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Opinion Editorial
Monday, March 31, 1997
Inflation Wipes Out Capital Gains Bruce Bartlett	A new study from Congress's Joint Committee on Taxation (JCT) provides fresh evidence of the deleterious impact of inflation on capital gains. The study looked at a sample of taxpayers with sales of corporate stock in 1994, with such sales broken down by how long the stock had been held. From these data, the JCT was able to decompose the gains into their real and inflationary components. They show that 35.1 percent of reported capital gains on corporate stock in 1994 represented nothing but inflation (see figure). The longer a taxpayer held on to his or her stock before selling it, the more inflation tended to erode the gain. Indeed, inflationary gains exceed 100 percent of some nominal gains, meaning that in real (inflation-adjusted) terms the taxpayer actually experienced a loss. These new data confirm the results of previous studies of the impact of inflation on capital gains. A 1978 study by Martin Feldstein of Harvard and Joel Slemrod of the University of Michigan found that the $4.5 billion in nominal capital gains on corporate stock reported in 1973 represented a real loss of $1 billion. A 1980 study by Robert Esner of Northwestern University aggregated all capital gains by households between 1946 and 1977. He found that inflation wiped out more than 100 percent of all gains, leaving households with a real loss of $231 billion over the whole period. A 1985 study by the Treasury Department found that the $5.7 billion in gains on corporate stock reported by taxpayers in 1977 actually represented a real loss of $3.5 billion. A 1990 study by the Congressional Budget Office found that the $17.7 billion in nominal gains on corporate stock in 1981 were actually a real loss of $5 billion. The reason why this is important is because taxes must be paid on inflationary gains, even though they do not represent any real increase in purchasing power. As a consequence, taxes can easily eat up more than 100 percent of any real capital gain, even though the top statutory rate is just 28 percent. Moreover, taxpayers with the same nominal gains can pay wildly different real effective tax rates, depending on how long they held their assets and the rate of inflation. And the impact of inflation tends to be greatest for middle income taxpayers. According to the Treasury Department, the effective tax rate on all capital gains in 1994 was 23.7 percent. With inflation accounting for $800 million of gains reported in 1994 in the JCT sample, this suggests that these taxpayers alone paid $190 million more in capital gains taxes that year than if capital gains were indexed to inflation. The figure for all taxpayers would be close to $13 billion. Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, March 31, 1997. For more on Capital Gains Taxes and Growth go to http://www.ncpa.org/pi/taxes/taxes3.html#5 Home |  Support Us |  All Issues |  Social Security Debate Central |  Contact Us