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Question: It seems to me that a large portion of "capital gains" is actually caused by inflation (depreciation of the value of the dollar) and that the federal tax on capital gains is just another way to unjustly penalize (gouge) those who own property of some sort. It would seem fair, honest and logical to adjust capital gains for inflation, which is largely caused by the federal government. Why have we never heard of adjusting capital gains for inflation?
— Mike Frimpter; Naples, FL
Answer: The British do adjust capital gains for inflation, but at least when I last lived there in the early '90s the capital-gains tax rate was the same as the income tax rate, then 40%. One problem with adjusting the capital gains tax for inflation is that the accounting quickly gets very nasty -each asset has to be deflated by the consumer price index (CPI) for the month in which it was bought. So the preference here is to compensate by having a lower capital gains tax rate.
An even worse rip-off in the United States is the income tax on U.S. Treasury bonds. If you're in a 45% tax bracket (including state and local tax) and you buy a 10-year Treasury yielding 4% while inflation is 3%, you will receive net 55% x 4% = 2.2%, while your capital will erode by 3%. In short, you will be worse off on an after-tax basis. Even worse, the inflation-linked Treasury Inflation-Protected Securities (TIPS) are taxable both on income and on an increase in inflation. That means that a 2% TIPS will pay 45% x (2%+3%) in the above case, and the holder will be left with income of 2.75% plus a capital gain, while inflation is 3%.
Needless to say, this excess tax – like the far-too-low current interest rates, happens because it's convenient for politicians.
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