By Ryan Ellis
In the past week, there has been a flurry of press accounts that President Trump has directed the Treasury Department to examine whether they have the power to let investors index cost basis to inflation when calculating capital gains. This has taken the press corps by surprise, but it is an issue that has been around a long time — dating all the way back to a 1992 memo (updated in 2012) by former Reagan assistant Attorney General Charles Cooper.
The assertion Cooper and conservatives like Americans for Tax Reform, the National Taxpayers Union, the Club for Growth, and my own Center for a Free Economy are making is a simple one: “Cost” is not defined in the tax statute, and therefore the Treasury Department has the authority to define “cost” in a reasonable way. A levelheaded way to define the cost of an investment is what that cost would be in today’s dollars — that is, the cost adjusted for inflation.
Treasury can and should do this on its own. While Congress gets to write tax laws, the Treasury gets to implement them. There are no serious “branches of government” concerns here — the Congress writes the laws under Article I of the Constitution, and the executive implements them under Article II.
This simple definitional change would have a profound pro-growth impact on our economy. According to former Treasury economist Gary Robbins, one-quarter of unrealized capital gains are merely the result of inflation increasing the price of the underlying assets. That means removing this unfair “inflation tax” from capital gains calculations would be the equivalent of a one-quarter rate cut on capital gains — an effective rate cut from nearly 24 percent to nearly 18 percent for individuals, and from 21 percent to 16 percent for corporations. Reducing the tax rate on capital means a more productive economy, higher wages, and probably more tax revenue than before the change.
Invariably, this rather modest definition change is portrayed by the press as a handout to the Mr. Moneybags character in the Monopoly game. In fact, taking inflation out of the capital gains tax would help normal, middle-class Americans in all sorts of ways.
Start with homeowners. Under current tax law, anyone who has lived in and owned their primary residence for at least two years can exclude up to $250,000 of gain upon sale ($500,000 in the case of a married couple). These numbers haven’t been updated since 1998. There are millions of older couples who bought houses in the 1970s or 1980s and now are looking to sell their empty nests as retirement nears. The Federal Reserve reports that the median new home sales price in 1970 was $24,000. In 1980, it was $63,000. A homeowner selling his 1970 or 1980 home for as little as $350,000 today would have to pay capital gains tax on part of the sale. But if this homeowner was allowed to adjust his purchase price to inflation, the sale would be tax-free. Everyone is “rich” (at least in the eyes of the IRS) the year they sell their home, but there’s no reason we should be punishing seniors who have paid taxes all their lives with an inflation tax on their house.
Then, there are family farmers. Farmland in Iowa in 1975 averaged $1,095 per acre. By 2017, this had grown to $7,326 per acre. But the inflation-adjusted 1975 price of the land is $3,890 per acre. Assuming a 24 percent capital gains rate, using inflation-adjusted basis instead of purchase price basis would lower the capital gains tax per acre from $1,495 to $825. Family farmers who find themselves land-rich but cash-poor would immediately be better off.
What about seniors who saved in stock purchase plans throughout their working careers? Many employees didn’t have access to 401(k) plans, and instead bought stocks in sectors like utilities and energy companies every week via a payroll deduction. Now living off the dividends from these stocks, seniors are also sitting on large unrealized capital gains. A stock bought for $5 in 1970 might be worth $50 today. Seniors should be able to count the real purchase price of that stock as their basis when they sell. Instead, a lifetime of savings is eaten up by an unfair inflation tax on their nest eggs.
What about collectors who sell baseball cards, Star Wars toys, and other memorabilia on Ebay? If a child buys a toy in 1980 for $5 and can sell it today for $100, why can’t they use the $5 number in today’s inflation-adjusted terms ($16) instead when figuring gain on the sale? Ebay reports there are 25 million sellers on that platform, and all of them stand to gain from this common-sense correction to the definition of cost.
The Tax Cuts and Jobs Act of 2017 was a big help to middle class families — the standard deduction was doubled, the child tax credit was doubled, and rates were reduced across the board. By updating the definition of “cost” to take inflation out of the capital gains tax, we can deliver another solid tax cut to ordinary Americans.