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By Kaustuv Basu
Should capital gains be indexed to inflation?Americans for Tax Reform, a conservative group, thinks it would be a good idea for the Trump administration to direct the Treasury Department to calculate capital gains while accounting for inflation, to increase economic growth and wages.
“A capital gain is defined in the tax code as the value of an asset at the time of sale minus the ‘cost,’” according to a recent blog post by Alexander Hendrie, the director for tax policy at the Americans for Tax Reform. Since the Internal Revenue Code was created, “Treasury has interpreted ‘cost’ to mean the original purchase price at the time of purchase. This interpretation fails to take into account any gain that is based on inflation,” the post said.
The idea of indexing capital gains to inflation has been kicking around for a few decades. But some say it is just a plan to cut capital gains.
Edward Kleinbard, a law professor at the University of Southern California, pointed out that inflation is and has been at historically low levels. “Whatever its implications, those apply throughout the economy, including to wage incomes,” he said in an email.
Kleinbard said that capital gains currently enjoy a double discount—an “arbitrarily low rate” and “deferral, rather than paying the tax as gains accrue.” Real reform would encompass a comprehensive approach to all capital income, he said.
The ATR post said there is a clear policy rationale for indexing capital gains to inflation, including eliminating a barrier to investing in the economy.
Alan Cole, an economist with the conservative Tax Foundation, said indexing the current capital gains structure would be good policy.
Capital gains taxes are helpful in extreme cases when people make big fortunes by investing early, Cole said. “If there is someone who is saving much more modestly, and earning more modest returns, inflation could eat away a big portion of that return,” he said. Indexing to inflation would result in people investing more and that would be good for the economy, he said.
Asked about the revenue loss, Cole said one option might be to tax prior investments under the old tax structure while applying the indexing rule to new investments. “In that case, I would see it as being less than a $100 billion dollars over the budget window,” he said.
The ATR post suggested that the Trump administration can ask the Treasury Department to start indexing capital gains taxes to inflation. It cited a 1992 legal memo commissioned by the National Chamber Foundation that said the “Treasury has interpretive discretion in this case.”
A former Democratic Senate aide said there are technical and political problems with the proposal. “The technical problem is what measure of inflation do you use?” the former aide asked. “What do you use as the appropriate price index?”
“I remember, way back, being part of the argument that it was difficult for this to be done administratively and it was much cleaner to do it through legislation,” the former aide said.
Questions remain about Treasury’s authority to implement the idea through regulations, the former aide said. President George H. W. Bush’s administration concluded that it couldn’t, although conservatives have pushed for it since, the former aide said.
To agree that Treasury can issue such regulations suggests “a pretty expansive view of Treasury’s regulatory authority,” the former aide said.
“If you have the position that they didn’t have the authority to issue a Section 385 rule, how is it that they have the authority to index capital gains by fiat?” the former aide asked, referring to earnings stripping regulations from the previous administration that are now being reexamined by Treasury.
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