By Ryan Ellis
It was reported today that Larry Kudlow will be named the new director of the National Economic Council at the White House. A longtime veteran of the supply side tax movement, Kudlow is expected to steer the West Wing and President Trump in a solidly pro-growth direction.
There’s one project that Kudlow needs to get to work on right away: indexing the basis of capital gains to inflation. This is a cause which has been close to his heart for many years. Just last August, Kudlow wrote an op-ed for CNBC urging President Trump to do this by executive order. In that op-ed he wrote:
Former Treasury economist Gary Robbins estimates that indexing capital gains for inflation [in 2017] would, by 2025, create an additional 400,000 jobs, grow the U.S. capital stock by $1.1 trillion and boost GDP by roughly $500 billion. That all translates to an additional $3,600 for the average household…Capital gains taxes totaled $134 billion [in 2016]. Approximately one-fourth of that revenue was, according to Gary Robbins, generated by taxing inflationary gains. That translates to a $34 billion tax on phantom income.
The “index cap gains to inflation” cause has a lot of pedigree in the conservative anti-tax movement. Grover Norquist of Americans for Tax Reform has been at it for decades, going all the way back to the George H.W. Bush administration. This finally may be the time that this issue is ready to cross the finish line, a testament to Grover’s persistent activism (full disclosure, I worked for Grover and ATR as Tax Policy Director from 2006 to 2015).
Lately, the coalition building mantle here has been picked up by the Club for Growth, who in January organized a joint letter on the subject to President Trump and Treasury Secretary Steve Mnuchin. One of those signers was none other than Larry Kudlow. Joining him was Norquist, Heritage Action, the National Taxpayers Union, the American Conservative Union, Freedom Works, Americans for Prosperity, the Family Business Coalition (where I’m a senior tax consultant), and more than a dozen others. It’s a “who’s who” of conservative anti-tax activists.
Phil Kerpen of American Commitment has organized a one-man Twitter campaign for cap gains indexation, and he will deserve much of the credit if it happens, too.
How would indexing capital gains basis to inflation work?
In the tax world, reporting a capital gain is a pretty simple exercise. When you sell an asset, like a stock, you report how much you sold it for. You can subtract what you bought it for (your “basis”) from what you sold it for to arrive at your gain. You pay tax on the gain. If you’ve held the asset longer than a year, you generally pay tax at a lower rate (currently 20 percent, plus the 3.8 percent Obamacare investment surtax) instead of the ordinary tax rate (which currently runs as high as 37 percent, plus the surtax).
A problem arises in that your basis purchase may have happened many years ago. The real value of the money you used to buy a stock has been eroded by inflation. For example, $100 in 1990 is only worth $51.41 today, a little more than half the supposed basis in real terms. If you were instead allowed to index the $100 basis to inflation, it would be worth $194.52 today, nearly double the nominal purchase price.
Someone whose $100 initial investment has grown to $500 would see a big difference in taxes:
Current Law Indexed Basis
Initial 1990 Investment $100 $100
Adjusted Basis $100 $194.52
2018 Sales Price $500 $500
Capital Gain $400 $305.48
Tax (23.8 percent rate) $95.20 $72.70
That’s a giant swing. By indexing the basis to inflation, our investor gets to keep more of his own money. That’s then available to reinvest in other ventures or for him to consume. Uncle Sam still gets to tax the gain–he just doesn’t get to take the phantom gains attributable to inflation. In fact, $22.50 of the current law tax–nearly one quarter of the tax bill–is entirely due to inflation, not any real increase in wealth.
Another way of thinking about this is that indexing capital gains to inflation is like cutting the capital gains tax rate from an effective 23.8 percent today to 18 percent on average. This is the way we get the missing piece of the Trump tax cut–a capital gains tax cut–into law.
Decades of legal scholarship make it clear that the executive branch has the power to do this themselves–Congress doesn’t need to pass a law. Both Club for Growth and ATR have reams of legal memos which prove that the president can make this change administratively. Any modesty about exerting executive interpretation of statute which might have existed in prior years should be completely cured by the reckless and cavalier regulatory attitude the Obama Administration had toward their own health care law. Indexing the basis of capital gains to inflation is nothing by comparison.
The immediate rise in the after-tax value of stocks won’t just help those who hold the investment directly–it should also increase the share price over time of all the assets held in 401(k)s and defined benefit pensions, IRAs, HSAs, and 529 education savings accounts. Indexing gains to inflation would also be an indirect cut in the death tax, as assets which might have been held at death can instead be sold for far less tax ahead of time. Finally, indexing of capital gains basis could also pave the way to indexing the basis of depreciable property, like real estate, to inflation as well. Super long depreciation lives are an inhibition to neutral cost recovery–but Larry Kudlow can save that fight for next time.
Capital assets, of course, are far more than just stocks, bonds, mutual funds, and exchange traded funds. This law change would help owners of real estate, including corporate owners of real estate. It would help small businesses who pay the capital gains tax when acquired by larger firms. It would help everyone in America with a prized collection of old baseball cards or stamps sitting in an album in their den. This is truly a tax cut for everyone.
Now is the time, and now is the moment, to finally get this done. Index the basis of capital gains to inflation. Larry Kudlow and Donald Trump make the perfect team to do it.
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