Of Course The Capital Gains Tax Should Be Indexed To Inflation – What Are You, Economically Illiterate?

The Trump Administration has proposed that capital gains should be adjusted for inflation before the profit that should be taxed is calculated. This is one of those obviously correct things to do which is kicking up the most awful political stink. The why it’s sensible is because only post-inflation profits are actually profits. So, if we’re going to tax profits we should be taxing those calculated post-inflation. That’s not difficult, is it?

Yet stink there is:

The tax cuts for the rich that the Trump administration pushed through a mostly compliant and willing Congress were evidently insufficient for the wealthiest people in the country.

According to a report from the New York Times, the Treasury Department is considering what might seem like a small wonky tweak to the tax code but would manifest as a $100 billion tax cut to the rich.

The correct answer to that is that if this is so then those rich have been charged $100 billion in tax too much on profits they’ve not made. Not what we hope the tax system will do to people, really.

According to independent analyses, Trump’s plan would mainly benefit wealthy Americans, who make up a larger portion of asset sales. The Penn-Wharton Budget Model estimated that the change would cut taxes by $102 billion over 10 years, with 97.5% of the benefit from capital-gains inflation indexing going to the top 10% of income earners. In fact, according to its estimate, 63% of the benefit would go to just the top 0.1% of income earners.

That just means that those groups have been overpaying their taxes all these years.

“At a time when the wealthiest are doing better than ever, to give the top 1 percent another advantage is an outrage,” Senate Democratic leader Chuck Schumer said.

It’s correcting a disadvantage, not offering one.

To set up an example. Imagine that you, back in the past, invested US dollars into a Swiss Franc equity. That equity hasn’t risen in Swiss Franc terms at all over the years. However, the Swiss Franc has doubled against the US dollar. Now you sell. You’ve twice as many dollars as you started with. Uncle Sam would like 20% of that 50%. But you’ve not actually made an economic profit at all. Everything has come as a result of the US $ falling against the CHF. That is, the policy followed by the US Government to allow a modicum of inflation each year has led to a fall in the value of the $. There is no economic profit here at all, only an accounting one stemming from that inflation. A nominal profit, not a real one. The spending power of your double the number of dollars is the same as your starting number.

That is, the government is gaining tax revenue as a result of the inflation it itself creates. That’s not an incentive that’ll lead to suitable concerns about how much inflation government creates, is it?

Now it’s true that capital gains probably shouldn’t be taxed at all given optimal tax theory. But we’re all aware that that’s never going to be politically possible. But if we are to tax capital gains then the very least we can be doing is to tax real gains, not purely nominal ones. Thus the purchase price of an asset should be adjusted by the inflation rate before we calculate those gains that should be taxed.

As has been true with a number of things – and as is definitively not true about others – the Trump Administration is trying to take an obvious and fair, even necessary, step but the entrenched status quo addicts are screaming blue murder about it. Seriously, leave aside the “rich people must pay more” rhetoric and try to come up with a valid argument for taxing purely inflationary profits. Make sure that whatever your argument is works for corporates as well as individuals too.

Got one?

Well then.