There Are ‘Phantom’ Capital Gains Now?
I haven’t paid much attention to the presidential race, but something related to it in the Wall Street Journal caught my eye. Apparently there is such a thing as ‘phantom’ capital gains now and one Rudy Giuliani wants to make sure you’re not taxed on them. So what, you may ask, are phantom capital gains and why should you care?
‘Phantom capital gains’
The term ‘phantom capital gains’ refers to the fact that when you sell appreciated assets (e.g. stocks), you pay capital gains tax based on your basis (the price you paid for them whenever you bought them). Since then inflation has likely eroded the buying power of the dollar. So now that you’re selling them, the cash proceeds you receive are worth less in ‘real’ terms. You must pay taxes on any gains, regardless of that gain’s real buying power. With me so far?
Rudy Giuliani and other anti-tax advocates think people should not be taxed on the full nominal amount of those capital gains. In Giuliani’s plan, the capital gains that are subject to taxation would be indexed for inflation.
It’s a question of who wins and who loses…again
I have to admit, as a stock-owning citizen of these United States, when I first read about it, I was enticed by the idea. Paying less in taxes appeals to everyone’s basest instincts. But as I continued to read the WSJ article, I realized this was a very bad idea indeed.
You see, as I thought about the plan, it occurred to me that although my family owns way more equities than the average person in the U.S., this plan wouldn’t do much for me personally. Most of the stock I own is in tax-advantaged accounts like IRAs and 401(k)s already. Indeed, this is the case for the overwhelming number of people who own stocks in this country at all. Yes, we have a taxable investment account. But its contribution to our overall net worth is relatively small.
And we’re decidedly in the minority of families. Many own no stock at all (about 50% do). Of families that do own stock, many don’t own very much. And, again, most likely they hold it in already tax-advantaged accounts.
Consider that the median (half below; half above) 401(k) account balance in 2006 was $66,650 according to the Employee Benefit Research Institute (EBRI), a well-regarded organization. (There’s a caveat to that number, however. The data only holds for people who held 401(k) accounts for the entire 1999-2006 time period. Many people either don’t participate in 401(k)s at all or did for only part of that time. I don’t want to commit data torture, but you get the point.)
So who would benefit from an indexing of capital gains to inflation? Drum roll please.
Not surprisingly, the wealthy will be the overwhelming winners if a plan like Giuliani’s becomes law. Doing something like this is the opposite of progress, to me. It increases rather than decreases wealth inequality. Whether you agree on whether capital gains taxes are good or bad at all is really immaterial. A tax like this overwhelmingly benefits those most able to pay taxes.
Let me emphasize at this point that a plan like this would benefit me personally. That’s important, because I’m not saying “tax the other guy” as is so often the case. I just think our tax system ought to be progressive and I’d like to see income and wealth inequality in this country shrink instead of grow.
But that’s just me.
January 22nd, 2008 at 11:34 am
Nice analysis. I agree that it sounds good at first. Then I think that my money’s actually in the Roth and there’s no tax anyway. Almost all of my parents’ money (and they’re upper middle class ish) is in retirement accounts. My husbands parents have little or no money invested (lower middle class formerly poor).
January 22nd, 2008 at 12:40 pm
It sounds like Giuliani is fishing for something to scare his base with. What could be scarier than a “phantom” tax? Oh–I know–the AMT. I’d like to hear more about that one.
Re: progressivity. Using statistical terms, I’m a lot more interested in metrics like median and min (and even more in the actual distribution) than in the range (difference between highest and lowest) of incomes/net worths in America. The so-called gap between rich and poor (two Americas, etc) is too simplistic. Some of the gapminder.org analysis of countries would surely apply within a country as well.
January 22nd, 2008 at 11:34 pm
There definitely needs to be a change to capital gains. Perhaps 6 months as a first tier.
January 22nd, 2008 at 11:35 pm
Maybe 6 months would be a good start for a new capital gain holding period.
January 22nd, 2008 at 11:43 pm
Interesting stuff, I deal with phantom income, haven’t heard of this yet.
February 1st, 2008 at 6:04 pm
[…] a while and I like a lot of his articles, I wanted to pull my hair our when I read his article on Phantom Capital Gains. For a quick background on what he was talking about I will paste his first paragraph as he does a […]
September 25th, 2008 at 10:25 am
While you are correct the Phantom Gains relief would exclusively benefit those who invest actively enough to be subject to capital gains tax (the wealthy, as you say).
The fault I find in your logic is that addressing Phantom Capital Gains is not a tax PLAN, rather a solution to one issue that is relevant in today’s economy. No middle or lower class citizen is penalized by the Phantom Gains relief.
Let’s assume I buy an asset for $10m, it earns 10% and i sell it for $11m a year and 1 day later. However, because of current market conditions and uncharacteristically high inflation (ie weak dollar (ie $11m isnt worth as much as it was when i put up $10m)) the government would provide an inflation index that I would be able to apply to that Capital Gain. Let’s say that index was 5%.
Now, my 10% gain is adjusted to 5% (10-5), indicated my realized profit was now $500k, not $1m. Now, rather than paying $150,000 in Capital Gains Tax (15%), I am able to pay $75,000 on my net gain after the Phantom index is applied.
Now, as a “wealthy” business owner, I get to the end of the year and I am looking at my budget. That $75,000 would easily cover an employee with a $60,000 salary, or 2 $30,000 salaries. That’s real.
So is there really no benefit to the “little” guy when you provide legitimate help to SMALL businesses all the way up to the biggest of the big?? My example is happening right now. We run a 3 man real estate investment company. We have 3 principals, all of which pitch in to maintain the general office & administrative duties. With that kind of savings, just my little company could hire that office assistant, inject job growth and help reduce unemployment on a local level.
Now multiply that by how ever many small and large businesses there are across the country looking at their bottom line and making serious financial decisions. There is nothing scary about it.
September 25th, 2008 at 10:27 am
socialism is not progressive.