Tuesday, February 07, 2012

Cap Gains and Inflation

I noted earlier that the cap gains not being inflation adjusted is an (potentially major) issue. I've since thought about it more and no longer think so. The thinking goes something like this:

I buy a [house, stock, painting, ...] worth a total of $100k. I keep it for 20 years, during which inflation averages 2.5%. I sell it for $250k, a $150k gain, but only an $87k gain when adjusting my original $100k investment for inflation. That's a pretty big difference in income to pay taxes on and I can see why [rich] people would say it is unfair, but the thing is: bullshit!

If I take that same $100k dollars and sock it away in a savings account that pays interest averaging 2.5% over that same time frame, then I end up with ~$164k...but every one of those dollars was (well, should have been) reported on tax forms in each of those intervening years, so I was, in fact, taxed on all $64k of interest. Moreover, I was taxed at my marginal income tax rate which, assuming I am working throughout, is likely to be higher than the cap gains rate!

So even without an adjustment for inflation, low cap gains rate distorts the tax code, and tilts toward wealth, and away from income (and savings). Capital gains should be considered and taxed as normal income. Period.

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