Written by: Keith Frame, CPA

Are capital gains tax rates a give-away to the rich? It seems I continue to hear this argument in the super-hyped partisan atmosphere we live in these days.

Perhaps low long term capital gains rates do spur economic activity that is beneficial to the economy as a whole – I would argue that they do.

But lost in all the politics is a basic economic fact as to why long term capital gain rates should be lower than tax rates on other income.

Let’s say for example you purchase a capital asset such as a stock and hold it for ten years. You paid $10,000 for it in year one and sell it for $20,000 in year ten. Inflation during this period of time is 3% per year.

Tax law says your taxable gain is $10,000 even though $3,439 of that gain is attributable to inflation alone. This is the basic economic argument for lower rates on long term capital gains – it’s only fair! A lower rate is just a simpler way of adjusting for the effects of inflation in tax law.

Tax law previously allowed us to exclude a portion of capital gains from taxation. This provision was eliminated during the Reagan tax reform years when all tax rates were brought down substantially. The lower capital gain rate was reinstated as tax rates drifted back up during the 1990’s.

Subjecting long term capital gain income to the same tax rates as all other income is an inherently unfair scheme that taxes income that doesn’t exist.