates on capital gains and dividends. He’d also roll back business taxes and work to repeal the onerous alternative minimum tax. These are good ideas—and far better than those that Democratic candidates Hillary Clinton and Barack Obama, who propose to eliminate the Bush tax cuts for families earning $200,000 and $250,000 respectively, have offered. But so far, only Romney has come forward with a daring new proposal to encourage tens of millions of Americans to invest in the capital markets.

Here’s a good question for McCain before next Tuesday’s nationwide primary showdown: Do you support a Romney-style investment-creating plan—and if not, why not?

Nicole Gelinas is a contributing editor to City Journal and a Chartered Financial Analyst.