Donald Trump loves to cut taxes, particularly on the rich. Donald Trump also loves to do things without Congress’ permission, like start trade wars.
Now, the White House appears to be contemplating a proposal that would combine our president’s two great loves into one, by using a legally questionable regulatory move to enact a $100 billion tax cut for the wealthy without bothering to pass a pesky bill through Capitol Hill first. In an interview reported Monday by the New York Times, Treasury Secretary Steve Mnuchin said his department is looking into whether it can unilaterally alter the rules Americans use to calculate their capital gains taxes in order to account for inflation when they sell assets like stocks and bonds, a technical tweak that would result in a huge windfall for investors.
“If it can’t get done through a legislation process, we will look at what tools at Treasury we have to do it on our own and we’ll consider that,” Mnuchin told the Times. He added that Treasury was still “studying” whether it could make the change on its own.
While cutting taxes for the rich by decree may seem like an overwrought parody of Trump’s specific governing ethos, this idea has actually been on the wish list of Wall Street conservatives for decades: The George H.W. Bush administration examined and rejected the idea all the way back in 1992. None other than Larry Kudlow, director of Trump’s National Economic Council, has been a longtime proponent, which may help explain why this plan for a glorified bank heist is enjoying new life today.
Here’s how the plan would work. Today, investors pay capital gains taxes on the difference between the purchase price of an asset and its sales price. If you bought Netflix at $100 per share and later unloaded it at $400, you would owe the IRS taxes on a $300 profit. (Also, congratulations, you’re buying our next round of drinks.) The Treasury is debating whether to let investors adjust the purchase price of their assets for inflation when they do this math. Under this system, if you held those Netflix shares for three years during which inflation averaged 2 percent annually, you would report to the IRS that you bought them for about $106 a share, and pay taxes on a $294 profit.
This change would be both expensive and deeply regressive. In March, analysts at the Penn-Wharton Budget Model estimated that indexing capital gains taxes to inflation would cost the federal government $102 billion over a decade in lost revenue. Leonard Burman of the Tax Policy Center believes it could be even more of a money suck; based on data from 2012, he’s ballparked the cost at $10 billion to $20 billion per year. (To put that in a little perspective, the feds spend $16.5 billion annually on Temporary Assistance for Needy Families, aka the entire system of cash welfare and work supports that’s supposed to help the poor.) The benefits would largely go to the very wealthy: According to the Tax Policy Center, almost 77 percent of capital gains taxes are paid by households earning more than $1 million per year.
You might think there would be some vaguely plausible policy justification for all of this other than handing out another extravagant tax cut to families pulling down seven figures. If so, you would be wrong.
Advocates for this move—who, again, have been agitating for it at least since the George H.W. Bush administration—usually offer two kinds of arguments in its favor. First, they claim, as usual, that cutting taxes on capital gains will give the economy a boost by encouraging investment. (Never mind that there appears to be more than ample money floating around the capital markets.) Second, they claim it will make the tax code more fair.
This suggestion is ever so slightly less absurd on its face, since there are some reasonable arguments for linking capital gains math to inflation as part of a wider reform of the tax code. The government is only supposed to tax households when they make money, the thinking goes, and if your stock portfolio only keeps pace with the rising cost of living, you’re not really getting any richer. “The fundamental argument [for indexing] is that it measures income more accurately,” University of Pennsylvania Law School professor Reed Shuldiner, who wrote one of the classic papers on the subject, told me. In theory, Washington could make the tweak without losing any revenue by also bumping up the tax rate on capital gains. That might make the internal revenue code conceptually more equitable without pouring grotesque amounts of money into the Mercer family’s yacht fund.
But there are also problems with the idea. For starters, it’s probably a pain. Indexing requires investors to keep careful track of exactly when they buy their assets, which Shuldiner told me is one reason why lawmakers abandoned the idea during the tax reform push of 1986. Doing so today would be easier with stocks—all the trading is digital, after all—but could be tricky with things like real estate and would still require a load of expensive paperwork. More importantly, it’s not really necessary. Indexing was a popular idea 30 years ago, when out-of-control inflation was a recent memory. Today, inflation is low and stable, and investors can basically plan for it. They also pay a lower tax rate on their profits from playing the market than workers do on their wages, which, if you ask an economist, is supposed to be a crude way of easing inflation’s bite.
Trump’s team doesn’t want to change the treatment of investment income as part of a broad, carefully thought out reform plan, however. It’s “studying” whether to tweak the treatment of capital gains without any concern for how it might affect other parts of the tax code. “On a scale of 1 to 10 where 10 is a great idea and 1 is an awful idea, it’s 2 or 3,” Shuldiner told me. Aside from handing a giant, unearned tax break to investors who bought stocks years ago, the move could create opportunities for new or more profitable tax shelters. “Indexing via executive action would be an invitation to arbitrage,” tax law professors Daniel Hemel of the University of Chicago and David Kamin of New York University wrote in a recent paper critiquing the administration’s idea. The move would be a giveaway not just to the wealthy investor class but also to their accountants.
In their paper, Hemel and Kamin argue persuasively that the Trump administration lacks the legal power to make this change by fiat. Tax lobbyists say Treasury has the authority because it’s supposedly ambiguous what Congress meant when it inserted the word cost into the tax code during the early 20th century. Very few others seem to think this is the case; the first Bush Justice Department concluded that “the legislative record evidences a clear congressional intent that ‘cost’ be given its common and ordinary meaning, that is, price paid in nominal dollars not adjusted for inflation.” The debate is even more absurd when you consider that Congress has changed the capital gains rate many times over the years, and none of its budget projections involved indexing the tax to inflation.
But a weak legal argument might not stop the White House from acting. Kamin told me he was worried that Treasury might go ahead with the change, knowing it could be overturned in court, because it could still give investors a chance to sell off their stocks at a lower tax rate. “They might hope that in the interim they let the horse out of the barn and a few people get large windfalls,” he said. If so, it would be a pure smash-and-grab on behalf of the rich. What could be more Trumpian?