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Index Capital Gains for Inflation?


As someone who has long supported a Tax Code change to index capital gains for inflation, I am very happy to have read more than one recent story about a proposal currently in Congress. Indexing has failed many prior attempts over three decades, but this time just might be different.

Many people know the difference between “real” and “nominal” profits. “Nominal” refers to an actual numerical gain; i.e. buy a stock for $100, and sell it later for $200, and the “nominal” profit = $100. In the current Tax Code, the entire $100 is taxable. “Real” profit however, is the reduced value of the profit due to inflation incurred during the holding period. In the last example, if inflation had been 20% during the holding period, the “real” profit (the taxable part) would only be $80.

There is a simple argument in favor of indexing capital gains, as taxing the inflationary part of the gain is unfair and discourages investment. In Washington, D.C., of course, nothing is simple, and few things are considered “fair.”  Opponents claim that the distribution of tax savings would benefit primarily wealthier people.

There are several considerations that have given me recent optimism for passage of indexing. In no particular order, they include:

  • Having a businessman President steeped in real estate, depreciation, capital gains, and inflation, makes Trump the logical person to drive the current discussion
  • Among the proponents pushing this through Congress is Grover Norquist (from Americans for Tax Reform), who understands far better than most elected officials the benefits of passing tax reform, and many Washington insiders listen to him
  • The current crop of White House economic advisors, including Larry Kudlow and Art Laffer, are not Keynesians, and understand that economic activity in the private sector is far more important than in government (Governments can print money, but they can’t print wealth)
  • Having seen the success of the Tax Cuts and Jobs Act of 2017, many more elected Republicans have come to understand Economics 101 regarding lower taxes
  • The public taste for tax cuts is still fresh, though the Administration did not do a good job educating the public on the concept, and then highlighting the results

There are also reasons for trepidation, including, in no special order:

  • Virtually the entire media complex tries to make Trump look bad, at least until the 2020 election
  • The government is loath to use dynamic scoring for economic proposals, preferring the old static process (Dynamic scoring would show that increased economic activity from the indexing proposal would raise revenue for the public and the government)
  • Indexing is a complex issue that will require extensive planning and design

Still, this time I do believe that the indexing push may produce results. If so, income planning, tax planning, and estate planning will all be enhanced for the average citizen – you do not have to be a “one-percent” upper-income American to benefit from user-friendly tax law. My fingers are crossed.

Van Wie Financial is fee-only. For a reason.