Earlier this month, President Trump announced that he and US Treasurer, Steven Mnuchin, were determining if they had authority to unilaterally pass a massive and permanent new tax cut related to capital gains. While the 2017 Tax Reform Act was spun as a “tax cut for the middle class,” this new proposed tax cut clearly benefits the wealthiest in America. In fact, according to the Wharton School of Business, over 63%[i] of the new proposed tax cut would benefit just one tenth of one percent of the richest families in America.
Under current law, when you buy a stock or mutual fund, the price you pay today is marked as your cost basis or taxable basis. The price you sell that holding for in the future is the market value. The difference between the market value (what you sold the investment for) and the cost basis (what you bought the investment at) is the capital gain, subject to taxation at both the Federal and State levels. President Trump’s new capital gains tax proposal would increase the base purchase price (basis) every year by an inflation factor. This would inherently decrease the gain, and related capital gains tax.
As an example, say you purchase a stock for $10,000 in 1990. It’s grown in value and if you sold it in the market today, you would receive $25,000 for that same stock, resulting in a gain of $15,000. Under the current tax laws, a California resident might be subject to a tax expense of $3,750 (Federal capital gains tax rate of 15% + estimated CA tax rate of 10%). However, under the new proposed tax law, the basis of $10,000 would get marked up every year since the time of purchase for inflation. If we used the CPI index as the inflation factor[ii], the adjusted basis would be closer to $20,000. The resulting gain after inflation would be reduced to $5,000 instead of the original $15,000 gain and the tax might be closer to $1,300; a tax savings of $2,450 or a 65%. According to the Wharton Budget Model, if the capital gains tax change is pushed through, the tax reform would cost the US more than $100 billion in tax revenue over the next 10 years and the top 1% of US earners would take 86% of the benefit[iii].
Democrats are already pledging to fight the measure due to the bias of the capital gains tax bill to benefit the wealthy and the consequential strain on the national budget. Normally changes to the tax code go through Congress, but President Trump knows his tax cut proposal would die there. As such, he and Treasurer Mnuchin are investigating whether the office of the Treasurer has the authority to make this tax change unilaterally. The last time changes to the capital gains taxes were considered was under President George H. W. Bush in 1992[iv]. However, at that time, it was determined that the US Treasury office did NOT have the authority to make changes on its own. Therefore, if President Trump proceeds to circumvent congress and push his tax cut through, his bill will definitely face legal challenges.
Noise regarding the capital gains tax-cut has quieted for now. However, if the tax cut is pushed through, even for a short window of time, the change will unleash a wave of volatility in the stock market. People who have long held stock positions fraught with unrealized gain may sell large stakes of ownership to take advantage of what is sure to be a limited tax-savings opportunity.
Unfortunately, the Tax Reform Act of 2017 and the newly proposed capital gains tax cut benefit the ultra-wealthy at the detriment of valuable government programs like Medicare, Medicaid and Social Security. The gap between the rich and the poor is widening and the middle class is shrinking. The President’s divisive behavior continues to pit people against each other rather than bring them together. Only time will tell where this newest idea settles.