Editor’s note: Richard L. Kaplan, the Guy Raymond Jones Chair in Law at Illinois, is an internationally recognized expert on U.S. tax policy. In an interview with News Bureau business and law editor Phil Ciciora, he discusses the effects of indexing capital gains taxes to inflation, a policy maneuver that has been suggested as a potential stimulus to a slowing economy.
President Trump recently said that he was interested in indexing capital gains for inflation. What would that entail?
The basic idea is fairly simple and really very sensible. If you bought a stock for $10,000 in 1999 and sold it this year for $12,000, the nominal gain of $2,000 completely ignores the different values of a dollar today versus 20 years ago. Under indexation, the $10,000 cost “basis” of this stock would be adjusted by some appropriate measure of inflation – perhaps the gross national product implicit price deflator – before computing gain or loss on the transaction. For assets that are held many years, the result in most cases would be smaller gains to pay tax on and, in many cases, actual losses to deduct against other income.
Why hasn’t this change been adopted before?
There are several major implementation challenges, most notably the issue of debt. That is, inflation diminishes the burden of repaying obligations that are denominated in fixed dollar terms, so consistency requires that this economic benefit be recognized, especially when an asset is purchased with borrowed funds.
In addition, would the indexation regime apply only to assets acquired after this change became effective or would it apply to all assets sold after the enactment date, regardless of how long ago they were acquired? More generally, should inflation be factored into determining how much interest and dividend income should be taxed, or should indexation apply only to property sales?
There is also the compliance burden with assets that have been acquired in multiple batches over many years, such as mutual funds with reinvested distributions.
Finally, there is the question of whether a preferential tax rate for capital gains is appropriate if the gains have been calculated by removing inflation-induced increases.
Indexing the basis of capital assets, in other words, is a much more substantial change than it may at first appear.
Who would likely benefit from this change?
Any taxpayer who invests in property, especially stocks and real estate, and holds these assets for several years would benefit from a calculation of their taxable gains that recognizes the changing – and more specifically, the declining – value of the dollar over time. But given the substantial concentration of wealth in this country, it is inevitable that wealthier people would benefit disproportionately from this change, simply because they own more property than other people.
Can President Trump sidestep Congress and make this change unilaterally through executive action?
Previous Republican administrations have looked at this issue, most notably in 1992 under President George H.W. Bush, and concluded that such a major change could not be done administratively. After all, the definition of an asset’s basis as its “cost” has remained unchanged throughout the entire history of the federal income tax. So if a change is to be made, Congress would need to enact some indexation formula, as it has done for the tax code’s bracket ranges, standard deduction and numerous other provisions.