Been there, done that: Capital gains indexing is still a bad idea

Senators Ted Cruz (R-TX) and Tim Scott (R-SC) sent a letter to Treasury Secretary Scott Bessent last week urging him to index capital gains for inflation—without any act of Congress. House Republicans followed with a parallel letter days later.

This proposal has been around for decades, and the legal questions that once led the Department of Justice (DOJ) to conclude that indexing capital gains would require legislation are unchanged. So is the foundational principle that the power to tax rests with the legislative, not executive, branch of government. So is the fact that this is not good tax policy. But Sens. Cruz and Scott ask Secretary Bessent to reach a different conclusion.

The proposal aims to change the tax code by redefining “cost”

Under current law, an asset purchased for $100 and sold years later for $300 generally generates $200 in capital gain, subject to both preferential rates and exclusion rules. Indexing would reduce the gain to reflect only the real appreciation above inflation.

The senators argue that Bessent has the authority to do this without legislation by redefining “cost” to mean “inflation-adjusted cost.” This regulatory slight-of-hand is not a new idea. The George H.W. Bush administration considered such an administrative approach to indexing in 1992, but ultimately abandoned it after White House counsel and the Treasury Department, in addition to the DOJ, argued that the administration lacked the authority to do so.

Cruz has introduced the same proposal legislatively in 2018, 2021, and again this February. Cruz also urged Treasury Secretary Steven Mnuchin in 2019 to impose this change through regulatory authority, but Secretary Mnuchin deferred to Congress rather than act unilaterally.

The power to tax lies with Congress—and the courts are reinforcing that boundary

The legal case against executive action was weak in 1992, and it has only gotten weaker since. Then-Attorney General William Barr put it plainly: The question of whether the executive branch could index capital gains through administrative action was “clear” and he didn’t “think that a reasonable argument could be made to support that position.” Legal scholars revisited the question in 2018, arguing that doctrinal developments during the last twenty-five years only strengthened this conclusion.

The legal environment has, if anything, shifted further against executive action since 2018. In Loper Bright Enterprises v. Raimondo (2024), the Supreme Court overturned the Chevron doctrine, removing the presumption that courts should defer to agencies’ interpretations of ambiguous laws. This shift means that Treasury regulations are now more vulnerable to court challenges, not less—judges may now decide questions themselves rather than deferring to an agency’s “reasonable” interpretation given an unclear statute.

Indexing only capital gains would distort the tax code and disproportionately benefit the wealthiest

The underlying concern—that taxes shouldn’t fall on inflationary returns—is not itself unreasonable. When an investor holds an asset for decades, some of the nominal gain simply reflects a weaker dollar, not real wealth creation. TPC co-founder Len Burman has made this point carefully and repeatedly over the past three decades. Inflation distorts all forms of capital income and expense, not just capital gains. Interest, dividends, rents: all of them partly reflect inflation.

The fully consistent response would be to index the entire system. Reed Shuldiner laid out how that could work in a 1993 law review article (paywall) that stretched more than 100 pages. Such a proposal has never seriously been considered. Consistent indexing would also reduce deductions for businesses and individuals during periods of high inflation—a result proponents of indexing capital gains don’t appear to acknowledge.

Instead, indexing gains while leaving deductions and other forms of capital income unindexed would create a new distortion. An investor could borrow money and deduct nominal interest payments, invest in an asset where only real gains are taxed, and reduce their tax bill even if the investment produces little or no real profit. This concern has been raised by tax analysts across the ideological spectrum.

Capital gains also already receive preferential tax rates worth more than $225 billion per year, partly on the rationale that inflation is responsible for some portion of those gains. Indexing on top of that would compensate for inflation twice over, for an already favored asset class. And the benefits of such a policy would overwhelmingly accrue to the wealthiest households.

Most homeowners would not likely appreciate the impact of indexed capital gains

Proponents of this policy often argue that homeowners are a major beneficiary: Index gains on home sales, and long-time homeowners might be willing to sell, freeing up supply. But housing gains are already subject to a $250,000 exemption for single filers ($500,000 for joint), and 95% of households would owe no federal capital gains tax on a home sale under current law. So the number of homeowning beneficiaries would be far smaller than this argument implies.

And, as noted above, consistent treatment of assets and liabilities would require adjusting both sides of the ledger. This would mean reducing the deductible portion of mortgage interest to reflect only the real, inflation-adjusted borrowing cost. The 12 million households who benefit from the mortgage interest deduction would be unlikely to view that as a reasonable trade.

The indexing debate has been had, and the answers haven’t changed

Cruz and Scott call indexing “the single most pro-growth economic action the administration can take unilaterally.” But there is little credible empirical evidence that indexing capital gains produces meaningful economic growth.

Administrations have considered and rejected indexing many times. The legal authority to impose such changes to the tax code through regulatory action has been murky at best and now, in a post-Loper Bright world, likely to be even more precarious. The policy’s logic cannot hold up when it ignores half of the balance sheet. The distributional consequences are badly skewed. And the housing rationale collapses given who holds capital gains above the exclusion threshold compared to who holds mortgages.

The conclusion remains the same: Indexing capital gains is poor tax policy.