Letter to Treasury Secretary Mnuchin in Support of Indexing Capital Gains for Inflation

By SBE Council at 17 July, 2019, 12:36 pm

The Honorable Steven T. Mnuchin

Secretary

U.S. Department of the Treasury

1500 Pennsylvania Avenue, N.W.

Washington, D.C. 20220

Dear Secretary Mnuchin:

On behalf of the Small Business & Entrepreneurship Council (SBE Council) – an advocacy, research and education organization with more than 100,000 entrepreneur members and small business supporters nationwide – I am writing to express our strong support for using your authority to modify the calculation of capital gains for tax purposes to include the costs of inflation.

The taxation of capital gains arguably is one of the most economically destructive levies imposed by government. By reducing the potential returns to entrepreneurship and investment, the capital gains tax restrains business creation and development, and diminishes economic, income and employment growth.

Meanwhile, failing to index capital gains for inflation means that the real capital gains tax is markedly higher than the stated nominal rate. As SBE Council’s chief economist Raymond J. Keating explained in a December 2018 analysis:

[S]ince capital gains are not indexed, inflation increases the real capital gains tax rate. For example, the current nominal top federal capital gains tax rate on individuals stands at 23.8 percent. But consider what inflation does to the real capital gains tax rate.

Let’s take an example of a $1,000 investment that rises to $1,403 in five years at a 7 percent annual return. It is sold for a nominal capital gain of $403, with a capital gains tax of $96 resulting from the 23.8 percent rate. That tax already is too high given the importance of entrepreneurship and investment to economic, productivity, income and job growth, but when inflation is factored into the equation, the real rate rises much higher.

Even at a tame 2 percent annual inflation rate, the real capital gains tax rate on this investment jumps to 32.3 percent. At 3 percent annual inflation, the real tax rate is 39 percent, and at 4 percent annual inflation, the real capital gains tax rate hits 48.2 percent. That’s more than double the stated nominal rate.

In fact, it’s clear that capital gains taxes can even be paid on a real capital loss. That not only is counter-productive from an economic growth standpoint, but it also is glaringly unfair.

In terms of determining capital gains, the Treasury Department has the ability to add an inflation factor to the calculation. Most economists, investors and entrepreneurs will tell you that inflation is a very real cost, including when it comes to investment and returns. Indeed, the economic wisdom of indexing capital gains for inflation is not seriously in dispute.

The real question is a legal one, and at least two analyses – “The Legal Authority of the Department of the Treasury to Promulgate a Regulation Providing for Indexation of Capital Gains” by Charles J. Cooper, Michael A. Carvin and Vincent J. Colatriano, “The Regulatory Authority of the Treasury Department to index Capital Gains for Inflation: A Sequel” by Charles J. Cooper and Vincent Colatriano – show that it is permissible for the Treasury Department to use its authority to line up the calculation of capital gains with sound economics.

In the second analysis noted above, it was concluded: “To the contrary, jurisprudential developments over the last two decades have confirmed much of our original analysis and reinforced and strengthened our original conclusion that Treasury has regulatory authority to index capital gains for inflation.”

Taking the reasonable step of including an inflation adjustment in determining capital gains would boost incentives for entrepreneurship and investment, and unlock financial capital to be reallocated more efficiently. That would be good news for the creation and development of businesses, and for economic growth in the near term and over the long haul.

Thank you for your consideration of our views, and please do not hesitate to contact me for questions or additional information.

Sincerely,

Karen Kerrigan, President & CEO