Tuesday, July 31, 2018

I think the NYT's article title says it all

Today in the NYT, an article entitled "Trump Administration Mulls a Unilateral Tax Cut for the Rich" discusses the latest tax and budgetary outrage - a term that I think is justified here - that is under consideration in Washington:

It starts: "The Trump administration is considering bypassing Congress to grant a $100 billion tax cut mainly to the wealthy, a legally tenuous maneuver that would cut capital gains taxation and fulfill a long-held ambition of many investors and conservatives."

The idea would be to index assets for inflation for purposes of measuring capital gain, while not adjusting anything else for inflation.

To illustrate one of the main problems with doing this, Daniel Hemel and David Kamin explain:

"Imagine that a taxpayer buys an asset for $100 that is fully financed by a loan. Assume that the real interest rate is zero, that the inflation rate is 10%, and that the nominal interest rate on the loan is 10% as well. One year later, assuming no change in the real value of the asset, the asset will be worth $110 on account of inflation. If basis is indexed for inflation, the taxpayer can sell the asset for $110 and recognize no taxable gain. Assuming that the interest is properly allocable to a trade or business, the taxpayer can claim an interest deduction of $10 with no offsetting gain, despite the fact that the taxpayer is in the same pretax position as previously.  Put differently, the effort to eliminate the taxation of phantom gains leads to opportunities for the creation of phantom losses."

Inflation is in principle worth addressing, but comprehensively - albeit subject to the complexity costs of doing so, which are less worth incurring when the inflation rate is relatively low (as it has generally been for a number of years). But addressing inflation so selectively and piecemeal, creating heightened inconsistencies all across the Internal Revenue Code, is likely to make things worse, such as by encouraging rampant tax sheltering.

There are also other obvious problems with the proposal. Its being so regressive and losing so much revenue when the long-term fiscal gap is already exploding due to the 2017 tax act, ramped-up military spending, etc., goes beyond being reckless. It is also extremely aggressive as a regulatory move, exposes the hypocrisy of those doing it (who would be outraged if a Democratic administration were half as aggressive), and (as Hemel and Kamin argue) there is a good chance that the courts, at least if they address the issue in good faith, will strike it down as beyond regulatory discretion.

What's more, capital gains already benefit from deferral and a low rate, and even the issue of double taxation of corporate profits (where it's a sale of appreciated corporate stock) already verges on being a non-problem due to tax rate changes, not to mention adjustments in the capital markets.

In sum, despite the fact that inflationary gain is phantom gain as an economic matter, this is a horrible proposal and not one that I believe is being advanced in good faith, either legally or as a policy matter. Rather, it is another payoff to favored constituencies, and when it's financed (as it must be in the long run) many Trump voters will be among the main losers.

6 comments:

Greg Arzoomanian said...

"Imagine that a taxpayer buys an asset for $100 that is fully financed by a loan. Assume that the real interest rate is zero, that the inflation rate is 10%, and that the nominal interest rate on the loan is 10% as well. [...] Assuming that the interest is properly allocable to a trade or business, the taxpayer can claim an interest deduction of $10 with no offsetting gain, despite the fact that the taxpayer is in the same pretax position as previously.[...]"

The taxpayer *did* pay $10 in interest. Why shouldn't he get a deduction for it?

Daniel Shaviro said...

By the same token, the taxpayer netted $10 on the asset. The key here is consistent treatment - both include and deduct $10, or else do neither. The taxpayer paid out $110 and received $110, hence has net income of zero. But if he can exclude the $10 net inflow and deduct the $10 net outflow we have a money machine creating fake losses.

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Greg Arzoomanian said...
This comment has been removed by the author.
Nene W said...

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