Individual Capital Gains Income: Legislative History

Publication Date: May 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

Type:

Abstract:

Since the enactment of the individual income tax in 1913, the appropriate taxation of capital gains income has been a perennial topic of debate in Congress. Almost immediately legislative steps were initiated to change and modify the tax treatment of capital gains and losses. The latest changes in the tax treatment of individual capital gains income occurred in 1998 and 2003. It is highly probable that capital gains taxation will continue to be a topic of legislative interest in the 109th Congress.

Capital gains income is often discussed as if it were somehow different from other forms of income. Yet, for purposes of income taxation, it is essentially no different from any other form of income from capital. A capital gain or loss is merely the result of a sale or exchange of a capital asset. An asset sold for a higher price than its acquisition price produces a gain, an asset sold for a lower price than its acquisition price produces a loss.

Ideally, a tax consistent with a theoretically correct measure of income would be assessed on real (inflation-adjusted) income when that income accrues to the taxpayer. Conversely, real losses would be deducted as they accrue to the taxpayer. In addition, under an ideal comprehensive income tax, any untaxed real appreciation in the value of capital assets given as gifts or bequests would be subject to tax at the time of transfer.

Since 1913, at least twenty major legislative acts have affected the taxation of capital gains income and loss. Over this period, the definition of what constitutes a capital asset has been steadily expanded. There have been periods when capital losses were not deductible, periods when they were fully deductible, and periods when they were only partially deductible. Likewise, there have been periods when capital gains income has been partially taxed, fully taxed, or even excluded from tax.

The logical question to ask after reviewing past legislative changes is why, after 80 years, is there still controversy over the appropriate means of taxing capital gains income and loss? From a purely economic perspective, the appropriate means of taxing gains and losses from capital assets under a tax that measures income comprehensively is relatively clear. Indeed, workable procedures for an approach more consistent with the ideal tax treatment have been outlined in great detail in the past.