Is The Tax On Inflation Tax Really A Regressive Tax?

Question

Bear With Me...And Please Forgive My Tax Maze Ignorance

My understanding is that the basis of investments is stepped up at the death of individuals who execute transactions in a tax-efficient manner. For instance, taking a loan out (i.e. HELOC) on a property to monetize instead of selling and incurring a capital gain would allow for a stepped-up basis at death and a smaller tax liability. I am sure there are hundreds of other games like this that can be played as well.

So the question is whether or not this sort of tax is really regressive using the following logic:

1. People with money can hire advisors that would likely know about these games 
2. People without money cannot 
3. It seems logical that this would make the tax regressive past some breakpoint

If the government continues to deflate the currency going forward and the tax on inflation tax becomes more common will we see even more "revenue" transferred to the government coffers from those under said affluence barrier? Is this really a regressive tax?

Bryan Hancock · Answer

The erosion of purchasing power affects all parties...but it impacts the wealthy more because they have more assets.  The lack of indexing of assets to inflation impacts the somewhat wealthy MORE than the very wealthy IMO.  The lack of indexing actually HELPS the poor because they are net debtors.

So perhaps instead of it being a regressive tax it is a U-shaped tax.

Dave Toelkes · Answer

So, if I understand what you are saying....

The erosion of purchasing power due to devaluation of the dollar is really what you are calling the "inflation tax".

If I got it, then the erosion in purchasing power (the inflation tax) has been compounded by the decline in average per capita income over the past few years.

The working middle class has been hit with a double whammy and they don't even realize it.  If this keeps up, the middle class will eventually disappear and we will only have the wealthy and the welfare classes.

Bryan Hancock · Answer

Sure thing Daveâ€¦An inflation tax is getting taxes levied on your assets because of the erosion of the value of your dollars.  This is an insidious tax that the government levies on citizens because they only feel the effect indirectly.  It is in the governmentâ€™s best interest to have the inflation tax run around the cost of their funds so that they can borrow money for little more than the devaluation of the dollar.  This means the real rate of borrowing for the government is much lower than the stated rate on their bonds or bills.

The tax on inflation tax happens because the inflated value of assets (through dollar devaluation) is taxed AGAIN unless you know how to play games to avoid the tax.  These games involve stepping up tax bases and such.  Say you buy a home for $100k and it â€œappreciatesâ€ to $150k, but you lose $50k in purchasing power of your dollars through government confiscation via an inflation tax.  If you sell the home this $50k in â€œgainâ€ will be taxed AGAIN for a tax on inflation tax.

Clear as mud?

Dave Toelkes · Answer

Bryan,

You got me stymied.  I can't figure out how you are getting taxed on your taxes.  Could you give an example?

What is an inflation tax?  I have never heard of it.  Am I paying it and don't know?

Bryan Hancock · Answer

Hi Dave...thanks for the response.

Refinancing or incurring debt is just a way to pull out cash as a non-taxable event.  I realize this although my response may have been unclear at some point.

The theory is that the people who know these rules, laws, etc. are generally wealthy enough to hire the advisors who know the rules.  It is true that other well-informed folks know them too so I guess it isn't a perfect model.

Dave Toelkes · Answer

I am not quite clear on your question.  Anyone can borrow against equity in their property and avoid taxes on the loan proceeds.  Borrowed money is not taxable income unless the debt is forgiven.  You don't have to be wealthy with expensive advisors to do this.

Anyone can sell inherited property at its basis and avoid capital gains taxes, because there is no gain realized from the sale.  You don't have to be wealthy with expensive advisors to do this either.

Since there is no tax on the appreciated value of a property sold at its stepped up basis, your question about the regressive nature of a non-existent tax seems moot.

It seems that you are suggesting that encumbering a property with a HELOC (or any other form of financing) increases the basis in the property or reduces the taxable profit when the property is sold.  If so, then you are misinformed.  The presence or absence of financing on a property has no bearing on its taxable profit when the property is sold.

Bryan Hancock · Answer

Any thoughts on whether you follow the logic about this being a regressive tax?  A lot more would fall into this category too

I am wondering if the laws are written this way b/c of big lobbying by wealthy folks or if that is off base.

Sharad M. · Answer

Giving up deductions may end up costing more money due to higher tax, but I think would be worth the low stress.

Bryan Hancock · Answer

I actually bumped another thread today where I asked if investors would give up their deductions in exchange for a simpler tax code!

We pay as much in overhead bills now as we used to in taxes...attorneys, CPAs, bookkeepers, etc.  I really think the tax maze is one big jobs program.

Sharad M. · Answer

I 110% agree with you on this one. It's just ridic how complicated the tax system is. A while back some politician floated the idea of one-page tax return, now that would definitely be a step towards simplification of the tax system. Wishful thinking!