Tax Foundation: Indexing capital gains would give 'somewhat modest' boost to economy

A move President Trump is considering that would reduce the amount of capital gains taxes people pay would only have a "somewhat modest" impact on the economy, according to an analysis released Monday from the right-leaning Tax Foundation.

The think tank estimates that indexing capital gains to inflation would increase long-run gross domestic product (GDP) by 0.11 percent, or about $22 billion in 2018.

Trump said in an interview with Bloomberg last week that he's considering taking executive action to index capital gains - an idea that is supported by a number of GOP lawmakers and conservatives such as Americans for Tax Reform President Grover Norquist.

If capital gains were adjusted for inflation, it would reduct the amount of taxes people pay when they sell investments. The Tax Foundation gives an example: Under current policy, someone who bought an asset in 2000 for $100 and sold it in 2018 for $200 would pay capital gains taxes on $100. But since inflation increased the price level of the asset by 49 percent, if capital gains were indexed, the taxpayer would only pay capital gains taxes on $51.

Conservatives argue that indexing capital gains would increase economic growth because it would encourage investments. But Democrats argue that the move would add to the debt and largely benefit wealthy taxpayers, and that the Treasury Department doesn't have the authority to make the capital gains tax cut unilaterally.

The Tax Foundation said that they find that indexing capital gains would lead to modest growth for three reasons.

The first is that the additional incentives to invest created by indexing are provided to individual tax savers rather than businesses. The group noted that many individuals don't pay capital gains taxes because their investments are in retirement accounts such as 401(k)s.

The second reason the Tax Foundation thinks the economic impact would be limited is that the group thinks it's "unlikely that a large realization of locked-up gains will have any meaningful impact on long-run growth."

The third reason is that the effective tax rate on capital gains is already low compared to the effective tax rates on interest and dividends.

The Tax Foundation estimated that indexing capital gains to inflation would lower federal revenue by about $178 billion over 10 years before accounting for economic growth, and that doing so would reduce revenue by about $148 billion when economic growth is taken into account. The revenue loss would be small in the short run because there would be an initial boost in taxpayers selling assets, but the amount of revenue loss would increase in later years, the group said.

The Tax Foundation also said that "indexing capital gains to inflation would make the federal tax code less progressive."

Before factoring in economic growth, taxpayers in the bottom 80-percent of income would see their after-tax incomes increase by between 0.02 percent and 0.04 percent, while taxpayers in the top 1 percent of income would see their after-tax incomes increase by 0.83 percent, according to the analysis. 

View desktop version