Indexation of Capital Gains Is a Limp Solution to the Wrong Problem
When the 21st century began, the dollar was surging against the euro, Australian dollar, Canadian dollar, Swiss franc, and seemingly every other major currency. At the same time the price of gold (gold being the most objective measure of a currency’s value) was moving around in the $250 range. Just twenty years before, gold reached a then all-time high versus the dollar of $875. Though the dollar’s price would be unchanging in a reasonably sane world, it’s worth pointing out for the purposes of this piece that from 1981 to 2001, the dollar was rather strong. And then it wasn't.
Without going into too much detail, presidents get the dollar they want. George W. Bush’s Treasury wanted a weak dollar, and the markets complied. The latter was a broad repudiation of the currency policies that had mostly prevailed under Presidents Reagan and Clinton. Whereas the dollar had been “strong” versus other currencies and gold throughout the last two decades of the 20th century, it proceeded to plummet versus those same currencies and gold. Amid the dollar’s descent, oil spiked much as it had in the 1970s. Was oil suddenly scarce thanks to a failure among oil producers to meet demand? No. The dollar in which oil is measured was a fraction of its previous self. Oil reflected this truth.
Where it gets interesting is that “inflation” as measured by CPI didn’t mirror the dollar’s stupendous fall. While inflation is most certainly an effect of a decline in the unit of account (in our case, the dollar), and while measures of inflation in the 70s reflected the dollar’s sad devaluation, they didn’t in the 21st century. Even though the dollar was historically weak such that gold hit an all-time high of $1900 in August of 2011, the measures of inflation used by economists didn’t broadcast the greenback’s weakness. You see, inputs like food and energy known to be most sensitive to monetary error had been stripped out of the inflation indices such that what was, wasn’t. Inflation as calculated by government can be whatever bureaucrats want it to be. Eager to obscure (at least in headline form) Washington’s desired devaluation of the dollars we earn, what would normally have exposed the inflation was subtracted from the measure. A period of intense dollar decline (that’s what inflation is) didn’t reveal itself through CPI and the rest.
Which brings us to a debate presently taking place inside the Trump Treasury about capital gains on investment. As the Washington Post unhappily put it, there’s talk of a “tax cut for the wealthiest Americans” that would allow for capital gains “to be adjusted for inflation in a way that shields more of it [the gains] from taxation.” About the debate, it should always and everywhere be the goal of Republicans to reduce taxes on investment in any way they can. The problem is that this tax cut won't do that despite what supporters tell us. The excitable proponents of an inflation tax cut miss by a mile. Let’s call their policy miss a non sequitur as Republicans attack a symptom of inflation rather than the real problem. But first, a digression.
As readers can probably gather based on the Post's reporting, the left are up in arms about what the Trump administration may or may not do. Over at the New York Times, the endlessly confused Jim Tankersley (writing with Alan Rappeport) attacked the very notion of reducing the tax burden faced by investors as yet another giveaway to the supposedly devious rich. As Tankersley and Rappeport explained it, “[C]apital gains taxes are overwhelmingly paid by high earners,” “[I]ndependent analyses suggest that more than 97 percent of the benefits of indexing capital gains for inflation would go to the top 10 percent of income earners in America,” plus “the benefits would go to the super wealthy – the top 0.1 percent of American income earners.” You get it. If the rich benefit, that's really bad. Except that the rather self-unaware Times scribes unwittingly revealed an obvious truth: the rich create all the jobs. If they're capturing the majority of investment gains, simple logic dictates that they're putting the most wealth at risk. How fun it would be for Tankersley and Rappeport to be asked how corporations and jobs are created other than through investment funds that the rich uniquely supply. They would have no answer. Investment is the source of all job creation. The rich, per Tankersley and Rapperport, are the source of most investment. The mildly sentient get it. But that’s once again a digression.
Back to the wildly giddy proponents of indexation, you’d think Treasury had happened upon a previously undiscovered constitutional power to rid us of the income tax, or an ability to implement a much lower flat tax. Talking to the Times about indexation, Grover Norquist enthused that “[T]his would be in terms of its economic impact over the next several years, and long term, similar in size as the last tax cut.” Ryan Ellis, former tax policy director at Americans for Tax Reform, told the Times the benefits of indexation would be near immediate. Another tax-cut proponent said the impact on the economy would be “gigantic.” NEC director Larry Kudlow is known to be on board with indexation. It says here supporters are overpromising by a mile. Kudlow knows why. As he explained it in his very excellent book American Abundance,
“Inflation is a devastating tax on savings. But low inflation is a tax cut. By enhancing the value of financial assets, price stability rewards patient savers and investors. It is a stimulant to capital formation, new business start-ups and growth. Growth does not cause inflation, low inflation causes growth."
Kudlow was describing the Clinton years during which the Robert Rubin Treasury made a point of not talking down the dollar. That the dollar was not being devalued was a huge driver of the powerful stock market rally while Clinton was in the White House. As Kudlow put it, the strong, stable dollar was the “single most significant, inter-galactic, extra-celestial, interplanetary, and spiritual force behind the global stock market rally.” Kudlow understood then and understands now that inflation is an effect of the devaluation that logically drives away investors. Investors are buying future dollar income streams when they put money to work, which means that devaluation (inflation) acts as a tax on their capital commitments. It’s all very simple.
Looked at through the prism of capital gains indexation, Kudlow knows well that inflation as it’s measured today in no way captures the dollar devaluation that is the true tax on investors. Because it doesn’t, indexation of capital gains is the baseball equivalent of a bunt when a grand slam is needed. But even that’s giving indexation too much credit.
Even if CPI and other measures did capture the horrors of devaluation, indexing of capital gains would still be near meaningless. It would be because as Kudlow knows well, there are few capital gains to be had when the dollar is being diminished. The Bush (W.) and Carter years confirm this. Crucial here is that if the dollar is stable, there’s no need for Treasury to index anything.
The Republicans need to go back to the drawing board. They control all three federal branches. They should stop playing smallball, and stop overpromising. Their excitement about indexation of capital gains is the personification of overpromising. How about a big capital gains tax cut instead? Love or hate Donald Trump, he likes to sign big things. So give him something big to sign. And get him on board with a stable dollar, as opposed to vainly indexing away the horrid effects of one without an anchor.