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The Republican Study Committee Budget, “Preserving American Freedom,” proposes ending the inflation tax on savings and investment by indexing the calculation of capital gains taxes to inflation.

The budget, proposed by RSC Chairman Mike Johnson (R-La.) and RSC Budget and Spending Task Force Chairman Jim Banks (R-IN), also reduces the top two capital gains tax rates from 20 percent to 18 percent and from 15 percent to 13 percent.

For decades, Americans have paid capital gains taxes on phantom, inflationary gains which unfairly expose taxpayers to additional taxation. According to a 2013 analysis by the Tax Foundation, the average effective inflation indexed rate on capital gains between 1950 and 2012 was 42.5 percent, nearly twice today’s 23.8 percent top capital gains tax rate.

For example, an investor that makes a capital investment of $1,000 in 2000 and sells that investment for $2,000 in 2017 will be taxed for a $1,000 gain at a top capital gains tax rate of 23.8 percent. After adjusting for inflation, the “true gain” is much lower – just $579. (1,000 in 2000 – $1,421 in 2017). 

Ending the taxation of inflationary gains will have clear, immediate economic benefits.

Lowering the capital gains rate would encourage the formation of more capital and would result in the creation of more jobs. In turn, worker productivity and wages would be higher. 

Indexation would free up “sticky capital”—buildings, land, stocks—that are held by individuals or businesses rather than sold and put to higher and better use because much of the “capital gain” is inflation and the high capital gains tax discourages mobility of capital. The value of all property in America would increase.

In addition, recent history shows that reducing the tax on capital gains increases short-term federal revenues by creating an unlocking effect, where pent-up gains they had built up over time are realized at greater rates than they would be if the tax was not changed.

Treasury has the legal authority to index the calculation of capital gains taxes to inflation.

While it is unlikely that Congress will pass indexing legislation, the Treasury department also has the authority to re-define cost basis in an investment in such a way that the inflation tax on savings can be eliminated, based on legal scholarship going back decades.

Under the precedent set by the Supreme Court in Chevron U.S.A. v. National Resources Defense Council (1984), the ability of Treasury to add an inflation adjustment hinges on whether a new definition of “cost” is plausible. Currently, the capital gains tax is calculated as the difference between the cost of the asset and the sale price of the asset.

While in this context, “cost” is commonly understood to mean historical cost, this definition is not explicitly enshrined in law and Treasury has utilized regulatory discretion in the past. For instance, in 1918, Treasury decided that an asset’s cost was not strictly purchase price but was purchase price less depreciation and depletion taken by the taxpayer prior to sale.

Recent legal precedent proves that there is precedent for the term “cost” to include inflation. For instance, in Verizon v. FCC (2002) the Supreme Court affirmed that the term “cost” was ambiguous and the use of historical cost was not required by law.  National Cable & Telecommunications Ass’n v. Brand X Internet Services (2005), affirmed the right of an agency to interpret an ambiguous provision of the law, while in Mayo Foundation for Medical Education & Research v. United States (2011), the Supreme Court affirmed that the Chevron doctrine applies to Treasury regulations.

There is strong support for ending the inflation tax.

  • President Trump stated last year that he was “very strongly” considering a decision to index capital gains to inflation. 
  • Larry Kudlow, the President’s Chief Economic Advisor, has urged the President to end the inflation Tax in a CNBC column, describing the policy as a way to “spark a wave of prosperity.”
  • Treasury Secretary Steven Mnuchin also said that the administration is considering the policy.
  • Current and former members of Congress, including Vice President Mike Pence support indexing capital gains taxes to inflation. Pence introduced legislation in 2007 with 88 co-sponsors including now-Office of Management and Budget Director Mick Mulvaney, House Speaker Paul Ryan (R-Wis.), and House Ways and Means Chairman Kevin Brady (R-Texas).
  • Senator Ted Cruz (R-Texas) and Congressman Devin Nunes (R-Calif.) introduced legislation last year to index capital gains taxes to inflation. This legislation is supported by Senator Pat Toomey (R-Pa.) and Freedom Caucus Chairman Mark Meadows (R-N.C.)