Did you know that you sometimes pay taxes on profit that isn’t profit at all? The government might be taxing you on inflation.
Pretend I’m saving for a new violin. Yes, this entire post will be a “pretend” because I bought a violin a year ago, and I love it.
What if I find an instrument I like for $8,000? I only have $3,000 saved. I buy gold with my $3,000 and keep saving. Or rather trying to save. You know how it goes. Emergencies keep coming up, and I just can’t squirrel away any more money.
Finally, I check the value of my original investment and see it has doubled. Now my gold is worth $6,000. I’m excited until I find out that the price of the violin has also doubled. It costs $16,000.
I’m no closer to my goal. And when I sell my gold, I have to pay capital gains taxes on its “increased” value. If the capital gains tax rate is 15%, I’ll be sending $450 to the government.
Alan Blinder, a former member of the Federal Reserve Board, admitted that up until 1980 most capital gains taxes were paid on increased prices due to inflation and not on true increase in value. See "Capital Gains Taxes" by Stephen Moore.
The Economic Effects of Capital Gains Taxation makes a similar point. The table at the top of page eleven shows how much investors would pay in capital gains taxes due to inflation if they bought stock in certain years and sold it in 1994.
When the price of everything goes up, it isn’t profit. It’s inflation. Don’t tax it.
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