The Treasury Department is said to be studying the idea of providing some sort of inflation-protection (indexing) for the taxation of capital gains. Rep. Devin Nunes (R-CA) has introduced a bill (H.R. 6444) to do just that. Predictably, Washington Post writer Matt O’Brien instantly dismissed the idea as “Trump’s new plan to cut taxes for the rich.”
O’Brien relies on a two-page memo from John Ricco which yanks mysterious estimates out of a black box – the closed-economy Penn-Wharton Budget Model. The “microsimulation model” predicts that the Top 1 Percent’s share of federal income taxes paid could fall from 28.6% to 28.4% as result of taxing only real capital gains. “That’s real money,” exclaims O’Brien.
No model can estimate how much revenue might be lost by indexing (if any) because that depends on such unknowable things as future asset values, future tax laws and future inflation. Yet Mr. Rico magically “projects” future realizations to “estimate that such a policy would reduce individual tax revenues by $102 billion during the next decade [sic] from 2018-2027.” Does that imaginary $102 billion still look like “real money” when spread over Rico’s extended 20-year “decade?” It would be a microscopic fraction of CBO’s projected individual income taxes of $21.1 trillion over that period.
One problem with the notion that indexing capital gains could only benefit the top 5 percent (over $225,251 in 2016) is that it wrongly assumes the capital gains tax only applies to stock market gains. Another Washington Post article said, “Researchers have estimated that the top 5 percent of households in terms of income hold about two-thirds of all stock and mutual fund investments, putting wealthier Americans in the position of benefiting much more than others from any changes to capital gains rules.” But the capital gains most likely to be seriously exaggerated by decades of inflation are not gains from selling financial assets, but from selling real assets. After many years of even moderate inflation, an unindexed tax may be imposed on purely illusory “gains” from the sale of real property that actually involve a loss of real purchasing power. A 2016 report from the Congressional Budget Office and Joint Committee on Taxation, “The Distribution of Asset Holdings and Capital Gains” reports that Americans held $7.5 trillion in stocks and mutual funds in 2010, but $12.2 trillion in private businesses and $8.5 trillion in nonresidential real estate.
A related problem with conventional distribution tables is that they add realized capital gains to income in the year in which a farm, building or business is sold, which makes it true by definition that unusually large one-time gains are received by those with “high incomes” (including those gains).