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This article was originally published in The Gray Sheet

Executive Summary

CAPITAL GAINS FROM INVESTMENT IN FIRMS CAPITALIZED AT UP TO $25 MIL. would be partially shielded from federal taxes if investments are held at least five years under the Clinton Administration's deficit reduction/economic stimulus plan released Feb. 17. The proposal "will allow investors generally to exclude 50% of the gains earned from investment of the stock of a qualified small business (less than $25 mil. capitalization) when held at least five years," a White House Office of Management and Budget summary explains. The administration argues that the proposal would "both stimulate job creation over the short-term and increase investment over the long-term." The Treasury Department views the provision as a modified Bumpers proposal, referring to the support in recent years for a startup incentive from Senate Small Business Committee Chairman Dale Bumpers (D-Ark.). On Feb. 16, Bumpers and Rep. Robert Matsui (D-Calif.) introduced bills providing capital gains exclusions for investment in firms with gross assets of up to $100 mil. The bills (S 368/HR 902) are described as very close to the targeted capital gains legislation the two sponsored last year. Several provisions have been tightened to ensure, for example, that the favorable tax treatment applies only to first-time stock offerings. The Bumpers/Matsui legislation provides protection to stock purchased directly from a company with gross assets of less than $100 mil. and held for at least five years. Gains from investments of both "seed capital" (that is, the first $5 mil. raised by a company) and "venture capital," (up to the first $100 mil.) would also be eligible for a 50% tax exclusion after the five-year holding period. Seed capital would further be eligible for an additional 10% exclusion in subsequent years. The Clinton Administration's version of the targeted capital gains proposal will cost the federal Treasury an estimated $12 mil. in reduced taxes in 1994 and $467 mil. through 1997. The administration also is proposing a permanent investment tax credit for small businesses equipment purchases. The "credit will generally be 7% in 1993 and 1994 and 5% thereafter," OMB explains. "Small businesses operate at the margin and need a permanent incentive to invest, grow and provide new employment opportunities. At the same time, the decrease in the rate from 7% to 5% after two years will provide an incentive to accelerate investment and support the current recovery." Costs of this proposal could top $12 bil. over four years. The Clinton budget package also proposes to make permanent the research and experiment tax credit, which has been given a series of temporary extensions since it initially expired in 1985. The administration estimates the R&D proposal will result in reduced federal revenues of $6.4 bil. over four years. The administration has not yet specified whether it plans to alter the formula for computing the credit. The credit last year applied to 20% of a company's increases in research spending above a base year amount, generally derived from a ratio of research expenditures and receipts between 1984 and 1988.

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