Trump capital gains tax change is wise policy to boost our economy

Trump capital gains tax change is wise policy to boost our economy
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The White House is considering indexing capital gains to inflation. Setting aside the complex legal debates surrounding the implementation of such a policy, indexing capital gains to inflation is absolutely a goal that Washington should be pursuing. Doing so would increase investment, boost economic growth, and create a fairer tax system.

Currently, investing in a business through the stock market subjects the investor to multiple layers of taxation. First, investors pay income taxes on the income they receive from their work. Then, by investing in company stock they are indirectly subjected to corporate taxes, as the corporate tax reduces the growth rate of the stock. Upon selling their stock, they pay capital gains tax on the growth of their investment.

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This is an unfair distortionary system. Real tax rates on a source of income are disguised behind multiple layers, making it hard for investors to see the full tax they are paying. But there is another hidden tax the investor pays. While income tax brackets are adjusted to account for inflation, capital gains taxes receive no such allowance. If an asset grows below the rate of inflation, the investor can face a double whammy. Not only will the asset have declined in real value, but the investor will face a tax on this phantom “growth” in nominal value when it comes time to sell.

This hidden inflation tax exacerbates economic distortions from the capital gains tax as well. Not only are investments less profitable, but investors are also discouraged from selling long term assets for fear of eating a painful capital gains tax bill that vastly overstates their real income gain by not factoring in inflation. This “lock in” effect means that some investment dollars are not flowing to the most deserving projects. Instead, they are stuck in a dusty 40 year old stock portfolio.

The benefits of a shift in saving habits could be substantial. Unlocking all those dollars stuck in capital gains inflation limbo could free up dollars for investments in growth. Gary Robbins estimates the economic benefits of indexing capital gains means a $500 billion boost to gross domestic product by 2025, along with 400,000 new jobs, as capital stock balloons by $1.1 trillion. As investments are what drive wage increases, this would also mean returns to workers in the form of salary growth.

Detractors have pointed out that 86 percent of the benefit of capital gains indexing would go to the top 1 percent to label this another tax cut for the rich. It is true that capital gains taxes are, as it stands, mainly a concern for the wealthiest Americans. Yet that need not be the case, as removing this arbitrary disincentive to invest is a step along the road to encouraging more Americans to put part of their salaries in stocks. Moreover, the long term positive effects of an investment boom will affect far more than those who see an immediate impact on their tax bills.

Critics will decry the “lost revenue” associated with such a proposal. The Penn Wharton budget model places the revenue impact at $10 billion each year, but that does not take into account increased revenue coming from economic growth resulting from increased investment. Without knowing for certain how the dynamic feedback will work out, the number is nothing to sneeze at, but it could be offset by trimming spending to ensure we do not add to the deficit. An alternative measure would be to index capital gains to inflation moving forward, but not retroactively.

The government should end the inflation tax on capital gains. It is a smart and responsible way to free up hundreds of billions of investment dollars and get the wheels turning on long term wage growth. It also does not hurt that it is a much fairer way to tax the savings of Americans.

Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit focused on tax policy education and analysis.