Monday, February 4, 2008

Inflation and the IRS

"Rudy Giuliani's tax-reform proposals includes indexing capital gains taxes for inflation--that is, putting the original price of the asset in today's dollars. ... Accounting for inflation in this way has the advantages of producing more short-term revenue to the Treasury as long-term gains are 'unlocked.' ... The debate centers on the definition of income. ... To be money or its equivalent, the payment must have the power to command goods or services produced in the economy. Thus, if the money received from the sale of an asset cannot command more goods and services than the original capital invested, there clearly has been no income. Too few judges and members of Congress have a basic understanding of economics. As a result, they do not readily see how small but steady losses in value over long periods (except when it comes to their own salaries) is damaging. Inflation of 2%, 3% or 4% per year may seem trivial, but over time it causes great distortions--the U.S. dollar is now worth less than 1/20th of what it was worth in 1913 when the Fed was established", Richard Rahn (RR) at the WSJ, 17 January 2008.

"The tax code is what it is because proponents of equity have repeatedly incorporated their pet projects without considering the fact that their benefits inevitably breed tax abuses, or demands for equitable relief from other quarters. ... [L]et's also index the other side, debt financing. Creditors could claim inflation losses and debtors would be required to report income for paying back nominal instead of inflation-adjusted dollars. The debtors would then be able to claim a negative inflation adjustment to equity investment, however that might be computed", Del Diebig (DD), letter to the WSJ, 25 January 2008.

"But why not extend this concept to interest income? When a person has a savings account that pays 3%, and inflation is 3%, there is also no real gain", Carl Lind (CL) letter to the WSJ, 25 January 2008.

I agree with RR, "Too few judges and members of Congress have a basic understanding of economics". However I think RR naive to believe they don't understand inflation's effects on taxes. They understand all too well.

DD's and CL's points are well taken. Since they are decades old, I conclude Congress is happy with the IRS Code as is and uses the tax system and inflation to fleece creditors to benefit debtors. See my 5 October 2007 post.

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