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Yes, Index Capital Gains to Inflation. But Why Stop There?

Policymakers looking to continue the economic momentum gained by the Trump administration’s tax-and regulation-cutting policies are absolutely correct, and their next target should be the capital gains tax.

Tax cuts aimed at capital produce the most significant economic benefits. A legacy 2001 IPI study by economists Gary and Aldona Robbins shows that a cut in capital gains taxes would be one of two most effective to stimulate the economy. In their study, the Robbinses concluded that a capital gains cut would spur economic growth substantially more than any other stimulus measure, with economic growth of more than $10 for every dollar of lost revenue. 

They also make the argument that eliminating the capital gains tax entirely would be even more advantageous to the economy. “Abolishing the capital gains tax would promote entrepreneurship, business creation, U.S. competitiveness, and higher wages for American workers—especially for the most economically disadvantaged among us.”

It’s a compelling argument, especially considering the revenue generated by capital gains to the Treasury is paltry. As a share of total federal revenue, capital gains taxes averaged only about 4.2 percent from 1995 through 2009.

But at the very least, the capital gains tax should be indexed to inflation, and “is a tremendous idea regardless of how or why it’s done,” according to IPI president Tom Giovanetti

Writing in RealClearMarkets, Sen. Ted Cruz (R-Texas) and Americans for Tax Reform president Grover Norquist make the case, noting that while other tax code provisions (income tax brackets, the standard deduction, and the Earned Income Tax Credit) receive inflation-indexing treatment, capital gains currently does not.

“Treating capital gains taxes the same way should be a no-brainer,” they write. “This change [would] directly benefit the 54 percent of Americans that own stocks, it will also benefit the 55 million Americans who own a 401k.”

“Imagine, for example, a taxpayer who purchased one share of Coca-Cola stock in 1998 for $32.38. If they sold the stock earlier this year at $48.13, they would have a nominal gain of $15.76 and be taxed $3.75. The inflation-adjusted basis in today’s dollars, however, would be $50.50. That means the taxpayer would have to pay $3.75 in taxes on a $2.38 loss. Even when a taxpayer experiences a real gain, the effective capital gains rate can easily double the statutory rate passed by Congress.”

“In other words, taxpayers are being punished for the mere existence of inflation,” write Cruz and Norquist. 

Increased investment drives economic growth and job creation. Investment in capital assets, a foundation to a free economy, should be encouraged, not discouraged.  Rather than punishing taxpayers for risk-taking and investing, Congress should work with President Donald Trump to, at the very least, index capital gains to inflation. But don’t stop there; take the bold step of cutting or eliminating the tax entirely.

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