Stop Taxing Inflation: Trump-Congress Should Index Capital Gains for Inflation

Originally posted on Substack.

President Trump’s permanent tax reforms in the “One Big Beautiful Bill” marked a key step toward American economic prosperity. Yet, an essential follow-up remains: indexing capital gains taxes to inflation. This reform aligns not only with economic efficiency but also with fiscal responsibility and free-market principles.

Under current law, capital gains are taxed based on nominal returns rather than real, inflation-adjusted gains. Consider a middle-class investor who bought $100 in stocks at the start of President Biden’s term and sold them four years later for $122. While inflation during this period totaled roughly 22%, the investor faces capital gains taxes on the nominal $22 "profit," despite no real gain in purchasing power. This represents a hidden inflation tax, distorting actual economic gains.

Historically, periods of high inflation—such as the 1970s or the recent Biden-era inflation—illustrate how the capital gains tax can exceed effective rates of 50% or even surpass 100%, taxing phantom gains and sometimes resulting in taxes owed despite actual economic losses. Ending this punitive taxation promotes economic soundness and accurate fiscal measurement.

The Congressional Research Service highlights the current distortion clearly: capital gains are disproportionately affected by inflation compared to other forms of income due to their deferred nature. Although long-term assets benefit from deferrals and step-up basis provisions, short-term holdings disproportionately suffer, penalizing investors who allocate capital efficiently. Indexing capital gains for inflation rectifies this imbalance, enabling taxes to reflect genuine economic returns rather than artificial price increases.

Critics argue that indexing introduces complexity and could distort the tax code if other income forms—like interest and depreciation—remain unindexed. However, modern financial software and clear regulatory frameworks can mitigate these concerns, making inflation adjustments practical and manageable. The economic logic remains compelling: indexing capital gains ensures accurate taxation of real returns, not artificial, inflation-driven increases.

Economic benefits of indexing, even if modest, compound significantly. The 2018 Tax Foundation estimates that indexing would boost GDP by 0.11%, raise wages by 0.08%, and create roughly 21,800 jobs. More critically, indexing reduces the “lock-in effect,” where investors delay asset sales solely to avoid punitive taxation. Eliminating this distortion would release billions in capital to fuel entrepreneurial ventures and small businesses—engines of sustainable economic growth.

Beyond those near-term effects, indexing would also generate dynamic long-term benefits by lowering the effective tax burden on capital, thus increasing the after-tax return on investment. As capital becomes more mobile and profitable, asset values would likely rise, rewarding savers and improving household balance sheets. This appreciation would enhance long-term financial security, giving families greater ability to save, invest, and leave a legacy to future generations. In this way, indexing capital gains isn’t just pro-growth—it’s pro-legacy, fostering a culture of ownership and intergenerational prosperity.

Some caution, indexing could lead to less tax revenue in the short run. Yet historical data indicate that lower capital gains tax rates often prompt increased asset turnover, partially offsetting projected losses in a dynamic economy. Crucially, the real issue isn’t revenue shortfall—it's excessive federal spending. Fiscal responsibility demands disciplined spending policies rather than continuously seeking new revenue streams.

Stephen Moore points out that lower capital gains taxes can increase revenue by unlocking trillions of dollars in held capital. IRS data reveals that two-thirds of capital gains tax returns come from households earning under $200,000 annually, underscoring that indexing broadly benefits ordinary Americans. Certain types of capital gains—such as those from retirement savings, small business shares, farmland, and long-held real estate—would be well served by indexing, as they are more likely to reflect inflationary gains over time.

Indexing capital gains is not about fairness per se—it's about accurate fiscal policy and economic efficiency. Taxing unrealized, inflation-driven appreciation as income contradicts fundamental free-market principles. President Trump can—and should—take decisive action. Even if legally challenged, his action would spotlight a commitment to responsible fiscal policy. However, Congress should not wait. Lawmakers should enact indexing through legislation to ensure long-term stability, clarity, and legitimacy of the tax code.

Ultimately, indexing capital gains taxes to inflation isn't merely pro-growth; it's fiscally responsible and economically sound. Coupled with meaningful spending restraint, it represents the exact kind of policy reform needed for long-term American prosperity.