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The argument in favor of special tax treatment for capital gains income is that it encourages investments, thus providing the capital needed to expand our nation's economy. The reality is that the Internal Revenue Code currently rewards those who liquidate their investments, not those who keep their resources invested. By providing special treatment for investments owned for just over one year, we have promoted a short-term view of business activity. This is reflected in how corporate executives put more attention on quarterly results than on 20-year plans.
Compounding the problem is the complexity of reporting short-term and long-term gains and losses. Schedule D is "a riddle wrapped in a mystery inside an enigma" (Winston Churchill).
To strengthen our economy by refocusing on truly long-term performance, I propose a three-step classification of capital gains and losses:
| Classification | Holding Period | Reported |
|---|---|---|
| Short-term | less than 2 years | fully reported |
| Long-term | at least 2 years but less than 10 years | half reported |
| Exempt | at least 10 years | not reported |
Under this scheme, each classification would be reported separately without any offset of shorter period gains by longer period losses until after the reportable amounts are determined. Thus, $2,000 in short-term gains and $1,000 in medium-term losses would result in taxable income of $1,500 ($2,000 - $500). Note that gains on investments held ten years or longer are tax-free, and losses on such investments cannot be deducted from income.
The result would be added to or (in the case of a loss) subtracted from other income when determining taxable income. There would be no special capital gains tax rate.
This reform should include elimination of any special treatment of the gain on the sale of a taxpayer's home. Treating a home as an investment, the sale after owning it less than ten years would result in a reportable gain or loss. The sale after owning it more than ten years — when the largest gains are usually realized — would not be reportable. The $250,000 exclusion ($500,000 for married couples) would be eliminated. A loss (generally after a relatively shorter period of ownership) would be reportable.
Corporations generally make various investments in real estate, subsidiaries, customer and supplier companies, et cetera in their normal course of doing business. All capital gains and losses should be treated as ordinary income and expense by corporations; they should have no special tax treatment. Only when the gains and losses are clearly passed through to their stockholders as dividends — and those stockholders are corporeal persons — should special tax treatment apply. In that case, the recipients of the dividends get the special treatment.
31 March 2004
Updated 28 December 2012
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