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The Trump Administration Should Index Capital Gains To Inflation

By Adam Brandon

In 2016, economists scoffed at the notion made by then-candidate Donald Trump that he wanted "to establish a national goal of reaching 4% economic growth." One economist responded, "Donald Trump is dreaming." Another claimed that candidate Trump's "growth expectations are not realistic."

Fast-forward to the present. The Tax Cuts and Jobs Act has had a tremendous positive impact on the economy. Unemployment is at 4%. The economic growth rate in the second quarter of 2018 was 4.1%, putting America on the path to 3% annual growth for the first time since 2005.

Combined with the roll back of excessive Obama-era regulations that negatively impacted both businesses and consumers, the Trump administration's economic agenda has been a success. Challenges remain, of course, such as the administration's unwise penchant for protectionism and excessive spending from Congress.

The House Ways and Means Committee is seeking to build off the success of the Tax Cuts and Jobs Act. Chairman Kevin Brady, R-Texas, and the committee have rolled out a second phase of tax reform that would make the individual tax rates and the pass-through deduction permanent. The Tax Foundation has projected that making the individual tax rates permanent would grow the economy and add 1.5 million jobs.

But more can and should be accomplished by the Trump administration.

Reportedly, the administration is considering a change that would index capital gains to inflation, providing a massive tax cut that will spur more investment in the economy. After all, investment is the lifeblood of the economy and is what leads to economic expansion.

The capital gains tax rate is currently 15% for married couples filing jointly whose incomes are between $77,201 and $479,000. Married couples with incomes of more than $479,000 are taxed at a 20% rate. An additional 3.8% net investment income tax, which became law under ObamaCare, applies to married couples who earn more than $250,000.

As this tax scheme currently works, an individual who made an investment several years ago is taxed on the return. The dollar isn't worth what it was when the initial investment was made because of inflation. Still, the investor is unfairly taxed on an overstated return. Had inflation on the initial investment been taken into account, the return wouldn't have been as great and the investor's tax liability wouldn't have been as large.

Writing for the Tax Foundation, Alec Fornwalt explained, "For example, say an investor put $5,000 in the stock market in the year 2000. Under the current law, if that $5,000 generously turned into $8,000 over those 18 years, they would be taxed on the $3,000 gain, resulting in a tax liability of $450."

"The problem is, in 2018, that $5,000 from 2000 is equivalent to roughly $7,100 today. Inflation accounted for $2,100 of that gain. This means the investor only really made $900, not $3,000," he wrote. "Even worse, if an investment doesn't make more than the rate of inflation, the investor is taxed on gains that are not even gains at all. If that investor who invested $5,000 in 2000 sold the investment for $7,000 in 2018, the asset was actually sold at a real loss. However, under current tax treatment, the investor would still have a positive tax liability."

As one might imagine, so-called progressives are beside themselves at the prospect of indexing capital gains to inflation. Sen. Chuck Schumer, D-N.Y., complained that indexing capital gains to inflation would "give the top 1% another advantage."

Do Tax Cuts Favor The Rich?

The media also repeat this talking point, frequently mentioning the Penn-Wharton Budget Model showing that 97.5% of this tax cut would go to the top 10% of income earners.

Although the higher income earners are one of the left's biggest boogeymen, these are the very people who make investments in the economy. These investments can promote new ideas or expand existing businesses, create new jobs, and lead to higher wages. The goal should be to encourage more investment and, yes, profit because it keeps the entrepreneurial spirit of America alive.

Going through Congress to index capital gains to inflation is, of course, the preferred route. Unfortunately, Democrats will never let that happen. But there is nothing preventing the Department of the Treasury from issuing a regulation to define the term "cost" to include an adjustment for inflation.

President Trump and Treasury Secretary Steven Mnuchin are never going to convince Democrats that a pro-growth agenda works. But they don't have to. The Tax Cuts and Jobs Act and deregulation have spurred economic growth that America hasn't seen in more than a decade. Providing another round of tax cuts by indexing capital gains to inflation will build on the success of tax reform and provide another shot in the arm to our economy.

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