1 Making use of time on airplane, this thread is meant as a (non-partisan) discussion of capital gains taxation, in light of President Trump’s interest in indexing capital gains to inflation.
marketwatch.com/story/heres-wh…
marketwatch.com/story/heres-wh…
2 First, what does it mean to index capital gains? If you buy an, sell it 10 years later at $150, today you pay cap gains tax on the $50 increase. Under indexation, you would pay tax only on the $25 of gain over and above inflation. A tax cut.
3 As with any tax policy, we should consider behavioral responses (efficiency) & distributional aspects. I focus on efficiency b/c distributional effects clear (benefits go to those who own lots of assets, aka, the wealthy as reported by @kentsmetters)
budgetmodel.wharton.upenn.edu/economic-matte…
budgetmodel.wharton.upenn.edu/economic-matte…
4 Tax cut would increase deficit, & benefit goes to wealthiest. Most agree this desirable only if there is significant benefit to broader economy. Would indexing capital gains do this? Short answer is no, or at least, not much.
5 True, some economic models suggest we should not tax capital at all & instead rely on some form of consumption tax b/c capital investment fuels long-run economic growth.
6 If we did not care about distributional consequences, this might be optimal b/c growth is powerful force for good. But, to state the obvious, and to reinforce 4 above, “the capital is owned by those who own the capital” & this is highly concentrated.
7 Plenty of economic models have a role for capital taxation. We tend to implement this via a mix of corporate income taxation, dividend taxation, and capital gains.
8 One can look up the marginal statutory tax rates, but it is much harder to compute the effective rate because the corporate tax code is complex (investment tax credits, depreciation rules, etc) & also depends on what happens at individual level.
9 We tax dividends / cap gains at individual level. The effective rates vary enormously based on behavior. Rate varies with income, whether asset held in a retirement plan v a taxable account, how long asset is held, etc.
10 And, perhaps most importantly, capital gains can be indefinitely postponed because we tax upon realization (i.e., sale of the asset) rather than as the gains accrue. In other words, we do not tax you on the appreciation of a stock unless/until you sell it.
11 And even if you sell it, there are ways to continue to avoid tax. This is especially true in real estate:
thebalance.com/how-to-do-1031…
thebalance.com/how-to-do-1031…
12 You can also avoid cap gains tax by donating appreciated asset to charity (allowing you to simultaneously lower income tax) or by passing asset to heirs who get to wipe out the gains using what is known as “basis step up at death.”
13 If you somehow still manage to incur cap gains taxes despite all the opportunities to avoid it, the top rate is only 20%.
14 The case for indexing capital gains would make more sense if we indexed the entire tax code to inflation. Or if it was being done at the same time we started taxing cap gains on accrual (hard to do!) & eliminated basis step-up at death. That is not part of President’s proposal
15. As @jasonfurman pointed out yesterday, indexing part of tax code and not other parts can create other distortions.
16. At end of day, can lower capital gains taxes be good for the economy? Sure. Are they good for the economy if we finance them with higher deficits? Probably not. Do they pay for themselves? Definitely not. Do the wealthy benefit? Yes. Will the non-wealthy benefit? Unlikely.
Buy “an asset”
On net, my personal opinion is that there are many other policy tools available that would do more for growth & spread the benefits more equitably than indexing cap gains. I’m left feeling this is a “solution in search of a problem.”
Implicit in this tweet was a line I deleted when I was over the character limit in which I assumed a 10-year cumulative inflation of 25%, so that half the $50 gain was real and half was nominal.
