P roposals to index capital gains for inflation have recently reentered the public debate. The proposed change would eliminate taxes on the part of capital gains that reflects inflation. It would increase the basis (the amount subtracted from sales price to determine capital gains) by inflation occurring since acquisition of the asset. President Trump's head of the White House National Economic Council, Larry Kudlow, has long proposed the indexation of capital gains for inflation through regulation, and Americans for Tax Reform has written a letter urging Treasury Secretary Steven Mnuchin to index capital gains. Past analyses (as discussed in " History of Proposals to Index Capital Gains " section below) indicate that the change would require legislation. Senators Ted Cruz and James Inhofe have introduced S. 2688 , the Capital Gains Inflation Relief Act of 2018, which would index the basis of assets for purposes of the capital gains tax. Similar bills, H.R. 2017 and H.R. 6444 , have been introduced in the House by Representative Jack Emmer and Representative Devin Nunes. Chairman of the House Ways and Means Committee Kevin Brady has indicated that some discussion of this issue is ongoing. Under the current system, taxable income from investments is not adjusted for inflation, a treatment applying not only to capital gains, but to dividends, interest, and returns from depreciating assets (because depreciation is based on original cost). Although there is general agreement that measuring real income from capital assets requires an adjustment for inflation, all of these types of income receive other tax benefits that tend to offset the lack of inflation indexing and, in some cases, were explicitly adopted for that purpose. Capital gains reflect the change in value of an asset and are measured as the sale price minus the basis. Basis is generally the cost of acquiring the asset, but that cost is reduced by depreciation and increased by improvements in the case of assets such as buildings. Assets yielding capital gains have a number of tax benefits that reduce their effective tax rates, including a lower rate, deferral of tax until gains are realized, and exclusion of gain at death. Taxes on long-term capital gains held for at least a year (and dividends) are currently lower than those imposed on ordinary income, with 0%, 15%, and 20% rates. Those tax rules were not altered by the recent tax revision, as they remain linked to prior-law income levels. Taxpayers whose income would have fallen in the 15% or lower tax rate under the prior system pay no tax on capital gains and dividends. Taxpayers otherwise will pay a 15% tax rate except for those whose income would have fallen in the 39.6% bracket, who pay 20%. For married couples in 2018, the 15% rate applies at $156,150 of taxable income and the 20% rate applies at $480,050 of taxable income. A married couple with more than $250,000 of taxable income ($200,000 for a single) is also subject to a 3.8% tax (equivalent to the Medicare tax on labor income) on passive income, including capital gains (as well as dividends, interest, rents, royalties, and annuities and passive income from partnerships and Subchapter S firms) up to the amount in excess of $250,000 ($200,000 for a single) that is equivalent to the Medicare tax paid on self-employment income. Corporations pay taxes on gains at ordinary rates, now 21%. Certain types of capital gains have special rules. Gain that results from depreciation of assets is subject to tax at ordinary rates to the extent of the gain, although gain arising from depreciation of real property is subject to a 25% ceiling. Gain on collectibles is taxed at 28%. Gain on the sale of a home is eligible for a $500,000 exclusion for a married couple and a $250,000 exclusion for a single person. Capital gains receive two benefits not available to other forms of passive income, such as interest and dividends. First, tax is not paid until an asset is sold, allowing for a delay in tax payments; this deferral of tax is beneficial because of the time value of money. Second, assets that are held until death do not pay capital gains tax on the appreciation during the decedent's lifetime (and longer if, in turn, the decedent inherited appreciated assets). Assets received from inheritances are stepped-up, and the basis in the hands of the heir is the value at the time of death. (Thus, if the asset were immediately sold, there would be no capital gain.) Although evidence is limited, about half of capital gains are estimated to never be taxed because of the step-up in basis provision. Capital gains on corporate stock are also largely effectively exempt from income tax when they are held in a pension or individual retirement plan. Evidence indicates that about two-thirds of stocks owned by Americans are held in such an exempt form. The U.S. tax code contains restrictions on losses: although losses can offset gains (first netting against each type, long or short term, and then overall), the amount that can offset ordinary income is limited to $3,000 (which can be carried forward to the future). Allowing net short-term losses to offset net short-term gains dollar for dollar confers an advantage because short-term gains are taxed at ordinary rates and long-term gains are taxed at a lower rate. The limit prevents taxpayers from selectively selling assets with losses and not gains. The limit has become more restrictive because it has not been indexed for inflation since 1978. Dividends are also eligible for the same lower rates available for capital gains and the benefits of being held in pension and retirement plans. In addition, in most cases, dividends are not affected by the lack of inflation indexing because they are generally smaller than the real gain (as some real returns are typically reinvested and result in real appreciation of stocks). Taxes are levied on nominal interest at ordinary rates. However, inflation overall is beneficial to borrowers who are able to deduct nominal interest, thus bidding up the interest rate and compensating lenders. This benefit tends to be larger than the penalty for interest income because of the large share of interest-bearing assets in pension and retirement funds and indexing interest would increase the tax burden on interest financial assets (or rather, reduce the current subsidy that exists). In addition, some income from lending through bank accounts is never taxed because it is received as imputed income in the form of the value of banking services. Under tax law prior to the 2017 tax revision ( P.L. 115-97 ), the effect was also due to higher tax rates of the corporations and businesses borrowing funds compared to the rates of the lenders. This effect arising from the rate differentials may have been reversed, or at least reduced, because the tax revision reduced the tax rates on corporate and business incomes more than the rates on individuals. Depreciation deductions are taken on the asset's original cost, and the undepreciated basis (i.e., the amount of the cost left after depreciation deductions) is not increased by inflation. Nevertheless, depreciation is accelerated enough to offset or more than offset the effects of inflation, depending on the asset. Many depreciable assets are expensed (i.e., the cost deducted immediately), including investments in intangible assets and investments in equipment up to $1 million for smaller businesses (this expensing is phased out at $2.5 million). Since 2008, all equipment has been eligible for bonus depreciation (generally 50% of the cost could be expensed). Under the 2017 tax revision, P.L. 115-97 , equipment can be expensed through 2022, with expensing then phased out by 20% per year (each year 20% will be subject to depreciation over several years rather than being immediately deductible). Allowing a deduction for the cost of goods sold without indexing also results in taxation of the nominal return. Last-in, first-out (LIFO) inventory methods that treat the item sold as the last item acquired can roughly compensate for inflation (although the LIFO method also excludes real gain or loss in the value of the good, such as might occur, for example, with crude oil). Most firms do not use LIFO because the tax accounting method must be the same as the financial accounting method and using LIFO tends to reduce stated profits for financial purposes. Indexing would increase the basis of the asset (i.e., the amount deducted from the sales price to determine gain or loss) by the change in the price level between the date of acquisition and the date of sale. For example, if the inflation rate is 2% and the real rate of return is 7%, an asset purchased for $100 would sell for $109.14 a year later if interest is compounded annually. The nominal gain is 9.14%. Without indexing, the gain if the asset were sold would be $9.14. With indexing, the basis would be increased from $100 to $102, and the gain would be $7.14, which is a 7% return on $102. For assets such as common stock, the basis is the purchase price. For assets that depreciate, such as machines and buildings, the basis is the purchase price minus cumulative depreciation plus improvements. For assets that are fully or almost fully depreciated, indexing the basis would increase taxes given the higher recapture tax rate on the gain reflecting depreciation (unless an exception were made). The effect of indexing for inflation depends on the measure of inflation used. There are several such measures, including the Consumer Price Index for All Urban Consumers (CPI-U), the chained CPI-U, and the gross domestic product (GDP) deflator (or implicit price deflator).