NCPA - National Center for Policy Analysis

Tax Bill Uses Obscure Adjustment To Index Capital Gains

August 23, 1999

One of the problems with the recent tax bill passed by the House and Senate is that it was put together in such haste tax experts are only now finding provisions in it that very, very few members of Congress were aware of when casting their votes. One of these is indexing for capital gains, which would protect investors from paying taxes on increases in assets resulting solely from inflation.

Congress may have erred in the way it has gone about indexing capital gains.

  • Instead of using the familiar Consumer Price Index (CPI), the conference bill uses the deflator for gross domestic product (GDP) to adjust assets for inflation.
  • Since the CPI has been used successfully since 1981 to index income tax brackets and the personal exemption, it doesn't really make any sense to switch to the obscure GDP deflator for indexing capital gains.
  • One problem that immediately arises from the GDP deflator is that it does not move in tandem with the CPI .

In general, the CPI tends to rise faster. The reason is because the deflator indexes inflation for the entire economy, whereas the CPI is limited to measuring prices for consumer goods and services only. Thus using the deflator is going to give investors less of a tax break than they may be expecting.

Another problem is that the GDP deflator is often revised, while the CPI never changes. This makes the deflator extremely inappropriate for tax purposes.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, August 23, 1999.


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