The Trump administration is considering lowering taxes on capital gains by using its authority to write Internal Revenue Service (IRS) regulations.
National Economic Council Director Larry Kudlow has publicly supported indexing capital gains for inflation for many years. Indexing would lower the effective tax rates on sales of long-term investments such as stocks, mutual funds, and residences. President Donald Trump has the authority to issue an executive order requiring the Treasury Department, which oversees the IRS, to change its method of calculation.
Currently, capital-gains tax rates on investments held for more than one year range from 0 percent for low-income individuals to 20 percent for those with taxable income above $434,550 for single persons or $488,850 for married couples. Most federal income-tax filers pay 15 percent for capital gains. The 2017 Tax Cuts and Jobs Act did not change those rates.
There are various Democrat proposals to raise capital gains tax rates on higher-income earners, and some Republicans oppose the Trump administration’s plan.
“Indexing the cost basis for capital gains to inflation would mark a dramatic change in U.S. tax policy,” Sen. Mitt Romney (R-UT) stated in a letter to Mnuchin opposing implementation of indexing through executive order, on September 13.
“Not only would such a change stand on dubious constitutional and legal ground, it would primarily benefit wealthy investors without supporting American workers,” Romney said.
Many Senate Republicans have come out in support of the plan.
Sen. Ted Cruz (R-TX) and 20 other Republican members of the U.S. Senate sent Mnuchin a letter urging him to use his regulatory authority to eliminate inflationary gains from the Treasury’s calculation of capital gains tax liability, on July 29.
“The United States economy has experienced historic levels of growth as a result of Congress and the current administration’s policies such as the Tax Cuts and Jobs Act,” the letter states. “Implementing a policy of indexing capital gains to inflation will help to perpetuate these successes by encouraging savings, investment, and innovation so that everyday Americans can continue to enjoy better lives and livelihoods.”
The inflation tax is “unfair,” and recalculating capital gains taxes would encourage economic growth, the letter states.
“Currently, the methodology Treasury employs to calculate capital gains ignores gains resulting from inflation and ultimately hampers economic growth,” Cruz wrote. “When a taxpayer sells a capital asset, they pay taxes on their gains—the difference between the basis and the sale price. Under current rules, Treasury determines the basis by looking at the sticker price at the time of purchase without consideration of the inflation-adjusted cost of the asset in today’s dollars.”
The current method of calculating capital gains taxes is flawed, says Kyle Pomerlau, chief economist and vice president of economic analysis at the Tax Foundation.
“If an asset appreciates only due to inflation, the current method overstates real gains and taxes income that an individual didn’t really earn,” Pomerlau said.
Taxing Capital Losses
Cruz is right to note the current rules make taxpayers face a tax liability even if they have suffered an actual loss, Pomerlau says.
“Under current law, an individual is subject to capital gains tax if they sell an asset that has appreciated in value,” Pomerlau said. “Sometimes, however, an asset may appreciate in value simply because the general price level has increased, not because the asset has increased in value in any real sense. If this happens, the current tax code could place a positive tax burden on an asset that didn’t really generate any income.”
An Inflation Tax
The value of an asset can be inflated by government’s devaluation of the dollar to stimulate the economy, says economist Edward Hudgins, research director of The Heartland Institute, which publishes Budget & Tax News.
“Indexing capital gains taxes to inflation is a minimum that should be in any tax reform package,” Hudgins said. “Indexing blocks the possibility of governments making illicit gains by inflating the currency. Indeed, the irresponsible deficit spending by politicians today is worse than at any time in the country’s history, with the federal debt as high as annual GNP. Indexing will protect the wealth of citizens if and when inflation returns.”
The burden of government at all levels is too high, says Hudgins.
“In spite of the very welcome tax cuts of 2017, Americans are still overtaxed: income taxes, corporate taxes, Social Security taxes, local sales and property taxes, and yes, capital gains taxes,” Hudgins said.
“If the capital gains tax were eliminated entirely, it could keep wealth in the hands of individuals and give them strong incentives to invest in productive activities and assets, keeping that wealth out of the hands of irresponsible, profligate politicians,” Hudgins said.
Calls for More
Lowering effective tax rates on capital gains wouldn’t have much effect, says Pomerlau.
“I do not think indexing would be significantly pro-growth,” Pomerlau said. “Capital gains already receive pretty good tax treatment under current law. As a result, the effective tax rate on gains is already pretty low. Adding indexing, which isn’t a significant tax cut, would do little to further reduce the effective tax rate.”
Congress and the Trump administration should focus on additional tax reforms, Pomerlau said.
“Mainly, they should focus on expanding tax-preferred savings vehicles like 401ks, IRAs, and Roth IRAs,” Pomerlau said. “These savings vehicles provide an even larger benefit than indexing does and are much less complex to administer than indexing.”
Ashley Herzog ([email protected]) writes from Avon Lake, Ohio.