Un-Slippery Slope

Taxes are a big item in the news today.

In 1992, Ross Perot proposed a “stair stepped” capital gains tax.  What that means is that the longer you hold a capital asset before you sell it relative to when you bought it, the lower the capital gains tax (CGT) rate would be on the marginal profit (capital gain).  Perot’s reasoning was that CGs realized from very quick buying and selling should be taxed at a higher rate than your parents’ house they bought 25 years ago and are selling now that the nest is empty because rapid buy-sell capital gains are usually shares in larger publicly traded corporations.  A higher tax on quicker asset flips would discourage quick asset flips, and would act as a deterrent to job outsourcing, which is usually a favorite short term tactic of short term CEOs of larger corporations (their average tenure isn’t that long anyway, about six years according to 2008 statistics) to get corporate profits up in a hurry, ergo the company’s stock price up in a hurry — The CEO’s performance bonuses are usually tagged to the stock price, and his or her golden parachute usually includes a lot of the company’s shares.

As it turned out, a stair stepped CGT would have deterred a lot of the real estate “flipping” of the last decade.

Perot wanted a ten percent drop in the CGT rate per year that the asset was held, with five “stair steps.”  What that means is that an asset sold within a year of being bought would be subject to a 50% CGT, 40% if between 1 and 2 years, 30% if between 2 and 3 years, 20% if between 3 and 4 years, 10% if between 4 and 5 years, and no capital gains taxes if the asset is sold more than five years after being purchased.

The only problem I have with that precise setup is that you might have situations where, in order to wait out a 10% rate drop, assets are held back then dumped onto the market all at once on their “anniversary.”  That will result in an artificial but ephemeral price collapse in certain assets, including but not limited to common stock and real estate, every once in awhile.  The reason that might not actually happen in the real world is that such a market glut of available assets resulting in the temporary price crash will mean less actual CGs upon sale.  But it’s something I wouldn’t want to risk if I were Chairman of the House Ways and Means Committee.

I think the better idea is to stair-step the capital gains tax NOT by year, but by day.  For instance, let’s say the top capital gains tax rate is 40%, and you want to stair step down to 0%.  (Actually, it would be more like a slippery slope, instead of a staircase.)  You could stair step it down from 40 to zero over 2,000 days (about 5.5 years), which would mean a 0.02% CGT rate discount for every day the asset is held relative to when it was purchased.

Example:  You buy 10,000 shares of XYZ Corporation today, September 19, 2011, at $18 a share.  On February 27, 2013, you sell them all for $34 a share.  What you purchased for $180,000, you sold for $340,000, meaning a $160,000 capital gain.  Since you sold it 527 days after you purchased it, you get a CGT rate discount of 527 x 0.02%, or 10.54%.  40% minus 10.54% is 29.46%.  And 29.46% times $160,000 is $47,136 that you owe Uncle Sam.  As an aside, 2000 days after today is March 11, 2017, so if you sell your XYZ shares on or after that day, your CGs are tax free.