Capital gains taxes in the US are variable today. If you hold a security for less than one year, you are taxed as normal income. If you hold it for over one year, you are taxed at a graduated rate: 0%, 15%, or 20%, depending on taxable income. An additional 3.8% tax is added for high earners. A primary residence sale may generate a capital gain on equity generated during ownership. As it stands today, a homeowner may receive a gain of $250,000 or $500,000 (single/married) tax-free. A higher amount is subject to tax. This exemption for homes has been in place since 1997.
Phantom Gain: Without indexing, investors can be taxed on pure inflation even when they have suffered a real economic loss.
Neither of these taxes accounts for inflation. A dollar today is worth more than a dollar tomorrow. If you hold onto a security or residence for an extended time, in real terms you could be theoretically losing money on a sale of the asset. Regardless, it makes sense to ease the capital gains tax, including the potential for indexing for inflation.
Today it is being widely reported that the Trump Administration is considering lowering capital gains for individuals. The source is National Economic Council Director Kevin Hassett and former NEC Director Larry Kudlow.
On Fox News, Kudlow claimed that he had discussed the possibility of indexing capital gains to inflation. He said Trump liked the idea.
Hassett said that lowering capital gains could emerge as part of the White House policy before the midterms.
Either way, a reduction in capital gains would be good for investors, capital markets and holders of private securities. As the percentage of households holding equities continues to rise and is now over 60% of the country, this type of policy could help sway voters towards the Republican platform this coming fall.
In the past, a reduction in capital gains has been tied to an increase in private equity. Analyses around the 1997 and 2003 U.S. rate cuts found PE-sponsored acquisitions roughly doubled in relative terms, with PE buyers also paying higher premiums. This means investing in exempt securities could see a rise in activity as investors see potentially greater benefits for purchasing these risky assets. It would also be good for issuers as they may see an increase in interest from investors.
For public markets, inherently, a lower capital gains tax would help to drive overall markets higher as more investors view participation as beneficial to their overall wealth.
Large segments of the economy are driven by how the populace “feels”. When markets are rising and investors see their wealth on the rise, they are more inclined to spend money helping to fuel the economy. When markets decline, this has an overall impact of causing people to slow or hold back on purchases. While markets have been very resilient, a lower capital gains tax could have significant long-term benefits as firms, including private ones, can access the capital they need to grow and more investors participate in the markets to grow their wealth.
Lower taxes on capital gains encourage investment, entrepreneurship, and capital formation, and can lift GDP, wages, and other taxable income. While it is difficult to predict whether or not a multiplier effect would mitigate any reduction in tax revenue, especially when the budget deficit is on the rise, a lower tax would be a boon for the economy and investors.