We wanted to bring you this news as it unfolds. We have noted that the Trump Administration is considering indexing capital gains taxes to inflation. Under the proposal Mnuchin has the legal authority to change the indexing of capital gains taxes from nominal terms to inflation-adjusted terms, without an act of Congress. The proposal would eliminate taxing inflationary capital gains by indexing that gain to inflation and taxing only the after-inflation gain.
Estimates suggest that the tax change would be an 8-25% cut in the effective capital gains tax rate. This proposal increases the after-tax rate of return on stocks and will result in a significant unlocking of capital which would be a positive for US equities.
As far as timing is concerned, August and September have historically been weak months for stocks and Presidential approval ratings during midterm election years. Adjusting the capital gains tax during this time could be used as a work around.
The only taxpayers not receiving a significant tax cut from the 2017 tax changes are the wealthy in high tax states due to the limitations on state and local taxes (SALT). Indexing capital gains taxes to inflation is really a tax cut for the blue state taxpayers hurt by SALT (CA, NY, NJ, CT). High tax states would also likely to get a short-term reprieve from migration pains with federal taxes on capital gains reduced, effectively lowering the total tax obligation residents in high tax states now face. The reduced tax burden may motivate some residents in high tax states to stay where they are. Also, lower taxes on capital gains can unlock that capital (create asset sales) and create a taxable event in which the states can collect their tax. States benefit from this windfall.
A capital gains tax cut is one of the few tax changes that actually pays for itself. In 2003 the capital gains tax was cut by 25%. Following the tax cut, CBO expected to collect $260bn in capital gains tax revenue over five years. Revenues actually totaled $427bn in that time period, 67% higher than projected, as investors unlocked (sold) their capital. The 1997 capital gains tax cut produced similar results.
While there is a belief that Treasury has the legal authority to index capital gains to inflation, the statute is murky enough that a lawsuit would likely follow. We will keep you posted as this development unfolds. Please call or email us with any questions. Source: Strategas