Much of the federal tax code was indexed for inflation in the 1980s when President Reagan achieved bipartisan support for tax reform. Capital gains taxes are an exception, but that may soon change — which would provide another boost to the economy.
According to Wall Street Journal columnist Kimberley A. Strassel, “momentum is building” for indexing of capital gains.
Currently, “businesses and individuals pay taxes on the full nominal amount they earn on investments, even though inflation eats up a good chunk of any gain,” she wrote. “It’s not unheard of for taxes to exceed real gains after inflation. The result is significant capital distortion, as companies sit on buildings and property or investors sit on stock — rather than selling and thereby putting both assets and gains to more productive use.”
Larry Kudlow, supports indexing and last year wrote in favor of President Trump issuing an executive order to make the change. Since then, he has been named President Trump’s chief economic advisor. Kudlow’s article on CNBC uses this example: A person invests $1,000, then sells the investment 10 years later for $1,200. Inflation averaged 2.5% during that period, so the investment today is worth less in real terms than when the person bought it. Yet, under current law, the investor would pay a tax on the $200 capital gain.
While legislation has been introduced in both the House of Representatives and the Senate to index capital gains, getting further tax reform legislation through a divided Congress could be problematic. Strassel argues, though, that President Trump has the authority to make the change without Congressional approval.
Authority to Act in Dispute
The Justice Department’s Office of Legal Counsel determined in 1994 that the Treasury lacks the authority to index capital gains without Congressional support, but a 2012 paper by lawyers Chuck Cooper and Vincent Colatriano, which is being circulated by Americans for Tax Reform, concludes otherwise.
The paper “points out that the Internal Revenue Code does not require that the ‘cost’ of an asset be measured only as its original price — meaning there is no reason Treasury could not construe it in today’s dollars,” Strassel wrote. “More important, it noted that since the Supreme Court decision in Verizon Communications v. Federal Communications Commission (2002), regulators have leeway in how they define ‘cost.’ ”
Democrats on the Senate Finance Committee are opposing the change, arguing that it would be a giveaway to the wealthy and would increase the deficit, but “every capital gains tax cut in modern history has resulted in a rise in capital gains revenue.”
Kudlow wrote that indexing would remove a tax injustice and produce additional tax revenues, because, “Without the federal tax on inflationary gains, asset prices will adjust until they reach a new, higher equilibrium. Shareholders and other investors will see their portfolios grow. And the federal government will collect billions of dollars in new tax revenue as taxpayers realize real capital gains.”
As Strassel concluded, whether or not Congress approves indexing, President Trump can address the issue: “All it takes is a simple order.”