Tax code

Can indexing the tax code to inflation lead to smarter investment and growth?

As the U.S. economy emerges from the pandemic, it is important for U.S. lawmakers and policymakers to ensure that fiscal policy encourages growth while recognizing that inflation is at a 40-year high. One of the main levers civil servants can use is indexing to inflation, the Tax Foundation explained in a new paper ((https://taxfoundation.org/economic-growth-opportunity-tax-reforms/) yesterday.

By indexing structural elements of the IRS tax code that are not currently indexed to inflation and adopting tax-neutral Universal Savings Accounts, officials would “better recognize inflation in the code, providing more certainty for taxpayers, reducing penalties on savings and enhancing financial security.” said a Washington, DC-based nonpartisan think tank.

Investors with capital gains could benefit from indexing to inflation, the group argued.

Under current law, taxpayers pay capital gains tax on the difference between the purchase price of an asset (the basis) and the price when it was sold. “The base, however, is not adjusted for inflation, so while on paper it may look like someone has earned an income, after accounting for inflation it is possible that he has lost money. The adoption of a system of universal savings accounts, insofar as it is widely applicable, would effectively solve the problem of the taxation of nominal capital gains” , argued the Tax Foundation.

Net investment income tax (NIIT) should also be indexed to inflation, the organization said. The NIIT is a 3.8% tax on investment income for married filers earning more than $250,000 in Adjustable Gross Income (AGI) and for single filers earning more than $200,000 in AGI. The NIIT thresholds have not been adjusted since the law was introduced more than 10 years ago, so more taxpayers are being pressured into paying the NIIT, although it initially only targeted the very wealthy, the group said.

Capital losses are another provision that should be indexed to inflation, the group argued. When measuring taxable income, it makes sense to subtract capital losses from capital gains. “Having a limit on capital losses helps prevent abuse of the provision, but the limit should be increased from the current law by $3,000 to reflect the significant inflation that has occurred between 1978 and today’ today, and adjusted in the future,” the Tax Foundation argued.

The group also advocates for the removal of tax barriers to personal savings and the creation of a tax-neutral universal savings account.

The ideal tax code should ensure that consumption and savings are treated neutrally, according to the group “Instead, our tax code discourages savings with multiple levels of taxation: a dollar of income is taxed when it is earned under income tax, again when invested and earning further profits, again when reinvested profits are realized as a gain and subject to capital gains tax, and potentially again when given to heirs through inheritance and gift tax,” the Tax Foundation economists said.

Multiple layers of taxes encourage immediate consumption rather than saving, because consumption is subject to only one layer of taxes. “It has negative economic impacts by reducing the amount of savings available for productive investment in the United States. A smaller national savings pool also means that foreign savers can fund domestic opportunities, thereby reducing returns domestic investments going to domestic savers,” the economists argued.

Currently, taxpayers can mitigate some of the savings-related tax penalty by contributing to dedicated tax-neutral savings accounts for specific purposes, such as traditional or Roth retirement accounts and/or savings accounts. -studies.