CAPITAL GAINS (LOSSES) TAXATION

DEFINITION: A capital gain or loss is the difference between the cost of a capital asset and the proceeds received from the sale of that asset.

DISCUSSION: If one purchased a capital asset in 1955 for $1,000 and sold it in 2011 for $11,000, he or she would have a nominal capital gain of $10,000, but the economic gain would be less. The economic gain can be calculated by translating the 1955 dollars into 2011 dollars. Assuming the CPI (consumer price index) ratio of the 2011 to the 2011 is 15.0, the adjusted (real) cost equals $15,000, therefore the transaction would have resulted in an economic loss of $5,000.

If the tax code specified that there would be no distinction for capital gains from other income, the taxpayer would have to pay tax based upon a $9,000 gain. I think that result would fall within the ‘insult to injury’ genre.

In an effort at mitigating the inequity, Congress legislated that capital gains would be treated differently from other income.

Congress should have legislated that the base cost be adjusted (translated) into current dollars, but it, recognizing the problem and wanting to mitigate the unfairness, took an easy, but illogical and short-sighted, route by providing an arbitrary 50% (this has varied) reduction in the amount of the nominal gain that would be subject to income taxes.

There are short-term and long-term capital gains. Currently, a capital gain is long-term if the sale takes place more than one year after the purchase. Only long-term capital gains qualify for this beneficial tax treatment.

A holding period of one year to establish the status of ‘long-term’ appears to create the atmospheric conditions, which might act as a catalyst to stimulate market highs and lows for the purpose of creating long-term capital gains, thereby converting ordinary income into preferentially treated long-term capital gains. Artificialities are not good and will most likely be accompanied by unintended consequences.

The lure of profit should be sufficient to entice investments in capital assets. This lure is, also, attributable to short-term capital gains.

CONCLUSION: I suggest that legislation be passed to eliminate the current taxation of capital gains and to initiate a method of taxation that would index the base cost of a capital asset.

This change would be vasly more equitable, efficient, and effective than the current taxation of long-term capital gains, but would probably eliminate a great deal of the creativity of tax planners and Wall Street.

mz
09/19/11