The Annual Bailout of 'Investors'

Much huffing and puffing on the Potomac about a $700 billion bailout. Not a peep about one that could be just as big.

Every spring, thanks to a generous tax code provision, the Treasury picks up part of the tab for losing bets on Wall Street. Given last year's historic plunge, these personal bailouts might wind up rivaling TARP's $700 billion--and there's no dollar cap or cut-off date.

It all adds up to a looming hit on the Obama Administration. No matter how large the losses realized in 2008, no matter how long it takes investors to recoup, Uncle Sam will be sharing the pain. Deeply sharing: up to 35 percent depending on the loser's tax bracket, or 39.6 percent if Obama ends the Bush tax cuts for higher-income Americans.

Capital loss offsets are the tax code provision that soothes investor wounds. When the year's trades are reported on tax returns, losses offset taxable gains dollar-for-dollar. If net losses exceed gains, the loss offsets taxable income--by up to $3,000--and provides another tax saving.

Offsets never lose their tax-reducing power. Losses greater than $3,000 (as last year's probably were) are carried forward indefinitely until they're used up.

At 15 percent, the tax on long-term capital gains is low compared to the rate on ordinary income like wages. With capital loss offsets, the deal is even sweeter on the downside. While gains are taxed at less than half the top rate, losses are written off at 100 percent across the board. Could losing come any closer to winning?

Yes, say Senator John McCain and Michael Boskin, a former chairman of the Council of Economic Advisers. Senator McCain has proposed raising the capital loss offset against ordinary income from $3,000 to $15,000 per-year for 2008 and 2009. Boskin would up the number to $20,000.

All of which raises some interesting questions. Who profits from these write-offs? Is there good reason for the government (read: taxpayers) to subsidize investment losses? Might the tax system be fairer, and rates perhaps lower, if these subsidies were curbed or even ended?

The first question is easy. Roughly 50 percent of Americans own no stocks, so offsets hold nothing for them. Of the half who do own stocks, most have their portfolios in tax-sheltered retirement accounts. They don't get those write-offs, either.

That leaves a fairly narrow layer, those affluent enough to have non-retirement stock portfolios. In other words, the benefits of capital loss offsets flow solely to those who have ample capital. (If this hints at class warfare, here it is served neat by Warren Buffett: "There's class warfare, all right, but it's my class, the rich class, that's making war, and we're winning.")

As to whether subsidies for investors are a sound government policy, sure they are--but it's foolish to hand out tax breaks just for playing the market. Real investors, a thimbleful of the total, put seed money into initial public offerings (IPOs) and follow-on offerings. They grow jobs and grow businesses. The rest of us play the game at the tables down on Wall Street: we grow portfolios (if we're lucky), nothing more. Real investors have a strong claim to tax breaks. "Investors" have a frail claim, and it's time that Congress caught on.

Tax fairness--as always--is in the eye of the 1040 filer. Still, facts matter. Capital loss offsets benefit the few at the expense of the many. Like all tax deductions, they're paid for by taxpayers in the aggregate--through higher rates, fewer government services, or both. Taxes would be fairer without offsets. Short of repeal, Congress could set a dollar or percentage limit (a form of which was on the books years ago). At the least, the offset against ordinary income should be scrapped.

Except for real investors, who are 100 percent deserving of 100 percent offsets (and an income offset too). If they lose more than $3,000 in a year, Michael Boskin's $20,000 income offset is a starting point. Do I hear $30,000?