Why Black Leaders Should Support Capital Gains Tax Reduction

When the unemployment rate in Black America jumped from 7.6% to 8.7% last month, while holding at 3.6% for Whites, there was no mention of that glaring fact from Black America's political and civil rights establishment. That should hardly have come as a surprise to many. For a collective that prides itself on its race-consciousness, establishment Black leaders are absolutely color-blind when it comes to advancing an economic growth agenda for their constituents, almost one-third of whom live below the poverty line.

On this issue, the problem with traditional Black leaders - civil rights advocates and elected officials alike - has not been simply a lack of awareness of economic indicators, but rather one of poor strategy. Having openly wed themselves to the Democratic Party, these leaders have been forced to embrace a redistribution of wealth paradigm as opposed to one that promotes economic growth. In Democratic Party economics 101, wealth is neither created nor destroyed, but must be taken from the rich and given to the poor a la Robin Hood.

Unfortunately for nearly 40 years, the formula has not worked as advertised.

As a result of their bargain with the Democrats, many Black leaders equate big government spending programs with economic development. Nothing could be further from the truth. And after an estimated $5.5 trillion spent in social spending programs, from 1965 to 1993, the verdict is in, anti-poverty initiatives may have made life a bit more bearable for many Blacks mired in poverty but they have not lifted those same individuals out of poverty.

What is needed now, in order to foster wealth creation in inner cities throughout America, whether in troubled mid-sized locations like Cincinnati, Ohio or Newark, New Jersey, or in large size metropolitan areas like New York City, is the use of fiscal policy in the opposite direction than has been custom. Instead of a maintenance of existing tax burdens or even an increase in such in order to fund social spending programs for those in poverty; a reduction and elimination of tax burdens should become a top priority, in order to generate economic development and growth among the poor.

At the top of the list of tax burdens in need of ease or elimination are those on production and capital. And possibly, the most important of those is the capital gains tax. Why? Because of all of the communities in America, it is the Black community that has the lowest ratio of capital to labor. By not taxing capital gains, the capital to labor ratio is allowed to increase over time with capital becoming plentiful and available labor becoming scarce. Blacks would benefit the most from this scenario, as they are the most dependent upon their manual labor while having the smallest claims on capital.

With unemployment rising disproportionately and most rapidly in Black America, the belief, held by many Blacks, that they are the "last ones hired and the first ones fired" holds true, as the part-time and temporary jobs held by many Blacks are the first positions eliminated in an economic slowdown. The early signs of that were evident in the recently published Department of Labor unemployment figures.

The best response to this turn of events is to increase the amount of capital that flows in the Black community and which fosters entrepreneurial activity. As jobs begin to disappear the value of available labor decreases, bringing wages down among the working poor. Only an increase in liquidity and a decrease in barriers to capital formation can counteract a rapid rise in unemployment.

Unfortunately, for the Black electorate, the tax cut most demonized by the Democratic Party, and as a result, Black leaders, is a reduction in capital gains taxes. The cover story written to justify such attacks is that capital gains are simply income for the rich.

But that argument is a tired misnomer, straight out of the Democratic Party's class warfare handbook.

Capital gains are income, in their final incarnation, but their genesis can be found in real economic activity, far more important than the increased income that results from the sale of a particular stock. Most significantly, capital gains are the byproduct of financial investments offered in exchange for future claims on earnings, and those in the greatest need of such investments are nascent enterprises begun by individuals who lack collateral. Quite often, these investment opportunities are considered too risky for debt financing.

If the capital gains tax were reduced or eliminated it would reduce the risk to reward ratio that prohibits so many from investing in the inner city ventures and Black businesses that too frequently find themselves depicted as "credit risks".

It is stunning to see Black leaders out front in a war of rhetoric arguing against a reduction of the capital gains tax. Such arguments, at times, actually seem to undermine their efforts to help the Black community.If one were to factor in the predatory lending practices and redlining which civil rights leaders effectively argue take place in urban areas, it is hard to imagine a better antidote to such practices than a reduction or outright elimination of the capital gains tax in inner cities.

If redlining and predatory lending practices make capital scarce in the inner city, it is hard to imagine how government confiscation of a return on investment, in the form of a capital gains tax, helps things.

The argument against tax reduction pushed by most establishment Black leaders, at the insistence of the Democratic Party, is illogical.

How can the community that arguably faces the greatest barriers to capital formation be helped by a tax on capital?

While Black civil rights leaders, for the most part, are confined by partisan politics, not all Black leaders are so inhibited. To the surprise of many, in April of 1997 in an effort to ease racial tensions in Philadelphia, among other things, Nation of Islam Leader Minister Louis Farrakhan proposed that the capital gains tax be reduced. Ahead of his time, the Muslim leader, with no partisan loyalty, recognized the connection between the barriers to capital accumulation, poverty and racial tension in America's cities. Not surprisingly, virtually no one in the "mainstream media" recognized the potential paradigm shift that the Minister's proposal represented.

In addition to Minister Farrakhan, members of Congress like Rep. J.C. Watts of Oklahoma, Rep. William Jefferson of Louisiana and Rep. Danny Davis of Illinois have consistently demonstrated their support for capital gains tax elimination that targets minority groups in America. All three men vigorously supported the Community Renewal Act aimed at distressed rural and urban areas where many Blacks live. The Act eventually modified and signed into law by President Clinton did include a capital gains tax elimination for inner city and rural businesses but was tied to a provision that mandated that if one were to qualify for the capital gains tax exemption, they would have to hold their ownership stake in a business operating in an impoverished area for 5 years.

This 5 - year holding provision implicitly endorses a popular but erroneous proposition, that "patient" capital is required to bring meaningful investment into the inner city. On the contrary, the provision raises the cost of capital by reducing liquidity and actually reduces the amount of investment available for the most risky ventures. What cities need is not patient capital but risk capital, like that which Goldman, Sachs and Citicorp invest everyday in currency and equity markets.

For years the Black community has struggled from its excessive reliance upon debt rather than equity to finance its business enterprises. The 5-year holding period continues the devastating effects of that legacy. The provision mandating that an investor wait five years before receiving 100% capital gains tax elimination actually causes the investment to look more like a bond than an equity instrument because the investor is required to wait a certain amount of time before profiting from the use of their capital. If this provision were eliminated from the Community Renewal Act, in favor of a provision which shortens the required holding period to one year, it would result in not just more capital being poured into Black-owned enterprises and the little more than handful of struggling Black publicly-traded firms, but it also would result in several of these same enterprises attracting investment through initial public offerings (IPOs).

If Congress or President Bush were to move to reduce the holding period for capital gains tax exemption from five years to one in distressed urban and rural areas, while reducing the tax from 20% to 15 % for everyone else, the action would not only foster a boom in the equity markets, but would also help to promote economic development and economic growth in the Black community at a rate which has not been seen since the civil rights movement was absorbed by the Democratic Party.

Black civil rights leaders and politicians should support and even lead such efforts to reduce the capital gains tax

Party loyalty, among other factors, should not come before the prosperity of a whole people.

Cedric Muhammad

Thursday, May 24, 2001