by John L. Aldridge, Kyle Pomerleau
December 19, 2013
Under the federal tax code, the increase in an asset’s price is determined as the nominal amount (i.e., not adjusted for inflation). When an asset (often a stock) is sold above its purchase price, a gain is realized and is taxed. Any capital gain due to inflation is not accounted for, and the taxpayer is taxed on both their increase in income and on increases in prices economy-wide. As a result, the effective tax rate on the real (inflation indexed) capital gain has exceeded the statutory rate every year since 1950 and has averaged around 42 percent. In some instances, the practice of taxing the nominal gain can lead to an infinite effective rate on real capital gains when the increase in price is only due to inflation. In fact, if a taxpayer purchased an average stock in 1999, 2000, or 2007 and sold in 2013, they would be taxed entirely on inflation.