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Issues in the Indexation of Capital Gains

By: Arthur P. Hall, Ph.D.

Download Special Report No. 47

Special Report No. 47

Executive Summary A capital gain occurs, in general, when a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. payer sells an asset for a price that exceeds the purchase price. Indexing capital gains means adjusting the dollar value of an asset’s purchase price (usually upward) for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . This procedure reduces the amount of a capital gain subject to taxation.

Historically, U.S. taxpayers have had to pay taxes on capital gains that result solely from inflation. This practice has led, in many instances, to effective tax rates on inflation-adjusted capital gains that substantially exceed 100 percent.

For an average stock purchased in June of different years and sold in June of 1994, the current capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. Capital gains taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. results from real versus inflation-induced gains. The average stock, as bible / describes, is represented by the value of the Standard and Poor’s index of 500 stocks in June of each year from 1954 to 1994. Therefore, the fraction of the capital gains tax that is on real gains fluctuates, depending upon both the real and inflation-induced price of the stock at the time of purchase date and sale date.