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Washington needs to end hidden inflation tax on our capital gains

By Jenny Beth Martin

The federal government indexes Social Security payments to inflation, to ensure that beneficiary payments are not eroded by the silent tax of inflation. Why, then, does it not do the same for capital gains? That is a question being asked increasingly on Capitol Hill, as Republicans look to continue their efforts to foster economic dynamism and job growth, even as they strive to make the tax code fairer.

Say you purchased stock in 2000 for $1,000. You sold it in 2018 for $2,000. Under current regulations, which require you to calculate the capital gain using nominal values, your capital gain is the $2,000 sale price minus $1,000 purchase price, which equals $1,000. That would be the amount of investment profit on which you would apply the capital gains tax. But $1,000 in 2018 is not worth the same as $1,000 in 2000.

According to the Bureau of Labor Statistics inflation calculator, that $1,000 you spent in 2000 is only worth $681 in 2018. To have the same purchasing power as $1,000 in 2000, you would need $1,468 in 2018. So the proper calculation would then be the $2,000 sale price minus the $1,468 purchase price, which equals $532. That would be the amount on which you would apply the capital gains tax.

Republican Senator Ted Cruz of Texas gets it. On Tax Day this year, he and Republican Senator Jim Inhofe of Oklahoma introduced the Capital Gains Inflation Relief Act of 2018, which would end the taxation of capital gains based on inflation. That is not just the morally right thing to do, as no one should pay a tax on phantom “gains” that exist only on paper because of inflation, it is also the economically right thing to do.

It would immediately increase the value of real estate, stocks and the like, and would thereby encourage more investment, free up unproductive assets, and create more jobs. Cruz said that indexing capital gains for inflation “encourages people to invest more capital into businesses, and when you are investing more capital in business, it means you are hiring more people. It means you are buying more equipment, it means you are raising wages, and that you are driving economic growth.”

Inflation is one of the favorite tools of the Washington swamp. The government causes inflation by expanding the supply of money faster than the increase in goods and services. That leaves too many dollars chasing too few goods, which leads to price increases, as buyers bid up what they are willing to pay for scarce goods. Why not? They have more dollars in their pockets, even if they lack purchasing power.

The good news is that Cruz and Inhofe have introduced legislation to address this unfair and counterproductive aspect of the tax code. The better news is that the White House is believed to be considering accomplishing the same goal through a different route with an executive order, which would mean we would not have to wait for Congress to act.

Does President Trump have the power to make this change through an executive order? According to this memo published in 1993 by lawyers Charles Cooper, Michael Carvin, and Vincent Colatriano in the Virginia Tax Review, he does. Just in case anyone does not buy that argument, Cooper and Colatriano updated their argument in this piece, published in 2012 in the Harvard Journal of Law and Public Policy.

Larry Kudlow, director of the National Economic Council, recognizes the virtue of this move. In a column last year, before he was asked by President Trump to join the senior White House staff, Kudlow argued that the pledge to make America great again “requires nothing less than reigniting economic growth and prosperity” and “wealth creation is essential.” He added that the “president can take matters into his own hands by issuing an executive order to index capital gains for inflation.”

President Trump should sign the executive order, and Congress should move the legislation. An executive order now to get the policy in place as soon as possible, followed by legislation to enshrine the policy in law and ensure that a future president does not undo it with the stroke of a pen would be the perfect combination to solve this.

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