Tax Capital Gains If You Must, But Not Losses

By | May 3, 2021 | 0 Comments

President Biden wants to raise tax rates on capital gains. The progressive view is that this will hit mainly the rich. But in fact, many middle class and working class people have retirement funds or pensions invested in stocks or real estate. And when these stocks or real estate are sold, these taxes apply. So capital gains taxes can affect everyone.

These taxes vary from 34% in Finland to zero in Switzerland. One can argue that capital gains should be taxed like ordinary income like wages, to demonstrate fairness. Or one can argue that capital gains should not be taxed at all, to encourage investment. But no one – except perhaps a lunatic – argues that capital losses should be taxed. But they are.

Take this example. A couple bought a house in 1944 for $15,000. Yes, back then you could by a nice, two-story home in San Francisco for that price. The couple died and their children sold the house in 1967 for $32,000. Before they could inherit a penny, they had to pay a capital gains tax on the “gain” of $17,000. But was it really a gain? From 1944 to 1967, the cost of living roughly doubled. That is, a 1944 dollar was worth about 53 cents in 1967. So the capital gain wasn’t $17,000 but only $1,800. In actual buying power, the couple’s children had almost no gain when they sold their parents’ house.

Currently there is little inflation, though there is more than is claimed. Prices may not be going up sharply – yet. But quality is often going down. If you doubt this, see how rolls of toilet paper fit loosely in holders, because the rolls are about 2 inches narrower than they were a few years ago. But many expect more inflation in the near future. If this happens, many people will owe taxes on capital gains that in reality are losses.

Taxing capital “gains” on long-term investments runs the risk of taxing actual losses in buying power. For the government, this is a source of tax revenue. But for citizens, it is theft. It is also a disincentive for long-term investment. Why invest long term, when inflation may wipe out any paper profits? Better to speculate – get in and get out, while a dollar is still worth a dollar. Discouraging long-term investment is the last thing we should do.

So here is my proposal: Tax capital gains at whatever rate you think appropriate. Tax them like ordinary income if you must. But allow taxpayers to index the paper gain for inflation. Allow them to list the cost price and the selling price in dollars corrected for the cost of living, as published by the government itself. That is, tax gains, not losses.

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