The Trump administration is considering a plan to cut taxes for investors. The idea would be to index capital gains for inflation, so that rather than tax the entire gain of an asset, an investor would subtract the value of inflation, therefore reducing the taxable income.
This plan stands no chance of passage through Congress, which already absorbed a big political hit by passing a huge, regressive tax cut last year. Some right-wing senators have introduced a bill to index capital gains for inflation, but the Republican majority isn’t bothering to push it, because it won’t get enough votes. But the beautiful part is that Trump hopes to enact another tax cut, this one even more regressive, without passing any legislation through Congress. “If it can’t get done through a legislation process, we will look at what tools at Treasury we have to do it on our own and we’ll consider that,” says Treasury Secretary Steven Mnuchin.
Do you remember the years and years of hysterical right-wing denunciations of unilateral executive action by the Obama administration? It’s possible, just possible, that they did not represent a principled belief about the limits of executive statutory interpretation.
The rationale for indexing capital gains taxes to inflation is that it’s unfair for investors to pay tax on income that only represents inflation. That is to say, if you you buy a stock for $1,000, and its value increase to $1,500, under current law, you have to pay tax on the $500 gain when you sell the stock. Under Trump’s proposal, if you suppose inflation during that period totaled 10 percent, then $100 of the gain would be discounted, and you would only be taxed on a $400 gain.
The benefits of alleviating this very minor form of unfairness would be enjoyed almost exclusively by — you guessed it — the very rich. The highest-earning one percent of taxpayers would get more than 86 percent of the benefit of indexing capital gains for inflation.
In addition to increasing the national debt by approximately $100 billion over a decade, and increasing inequality, indexing capital gains would probably do more to detract from economic growth than to encourage it. Capital gains already enjoy favorable treatment from the tax code, and increasing that favoritism would simply exacerbate an already strong incentive for people to find ways to convert their income into capital gains. The most effective and sweeping effort to clean up the tax code, the 1986 Tax Reform Act, eliminated the preference for capital gains. Since then, the preference has gotten wider and wider.
Indexing capital gains would continue the anti-reform trend, adding massive complexity to the tax code. “This exercise quickly gets complex with additions to basis through, for example, reinvested dividends or new investments in a business,” writes Tax Policy Center economist Leonard Burman.
It would also encourage more tax sheltering. You could borrow money to finance an investment, and the borrowing would be fully tax-deductible, while only the inflation-adjusted part of the gain would be taxed. Even if the investment gained no real value, it would create a paper loss on your taxes.
Tax-law professors Daniel Hemel and David Kamin explain how such a scheme would work:
Imagine that a taxpayer buys an asset for $100 that is fully financed 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 10% as well. One year later, assuming no change in the real value of the asset, the asset will be worth $110 on account of inflation. If basis is indexed for inflation, the taxpayer can sell the asset for $110 and recognize no taxable gain. Assuming that the interest is properly allocable to a trade or business, the taxpayer can claim an interest deduction of $10 with no offsetting gain, despite the fact that the taxpayer is in the same pretax position as previously.
There is a grim irony in the fact that every prediction the Republicans have made about their tax cut has so far failed to come to fruition. They promised the tax cuts would inspire more business investment; no such increase has been seen. They insisted the official budget projections underestimated the growth effects of the cut, and that deficits would not rise. They are rising quickly.
This is, in a microcosm, three decades of Republican economic policy. Republicans have fixated on the tax burden paid by the rich as the foundation of economic growth. They insisted Bill Clinton’s tax hike on the rich would cause a recession, that George W. Bush’s tax cuts for the rich would usher in prosperity, and that Obama’s reversal of those would end the recovery. None of those predictions came true. Lawrence Kudlow, Trump’s chief economist, has made the most fantastical, and fantastically wrong, of these promises. And Kudlow is the chief proponent of Trump’s plan to enact it by fiat. (If Trump does try the capital-gains-indexing gambit, he could be challenged in court.)
For all his wavering and incoherence, Trump has delivered an impressive windfall for himself and his buddies. His hope of giving them another tax cut, without the bother of a public debate or a vote in Congress, shows that the Trump heist is far from over.