President Donald Trump is reportedly pushing for another change in tax policy by indexing capital gains for inflation. Implementing the change is projected to both (i) boost economic growth and (ii) result in a tax cut of $102 billion over the next decade (according to the Penn-Wharton Budget).
The capital gains tax is imposed whenever a capital asset is sold, such as an investment in stock or a mutual fund. Under the current tax law, the investor is taxed at the capital gains rate on the difference between the original price of the investment and the selling price. For example, if stock were purchased for $1 million and sold for $3 million, the investor would be taxed on the $2 million gain.
Under the proposed plan, investors would be allowed to adjust the original value of the investment upwards to account for inflation. In the same example, assume the inflation calculation yields an adjustment of $800,000 between the time the investment was acquired and subsequently disposed. As a result, the original purchase price of the investment would be adjusted to $1,800,000, reducing the taxable gain to $1,200,000. The inflation adjustment could save the investor $160,000 of capital gain tax, using a 20% capital gain tax rate.
The idea has been around for some time but never persevered due to legal challenges. In order for the plan to progress, the Treasury Department would have to redefine the word “cost” under the Revenue Act of 1918. The same plan was considered back in 1992 under President George H.W. Bush, but the Treasury Department determined that there were no legal grounds to support the change.