President Trump has two big problems. His first problem is that the stock market hasn’t been doing that great lately (Monday’s opening gains notwithstanding, the markets have a lot of work to do to reach the record highs seen earlier this year). His second and related problem is that Nancy Pelosi is about to become Speaker of the House, and there is therefore zero chance of pro-growth legislation being signed into law until after 2020. The good news is President Trump can do something about the stock market without having to take a stroll up Pennsylvania Avenue toward the Capitol — he can end the inflation tax on capital gains with the stroke of a pen.
Despite his critics in the media, some in his own party, and the never-ending attack machine fueled by Democrats, President Trump deserves a lot of credit for a booming economy. As former Hardee’s CEO Andy Puzder detailed last week in the Wall Street Journal, there simply isn’t any comparison between the last two years of President Barack Obama’s economy and the first two years of President Trump’s.
An economy growing at a tepid 1.5 percent rate after inflation under Obama is now growing at a real rate of more than 3 percent under Trump. Job openings are coming in at 75,000 per month since Inauguration Day, compared with less than 1,000 per month under latter-day Obama. Job growth averaged less than 150,000 per month under the last two years of President Obama, but well over 200,000 per month in the Trump years. Wage growth has accelerated. Unemployment is at a half-century low, including for historically disadvantaged parts of the American family. Business and consumer confidence is at new highs.
Before this year, we could have added another log to the economic pile — the stock market. The total return on the S&P 500 index averaged annual growth of a tepid 6.5 percent in Obama’s last two years in office. In 2017, the first Trump year, the index soared by nearly 22 percent, more than double the long-run historical average. But in 2018, stocks have corrected in a big way. The total return on the index for 2018 now stands at just north of 2 percent at the time of this writing, and at negative 7 percent for the past three months.
Maybe one reason for this sluggishness after a year of great improvement in retirement accounts is that despite his best efforts, Trump never managed to cut the tax rate on capital gains and dividends. When he came into office, the rate stood at 23.8 percent for individuals (which includes a 3.8 percentage point “net investment income surtax” courtesy of Obamacare). The late Sen. McCain, R-Ariz., torpedoed the last-ditch effort to repeal Obama’s signature healthcare law (and the taxes that went with it), and investment taxes weren’t taken up in the subsequent Tax Cuts and Jobs Act. So while corporations, smaller firms, and families with kids got welcome tax relief, Obama tax rates persist on stocks and other investments.
Let’s not kid ourselves. Pelosi won’t be helping to cut the capital gains tax. But the good news is she doesn’t have to.
Trump has expressed an interest in taking inflation out of the capital gains tax. He can do it by executive order. The Treasury Department can begin letting investors define cost basis in their capital gains not by what they originally paid for an asset, but what they paid for an asset plus inflation since that time. Someone buying a share of Coca-Cola stock in 1970 for $1.00 could instead report a cost basis of $6.70 (that is, $1.00 adjusted for inflation since 1970) if they sell the share today. That in turn reduces the profit and hence the capital gains tax owed.
The Tax Foundation estimates that one-third of capital gains held today are inflationary and would therefore be taken out of the tax equation if Trump ordered this tax rule put in place. Effectively, this means a one-third cut in the capital gains rate from nearly 24 percent today to less than 16 percent. There is no way a Pelosi-led House would ever consider it, but Trump could make it happen tomorrow.
It isn’t just stocks. A family buying a home in 1980 for $100,000 could inflation-adjust their cost basis to $325,000. That’s a big difference for older families in the suburbs that Republicans just lost in the midterm elections. It’s true that there’s already a capital gains tax exclusion for homeownership, but it hasn’t been adjusted since 1998 and ensnares more and more middle class home-sellers every year.
But the biggest impact is likely to be on stocks. According to the Economic Innovation Group, households are sitting on about $3.8 trillion in unrealized stock and mutual fund capital gains. If the Tax Foundation is correct, a third of that (more than $1 trillion) is attributable only to inflation. Trump could exempt $1 trillion of stock market value from the capital gains tax, and there is nothing Pelosi could do about it.
President Trump’s economy is doing very well — economic growth is north of 3 percent, jobs are being created, wages are rising, and confidence is soaring. But the president needs to give the stock market, and millions of retirement nest eggs, a lift. The best way to do that in an era of divided government is to take bold executive action. End the inflation tax on savings.
Ryan Ellis (@RyanLEllis) is president of the Center for a Free Economy.
