What are capital gains, really?

Before he left office for the first time in 2020, President Trump had advocated indexing to inflation the tax on capital gains.  Why?  Because a significant portion of the taxable gain was really the result of government-induced reduction in the value of money, AKA inflation...and not the real appreciation of the asset.  But then the forces of evil prevailed, and the tax on capital gains has remained untouched.

It would be nice if someone in the political sphere would mention that the existing and excessive taxation of capital gains is a major cause of urban blight.  What?  Really?

An investor in rental property, AKA a landlord, tends to grow old along with everyone and everything else.  As the property depreciates, so does the landlord.  In a less imperfect world, the aging landlord would sell the property to a much younger and more ambitious new investor, who would embark upon a major renovation of said premises.  But for the old landlord to do this, he would have to cough up about 20% of his “profits.”  Using the online inflation calculator, had he held the property for a mere twenty years, inflation would have added 63.4% to its value — or almost $317,000 to an original purchase price of $500,000.  Again, this is in addition to the actual market-driven increase in value.

So the old landlord holds onto the property — as it continues to depreciate — and waits for his heirs to inherit said premises with the statutory readjustment of the taxable principal amount.  Meanwhile, real-world depreciation continues — AKA blight.

Yeah, there’s the 1031 exchange, but by doing so, someone wanting to escape from being a landlord remains trapped in the role.  The exchange was originally configured to allow stock traders to avoid excessive taxation, but the principle was logically extended to most forms of investment.

By the way, investing is a good thing.  It would be nice if more folks did it, but various political tricks such as rent and eviction control scare investors away, making them search for safer locations.  Where I live, a huge additional property tax is imposed on vacant properties so as to encourage the increased availability of housing units, largely to accommodate drug-addicted vagrants who would otherwise be littering the landscape.

But the dumbest proposal of the modern era regarding capital gains was first burped out by then–Treasury secretary Janet Yellen.  She publicly advocated imposing a tax on unrealized capital gains.  Not only would the amount of gain have to be guessed at by some kind of appraisal, but, since no transaction had yet occurred, there were no proceeds that could be used to pay the tax.  Such a lame idea, if implemented, would have murdered the stock market along with a lot of other worthwhile investments.  And yet Yellen kept her job all the way until Biden lost his.

What gets left out of much economic palaver is the importance of capital formation.  The great historical example concerns America during WW2.  So many consumer items such as automobiles were unavailable that workers opted to take much of their pay in war bonds — which were strenuously promoted.  When the war ended, this stockpile of wealth was converted into suburban housing and other deferred niceties. 

Had capital formation been considered while Social Security was being concocted, the system wouldn’t be such a basket case today.  Back then, the population was a lot younger than it is now — and the pool of money could’ve been invested in mortgages and corporate bonds instead of just gathering dust in some D.C. bureaucratic warehouse.

Economic ignorance in the political world is excruciatingly commonplace.  Another example comes from Amity Shlaes’s The Common Man.  During the Great Depression, it was mandated that corporate profits be disbursed to the stockholders in order to put more money into circulation.  This prevented capital formation that could be used for technological modernization and just plain physical plant expansion — unless borrowed money was used, at additional expense.

We are now witnessing a housecleaning of all this garbage.  The bitter clingers to the status quo are rising up, though pathetically, to impede this process.

<p><em>Image: pasja1000 via <a href="https://pixabay.com/photos/money-cash-currency-finance-3125447/">Pixabay</a>, <a href="https://pixabay.com/service/terms/">Pixabay License</a>.</em></p>

Image: pasja1000 via Pixabay, Pixabay License.

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