On Monday, as negotiations over a fourth coronavirus stimulus package dragged on in Congress, President Donald Trump told reporters at the White House that he was "seriously considering" cutting taxes on capital gains to help boost the economy.
"We are looking very seriously at a capital-gains tax cut, and also an income tax cut for middle-income families," Trump said during the news conference.
Chief economic adviser for the White House, Larry Kudlow, and Treasury Secretary Steve Mnuchin on Wednesday separately clarified that the president does not have the authority to unilaterally cut the 20 percent long-term capital gains tax rate without Congress, which the administration is now pushing to cut by 5 percent.
"We'd like to take it back to 15 percent, where it was for quite a long time because it helps jobs, investment, productivity, and wages," Kudlow told reporters.
For those making less than $425,800 per year, the rate is already 15 percent, which highlights why come critics of cutting capital gains during the COVID-19 crisis say wealthy investors are the real beneficiaries.
"If you look at the distribution of capital gains, it's mostly going to folks who are probably doing fairly well or doing better than a lot of folks who are vulnerable right now," Garrett Watson, a senior policy analyst for the Tax Foundation, told Cheddar.
At the moment, it's unclear if the administration will take any executive action on capital gains, but there is another proposal, long advocated for by Kudlow and other Republicans, to effectively reduce the capital gains rate by indexing it to inflation, which would adjust the rate based on a "price index" that rises with inflation.
The way capital gains tax currently works is that a levy is assessed on the positive difference between the original price of an asset and the amount it sells for. With indexing, whatever percentage of that difference is attributed to inflation would be tax-free. For example, if an investment returns 5 percent over a certain period, but inflation rises 5 percent over that same period, then those gains would not be taxed.
In theory, this would put more money into the pockets of investors who can then cycle it back into the economy, but some tax experts argue that either indexing or direct cuts would offer minimal short-term relief and would likely benefit higher-income brackets rather than those most impacted by the coronavirus pandemic.
Kudlow's Hobbyhorse
The capital gains tax, an extension of the personal income tax, is currently divided into short-term and long-term capital gains.
Short-term capital gains are taxed at the regular rate based on your income level, along with wages, salaries, tips, etc., while long-term capital gains, those held for longer than a year, are taxed at a lower rate across three basic income brackets.
For those making $38,600 or less, the rate is zero percent. For everyone making between $38,600 and $425,800, the rate is 15 percent. For everyone above that, the rate is steady at 20 percent.
While Republicans have been tossing around the idea of indexing the rate since the inflation-wracked 1970s, President George H.W. Bush was the first to consider doing it with an executive order, that is until doubts about its legality squashed the proposal.
"The Justice Department concluded under the Bush Administration that it was not legal for the Treasury Department to do this unilaterally, that it would require legislation to pass through Congress, so it was dropped at that point," Kyle Pomerleau, resident fellow at the American Enterprise Institute, told Cheddar.
In the three decades since, the proposal was introduced several times in Congress, including one bill that was vetoed by President Bill Clinton. It wasn't until 2018 that a presidential administration once again proposed doing it administratively.
Kudlow started promoting indexing as part of a broader package of reforms he called "tax cuts 2.0," which were intended as a follow up to the administration's massive 2017 tax reductions.
At the time, the pre-COVID-19 economy was soaring, with record employment rates and an ascendant stock market. So Kudlow framed the proposal as something that would produce long-term growth, rather than provide short-term economic assistance.
He also emphasized his belief that not indexing was fundamentally unfair to investors.
"It is an unfair and misguided policy that punishes risk and success," Kudlow wrote in a column for Investor's Business Daily.
While Kudlow has since changed focus — arguing that cutting capital gains is crucial to a Phase 4 relief package — others maintain that indexing is a reasonable measure that nonetheless won't do much to alleviate the current economic downturn.
Bang for Your Buck
"A capital gains tax cut is probably not the place to focus on right now, either as a method of long-term growth, because it doesn't give you a lot of bang for your buck, or as a method of short-term growth because it isn't particularly well-targeted," Watson said.
The Washington, DC-based Tax Foundation released a study in February showing that indexing capital gains would increase the size of the economy by 0.11 percent, raise wages 0.08 percent, make the capital stock 0.26 larger, and add 21,800 full-time jobs.
Indexing would also reduce federal revenue by $178 billion over the next decade, according to the Tax Foundation analysis.
"There is evidence that indexing capital gains can have a positive effect on the economy, including job growth," Watson said. "The big question is: compared to what? Are there better tax changes we could make that may reduce revenue but increase growth more?"
Watson explained that the U.S. is currently awash in savings, so reducing taxes on capital gains wouldn't have the immediate economic impact that Trump and Kudlow described. The more pressing problem with the economy, he added, is a lack of viable investment opportunities due to low economic productivity.
In general, tax policy experts agree that indexing the tax code is a good thing. What they are more skeptical of is doing it piecemeal.
This could lead to what Watson calls tax arbitrage, which is when someone profits from inconsistencies in the tax code.
Outside of making the tax code potentially riper for manipulation, indexing is likely to benefit high-income taxpayers the most, according to both Watson and Pomerleau.
"Cutting taxes on savings and investments is maybe important and a reasonable goal for tax policy, but it doesn't seem to have much relation to the current economic situation," Pomerleau said. "I think providing economic relief to households makes more sense, and indexing doesn't go to households in need."
Skepticism of the proposal extends beyond tax experts to stalwart members of the financial community, which ostensibly has the most to gain from indexing or cutting the capital gains rate
CNBC host Jim Cramer tweeted Monday that "The rich do not need help. The unemployed do... The small business person does. That person does NOT have capital gains."
