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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President TrumpDonald John TrumpTrump mocks wind power: 'When the wind doesn't blow, just turn off the television' Pentagon investigator probing whether acting chief boosted former employer Boeing Trump blasts McCain, bemoans not getting 'thank you' for funeral MORE’s administration 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 a corporation’s stock they are indirectly subjected to corporate taxes, as the corporate tax reduces the stock’s growth rate. 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 a another, hidden tax that the investor pays. While income tax brackets are adjusted annually to account for inflation, capital gains taxes receive no such allowance. In fact, 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 the asset’s 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 aren’t flowing to the most deserving projects — they’re stuck in a dusty 40-year-old stock portfolio.

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

Detractors, and much of the media, have pointed to the fact that 86 percent of the benefit of capital gains indexing would go to the top 1 percent (and 99 percent of the benefit to the top 20 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 — 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 per 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 easily offset by trimming wasteful spending to ensure we don’t add to the deficit. An alternative measure would be to index capital gains to inflation moving forward, but not retroactively.

Ending the inflation tax on capital gains is a smart and way to free up hundreds of billions of investment dollars and get the wheels turning on long-term wage growth again. It doesn’t hurt that it’s a fairer way to tax Americans’ savings, as well.

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