A Powerful Economic Stimulus Tool

Now that we are faced with a recession, a National Taxpayers Union legal brief, originally issued in 1992 while another Bush was in office, has been reissued. That brief states that President Bush can index capital gains for inflation now to create an additional stimulus for our lagging economy without Congressional approval.

For roughly two decades, significant portions of the U.S. Tax Code have been tied to inflation rates. For example, the personal exemption, standard deduction, and tax bracket amounts for individual income tax returns rise each year to account for increases in the cost of living. Doing so avoids the “bracket creep” phenomenon that pushed Americans into paying progressively higher income tax rates even though their incomes were merely keeping up with inflation. Formerly, this amounted to an automatic tax increase without the necessity of an on the record vote by the Congress.

The most important source of income that remains to be indexed is capital gains. The “real cost” of assets like the stocks and bonds must be inflation-adjusted in calculating the sale profit to ensure that nominal gains due solely to inflation are not taxed. These nominal gains are not real gains because they do not represent any increase in purchasing power. Though the Treasury Department and Congress traditionally have defined “cost” as the asset’s original cost and a “gain” as the difference between the original price and the selling price these definitions are not established law. The Treasury therefore has administrative discretion to reinterpret “cost” to take account of the economic reality that a “gain” attributable solely to inflation adds nothing to the taxpayer’s real wealth or purchasing power. It’s time for the Administration to step forward and correct this major irrationality in the tax code. The legal authority of the Department of the Treasury to promulgate a regulation providing for the indexation of capital gains, is available at
www.ntu.org. The time is ripe to demand that the President, the Secretary of the Treasury and/or the Congress to take action to fix this anomaly in the tax code.

Inflation-indexing keeps taxpayers from being penalized or taxed on phantom gains that don’t result in any "real" increases of purchasing or earning power. Here is a simplified, hypothetical example:

Sale of a $10,000 Asset Held for 10 Years /span>

Current Policy

Original Price $6,000
Amount of Gain $4,000
Tax on Gain (15%) $600

Inflation-Indexing

Original price $6,000
Amount of Gain $4,000
Cumulative Inflation Rate over 10 years: 50%
Inflation-adjusted Gain (50% of $4,000): $2,000
Tax on Gain (15%): $300