Effective Capital Gains Tax Burdens Under Asymmetric Recognition of Real Losses

This paper compares three capital-gains tax designs for personally held assets: (i) the current nominal gains system; (ii) the new inflation indexation system with asymmetric treatment of real gains and losses; and (iii) a hypothetical system based on symmetric treatment of real gains and losses. We isolate the tax treatment of inflation-driven capital price changes by centring our analysis on the case where the expected capital-price path tracks the CPI. We make three findings. First, under the current system, which taxes nominal gains, the long-run CGT liability on an asset that merely preserves its purchasing power approaches 23.5 per cent of the asset's terminal value for a taxpayer on the top marginal tax rate. Second, the new system produces a loss recognition wedge, because real gains are fully recognised, while real losses are only recognised to the extent they are also nominal losses. At a 30-year horizon the resulting tax burden can exceed the tax burden of the current system. Third, the inflation rate contributes to the effective CGT burdens generated by both the current and the newly enacted systems, albeit via different channels: under the current system, inflation generates taxable nominal gains, while under the new system, inflation widens the band of unrecognised real losses. A symmetric real-gains tax avoids these distortions.