The Trump administration wants to change the way capital gains are taxed to factor in inflation.
To many, this may sound like a technical change of little consequence. To others, such as the Tax Policy Center’s Len Burman, it’s a “windfall” for the very rich who are still adding up their gains from the 2017 tax cut.
As a tax policy expert, I agree that the proposed change could make sense as part of broader tax reform that simplifies the tax code and benefits all taxpayers. But on its own, this policy would only make the tax code more regressive and less efficient.
To understand why, let’s review some of the basics.
What are capital gains?
In economics, a person’s income in a given year should include all inflows of new financial resources that can be used for either consumption or gains in net worth.
A familiar example is your paycheck. But financial resources don’t always come in the form of cash. Income can also come from the appreciation of non-cash assets such as stocks and real estate, also known as capital gains.
Most Americans get the vast majority of their income from wages and salaries. Among the top 1 percent, however, capital gains make up 36 percent of total income.
How are gains calculated and taxed?
The IRS needs to know how much money a taxpayer makes in a year in order to tax her properly under the 16th amendment, which was ratified in 1913 and gave the U.S. the power to tax incomes “from whatever source.”
Unlike wages, capital gains are harder to calculate – and harder to tax.
Ideally, we’d need to know how much value her investments gained. The value of some assets like stocks and mutual funds is straightforward because they are bought and sold frequently. But that’s not the case for assets like real estate or fine art that don’t change hands often. So it’s harder to know their value.
The solution has been to only tax capital gains when they are realized – that is, when the asset is sold. The gain is the difference between the sale price and the original purchase price, ignoring the impact of inflation, which erodes its real value.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMeX is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.