Republicans may have only one more chance to pass major legislation this year, and one question is whether they will use it to deliver another tax cut to the wealthy. One idea on the table would be to index the capital-gains tax to inflation — letting investors and homeowners off the hook for taxes on the real, not phantom, gains they actually pocketed.
After the price surge of the past five years, indexing would be a major windfall. For the investor class.
The statutory tax on long-term capital gains tops out at 23.8%, including the 3.8% Medicare surcharge on investment income. This rate applies to nominal gains, unadjusted for inflation, which means sellers of assets pay tax on phantom gains — the inflationary component representing no real increase in wealth. Indexing would codify that windfall and lower the effective rate on the largest source of wealth in the country.
Economists have long debated this question. Arthur Laffer, the supply-side economist whose tax-cut prescriptions helped concentrate wealth at the top over four decades, recently ran updated calculations showing how high the implicit subsidy to capital holders can be, assuming an asset is held for five years and earns a 5% inflation-adjusted annual return. Starting since inflation took off in 2021, he finds the effective tax rate on real capital gains has climbed to 51%, up from about 30% in the second half of the 2010s — evidence the wealthy are now paying closer to what their real gains actually cost the public.
That is not yet as high as a peak inflation-adjusted tax rate of nearly 130% on capital gains in the 1970s, when the wealthy paid a fairer share and the economy grew anyway. The line on Mr. Laffer’s chart has moved in the right direction — toward taxing real wealth rather than phantom gains — after several decades in which inflation was low and capital was taxed less than its real-world cost to the public.
The fix Laffer and his allies want is to let taxpayers “step up” their tax basis in line with inflation. It is also political cover for a Republican Party that has lost the argument on kitchen-table economics and is reaching for its familiar donor-class playbook. The talking point is that capital-gains tax cuts stimulate broad-based investment and growth — a claim with no record of delivering broad-based prosperity, dressed in the same “rising tides” rhetoric that has accompanied decades of broadly flat real wages for most working households.
The change would help the middle class is the line; the dollars tell a different story. About 74% of returns that filed a capital gain in 2022 had household incomes of less than $200,000, according to Internal Revenue Service data parsed by Americans for Tax Reform — a count of returns, not of dollars. The vast majority of capital-gains tax revenue comes from filers well above that threshold, where the bulk of the gains live. Profits on selling a home are taxed as capital gains, and the $250,000 exclusion ($500,000 per couple) lets most ordinary homeowners off entirely. The change would help investors with multiple properties and landlords who don’t qualify for the exclusion on rental or second-home sales, not the empty-nester who already claims the exclusion on their primary residence.
To that point, here is a chance for Republicans to lay down a marker on who they actually serve. The income-tax brackets are indexed to inflation already, to prevent bracket creep on wages. Capital gains are taxed on nominal gains today, which is why sellers pay tax on phantom inflation and end up closer to the real-world cost of their wealth — and indexing would undo that by letting them off the hook for taxes on gains they did not, in fact, realize in real terms.
The country needs someone to stand for the idea that yesterday’s inflation should not become tomorrow’s windfall for investors and homeowners whose real gains would otherwise help fund the schools, hospitals, and services the country actually needs. Republicans still have time to do the right thing instead.
