We may have an idea what was the (leaked) reason for today's selloff in Treasurys, which pushed the 10Y yield just shy of 3.00%.
According to the NYT, the Trump administration is considering a $100 billion unilateral tax cut meant to mainly help the wealthy, and is hopes to bypass Congress in implementing it "a legally tenuous maneuver that would cut capital gains taxation and fulfill a long-held ambition of many investors and conservatives."
However, despite the NYT's alarmist take, Trump's proposal actually does make some sense: what it calls for is to inflation-adjust one's long-term cost basis when calculating capital gains tax. Considering that various welfare programs like Social Security are already indexed for Cost of Living Adjustments, the idea is probably not that outlandish, especially if inflation were to suddenly explode higher.
Here's how it would work.
Currently, capital gains taxes are determined by subtracting the original price of an asset from the price at which it was sold and taxing the difference, usually at 20 percent. If a high earner spent $100,000 on stock in 1980, then sold it for $1 million today, she would owe taxes on $900,000. But if her original purchase price was adjusted for inflation, it would be about $300,000, reducing her taxable “gain” to $700,000. That would save the investor $40,000.
Treasury Secretary Steven Mnuchin hinted at the idea during last weekend's G-20 meeting in Buenos Aires, when he told reporters that his department was studying whether it could use its regulatory powers to allow Americans to account for inflation in determining capital gains tax liabilities. The Treasury Department could change the definition of “cost” for calculating capital gains, allowing taxpayers to adjust the initial value of an asset, such as a home or a share of stock, for inflation when it sells.
“If it can’t get done through a legislation process, we will look at what tools at Treasury we have to do it on our own and we’ll consider that,” Mnuchin said, emphasizing that he had not concluded whether the Treasury Department had the authority to act alone. “We are studying that internally, and we are also studying the economic costs and the impact on growth.”
To be sure, any such move would face near-certain court challenges, not to mention cause further turmoil inside the bond market, which is already rather displeased with Trump's recent busting of the US deficit. It would certainly reinforce a liberal critique of Republican tax policy at a time when Republicans are struggling to sell middle-class voters on the benefits of the tax cuts that President Trump signed into law late last year.
Chuck Schumer was, as usual, ready to hand out criticism:
“At a time when the deficit is out of control, wages are flat and the wealthiest are doing better than ever, to give the top 1 percent another advantage is an outrage and shows the Republicans’ true colors,” said Senator Chuck Schumer of New York, the Democratic leader. “Furthermore, Mr. Mnuchin thinks he can do it on his own, but everyone knows this must be done by legislation.”
Still, no matter whether an inflation adjustment is justified or not, it is indeed the case that high earners would be the biggest beneficiaries of a reduction in capital gains taxes, which however were untouched in the $1.5 trillion tax law that Trump signed last year.
According an independent analyses cited by the NYT, more than 97% of the benefits of indexing capital gains for inflation would go to the top 10 percent of income earners in America, while nearly two-thirds of the benefits would go to the super wealthy — the top 0.1 percent of American income earners.
In other words, the rich are about to get even richer.
Liberal tax economists see little benefit in it beyond another boon to the already rich.
“It would just be a very generous addition to the tax cuts they’ve already handed to the very wealthy,” said Alexandra Thornton, senior director of tax policy at the liberal Center for American Progress, “and it would play into the hands of their tax advisers, who would be well positioned to take advantage of the loopholes that were opened by it.”
And while the proposal is sure to have a contested fate in Congress - and the courts - two questions remains: how would Trump pass such a law, and who would pay for it.
Making the change by fiat would be a bold use of executive power — one that President George Bush’s administration considered and rejected in 1992, after concluding that the Treasury Department did not have the power to make the change on its own. Larry Kudlow, the chairman of the National Economic Council, has long advocated it.
Conservative advocates for the plan say that even if it is challenged in court, it could still goose the economy by unleashing a wave of asset sales. “No matter what the courts do, you’ll get the main economic benefit the day, the month after Treasury does this,” said Ryan Ellis, a tax lobbyist in Washington and former tax policy director at Americans for Tax Reform. So... would this wave of asset sales also lead to the market crash that Trump so desperately dreads?
The decades-long push to change the taxation of investment income has spurred a legal debate over the original meaning of the word “cost” in the Revenue Act of 1918, and over the authority of the Treasury Department to interpret the word in regulations.
“I think we ought to look at not penalizing Americans for inflation,” said Representative Kevin Brady of Texas, the Republican chairman of the Ways and Means Committee, who said he would like to see the Treasury Department make the change through regulation.
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As for who pays, the answer is simple: yield starved investors across the globe who remain inert to any suggestion that the ballooning US debt load could lead to a crisis.
According to the Wharton budget model, indexing capital gains to inflation would reduce government revenues by $102 billion over a decade, with 86 percent of the benefits going to the top 1 percent. A July report from the Congressional Research Service said that the additional debt incurred by indexing capital gains to inflation would most likely offset any stimulus that the smaller tax burden provided to the economy.
Trump's proposal is surprising as taxation of capital gains was not featured in the framework for the second round of tax cuts, released by the Ways and Means Committee last week. It is highly unlikely that Congress will pass another tax bill this year because of the slim Republican majority in the Senate.