Wednesday, October 04, 2006

Ending the Inflation Tax: Indexing Capital Gains

Income tax brackets have been indexed for inflation since the Reagan tax cuts of 1981 to prevent "bracket creep" - where inflation pushed income into higher tax brackets, resulting in an increase in income taxes and tax burden, but no increase in real purchasing power. There is now a house bill that would likewise index capital gains taxes for inflation. From yesterday's WSJ:

An investor who purchased a stock for $10 in 1956, and sold it for $20 today, would still pay a 15% capital gains tax on the transaction, even though adjusted for 50 years of inflation he'd be a net loser.

From 1979 to 1994, roughly 33% of the increase in shareholder wealth, or some $1.5 trillion, was due to inflation. This means Americans are paying far higher capital gains tax rates than advertised. A 1993 study by then Federal Reserve Board Governor Wayne Angell calculated that the average real tax rate on investments from 1972 to 1992 in Nasdaq stocks was 68%. It was 101% in the S&P 500, 123% in the NYSE, and 233% in the Dow Jones Industrials. On three of the four major indexes, the average taxes were higher than the actual return.

Inflation remains a hidden thief that transfers gains unfairly to the government from taxpayers. The Pence-Cantor bill would protect against this by allowing any taxpayer holding an asset for more than three years to have a gain or loss determined by a cost basis adjusted for inflation. The proposal would immediately raise the after-tax return on capital investment, thus providing an incentive for more of it.


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