Accounting for inflation in this way has the advantages of producing more short‐term revenue to the Treasury as long‐term gains are “unlocked.” Furthermore, lowering the cost of capital would stimulate investment and the stock markets, and would increase the fairness of the tax system by not taxing phantom gains for people at all income levels. It would also square capital‐gains taxation with the U.S. Constitution.
Assume you purchased a common stock in a company in 1984 for $100 a share and sold it in 2007 for $200 a share. Have you received any “income” from the sale of the shares of stock? The IRS would say “yes,” but this is clearly wrong. The IRS will claim that you had a $100 per share capital gain on the stock in the above example, yet actually the increase was solely a result of inflation. Because you cannot buy more goods and services with $200 now than you could have with $100 in 1984, you have had no “income” or wealth accretion.
Over the years numerous economists, lawyers and others have tried to fix this problem and have gotten nowhere with Congress. But now, due to increased concerns about inflation, economic growth and judicial salaries, the time may be right to move forward.
Chief Justice John Roberts has just renewed his call for an increase in pay for federal judges. He, his predecessor William Rehnquist and other judges have complained about the “steady erosion” of judicial salaries over the past 20 years. According to Article III, Section I of the U.S. Constitution, compensation of federal judges “shall not be diminished during their Continuance in Office.”
As inflation has outstripped the increase in judicial salaries, the judges have clearly had “diminished compensation” in real terms. Chief Justice Roberts currently makes $212,000 per year, yet all but five of his predecessors in the past 200 years made more in inflation‐adjusted dollars (Warren Burger’s 1969–1986 income averaged about $250,000 per year in 2006 dollars).
The debate centers on the definition of income. The 16th Amendment to the Constitution states, “The Congress shall have the power to lay and collect taxes on incomes,” and the Fifth Amendment clearly states, “No person shall … be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use without just compensation.”
If the portion of a capital gain due solely to inflation is not income, then taxation without inflation‐indexing is an unconstitutional taking of property. Income is commonly defined as, “the amount of money or its equivalent received during a period of time in exchange for labor or services from the sale of goods or property, or as profit from financial investments.”