President Trump, who famously likes to supersize his accomplishments, must not be satisfied with pushing the federal budget deficit above $1 trillion for the rest of his term. As staggering as that amount of red ink may be, he’s considering a tax cut that would widen the shortfall even further. What’s more, it would deliver little or nothing in return for the cost to the Treasury.
At issue is a Republican proposal to reduce the bite of capital gains taxes by making gains appear smaller for tax purposes. Today, the calculation is straightforward: the gain from the sale of an investment (shares of stock, for example, or a piece of real estate) is equal to how much more the item sold for than it cost to buy. Under the alternative being pushed by some Senate Republicans and anti-tax groups, the calculation wouldn’t be based on the original cost but on a higher number that takes into account all the inflation that has occurred since the item was purchased, lowering the gain.
In a sense, this is just another effort by the all-taxes-are-evil crowd to pay less for the services the federal government provides and shift the costs onto future generations. What makes this proposal unusual is that proponents aren’t calling for Congress to make the change; they want the president to do it unilaterally, through an executive order directing the Treasury Department to redefine the cost of a capital good as the price paid plus inflation.
Coming on the heels of a major GOP tax cut that’s spurring trillion-dollar deficits, the proposal is beyond fiscally irresponsible. It also represents the worst of trickle-down economics, given that the tax break would benefit the wealthy almost exclusively. According to the Tax Policy Center, households in the top 20% of U.S. earners, whose average incomes were $347,000, collected 90% of the taxable gains in 2018; more than half of the gains went to households in the top 0.1%, whose average incomes were $10.8 million.
The only thing reportedly holding the administration back at this point is the concern that such a move might be illegal. That’s the position the Treasury and Justice departments took in 1992, when they reviewed the issue for President George H.W. Bush, and they were right. Not only is the law crystal clear, so is the will of Congress, which has considered and rejected the idea of indexing capital gains for inflation several times in recent decades. But there are plenty of other reasons not to take this step.
The federal tax code already adjusts tax rates for inflation, gradually raising the amount a household must earn to qualify for higher tax brackets. The idea is to prevent people who receive cost-of-living increases in their pay from facing higher taxes when their income is just keeping pace with inflation.
Proponents of indexing capital gains for inflation make a similar argument, saying people shouldn’t be taxed on “phantom gains” caused by inflation. They also argue that the money people use to invest in stocks, homes and other capital assets is already taxed, and that is often the case. “This extra layer of taxation creates a bias against savings and suppresses productivity and new investment,” Americans for Tax Reform contended in a 2017 analysis, adding that “this hinders the creation of new jobs, higher wages, and increased economic growth.”
Except that economic data don’t bear out those assumptions. There’s little or no correlation between the capital-gains tax cuts (or increases) in the past and the performance of the U.S. economy. Besides, capital gains already get preferential treatment in the tax code: They’re taxed at a significantly lower rate than ordinary income, and no taxes are imposed until assets are sold and a gain is realized.
In addition, the proposal would open an alarming new loophole for savvy (and wealthy) taxpayers to exploit. That’s because it would reduce the tax collected on capital gains without reducing the offsetting interest deductions claimed by investors who borrowed money to purchase stocks and other assets. As law professors Daniel Hemel and David Kamin put it in a paper last year, “The effort to eliminate the taxation of phantom gains leads to opportunities for the creation of phantom losses.”
A fiscally responsible, rule-of-law-respecting administration would summarily reject the idea of indexing capital gains for inflation by executive order. Here’s hoping the current administration rejects it too.