On Friday, President Donald Trump used his favorite platform to suggest a political change that his administration has weighed in for at least a year: using presidential power to unilaterally reduce taxes for investors.
On Twitter, Trump linked to an op-ed by Senator Ted Cruz and veteran anti-tax cutter Grover Norquist, asking authorities to index capital gains for inflation. At the moment, they explain that if you bought a share of the stock in 1998 for $ 30 and sold it this year for $ 40, it would count as $ 10 in long-term capital gains for federal tax purposes. But adjusted for inflation, $ 30 in 1
That is the fundamental issue in favor of change: taxing inflation is, advocates of shifting arguments, unfair and hurting the economy by discouraging investment. The case against indexing against inflation is much simpler: This is a change that will overwhelmingly benefit the wealthiest Americans, who own an overwhelming share of shares, real estate and other capital whose sales will be affected. An estimate finds that 86.1 percent of the benefit will go to the richest 1 percent.
More concerning still, some legal scholars believe that making this change through the executive branch is illegal, and that congressional action would be necessary to do so – action that with the Democrats in control of the House is likely never to come.
What indexes capital gains for inflation would do
Long-term gains (that is, gains on properties or investments sold after being held for at least one year) are taxed at a lower rate than earned income. A single person's first $ 39,375 (and a couple's first $ 78,750) in capital gains are tax-free; then gains up to $ 434,550 ($ 488,850 for couples) are taxed at 15 percent and gains above that at 20 percent.
In contrast, the top rate of wage income is 37 per cent, which means that capital gains income from wealthy people is taxed at as little as half the wage income.
There are some reasons for indexing these gains for inflation, but one of them is the fact that long-term capital gains have eroded some of the value of inflation. If you buy a stock for $ 40 and sell it for $ 60 five years later, some of the gain is simply that prices have risen across the economy.
As UChicago's Daniel Hemel and NYU's David Kamin explain in a recent article on indexing, the current structure "provides a lower statutory rate for capital gains as a kind of" rough justice "that partially accounts for inflation." This trade-off – no indexing but lower interest rates – makes particular sense now, since inflation has been low (around or below 2 percent) and stable for decades. It is a normal cost that businesses can plan, and that the tax code can be offset, rather than an unpredictable danger.
Some tax experts, including Hemel and Kamin and Tax Policy Center Len Burman, argue that this combination of lower prices without indexing may be preferable to higher prices plus indexing (weighted by some tax reformers) for administrative reasons. What if, for example, the benefit comes from a house that you renovated? You have to keep an eye on not only when you bought the house and the underlying land, but when you bought new sinks, when you hired contractors to install them, when you had people to add insulation, and so on and so forth. It quickly becomes a very tough accounting problem.
However, for people whose main goal is to reduce capital taxes, such as Cruz, Norquist and some Trump administration officials, the alternative in question is not a higher rate of capital gains associated with indexing, but indexing with the exchange rate unchanged. Generally, this branch of the Republican Party is trying to minimize taxes on capital for fear of discouraging investment, and eliminating taxes on gains associated with inflation is a step in that direction. In 2016, Cruz ran for president on a platform that included complete rubbish of corporate income tax and cut the capital gains tax rate to 10 percent; it is fair to interpret indexing as a step closer to this goal.
The problem of doing this through the executive branch, Kamin and Hemel, argues, is twofold. For one thing, it can be illegal. In 1992, for the first Bush administration, the Office of Legal Counsel concluded that when the Revenue Act of 1918 states that capital gains should be calculated based on the original "cost of such property," the "cost" means the actual price paid – not the price adjusted for inflation. The conclusion was that the president and the Treasury lack the ability to adjust inflation without Congress. Kamin and Hemel argue that this conclusion has only been reinforced by subsequent court decisions.
The other problem is that the executive action does not force expenses – such as paid interest or depreciation of investments – to be adjusted for inflation on their part. Kamin and Hemel explain that this can be played by companies to create large-scale false losses to offset the tax:
Imagine that a taxpayer buys a $ 100 asset that is fully funded by a loan. Assume that the real interest rate is zero, that the inflation rate is 10%, and that the nominal interest rate on the loan is also 10%. One year later, assuming no change in the fair value of the asset, the asset will be worth $ 110 due to inflation. If the basis is indexed for inflation, the taxpayer can sell the asset for $ 110 and not recognize any taxable gain. Provided interest rates are allocated to a trade or business, taxpayers can claim a $ 10 interest deduction with no set-off gain, even though taxpayers are in the same pre-tax position as before
This has led some libertarian-inclined economists who are skeptical to tax on capital, such as Tax Foundation & # 39; s Kyle Pomerleau to express concern about making this change one-sided.
In addition to the gambling and legal issues, the change would also be purely regressive. The Penn Wharton budget model, a respected tax and budget model at the University of Pennsylvania, estimates that indexing to inflation will cost $ 102 billion over 10 years, and 86.1 percent of the benefit will go to the richest 1 percent of Americans. Nearly two-thirds would go to the richest 0.1 percent. Ownership and capital gains are incredibly concentrated, meaning cuts like this overwhelming abundance to the rich.
If you think taxes on capital are just too high, it's a grip that makes a lot of sense. But from every other perspective, it looks like an attempt to redirect $ 100 billion upwards to the richest people in America.