The following was printed in the August 31,
1992 issue of the Wall Street Journal. I apologize for the extraordinary
step of posting it here in this manner; but I was unable to locate it on the
Journal's website, even under the pay-per-use
service. This is important information, which I hope the Journal itself
will see fit to republish as soon as possible.
Capital Gains Tax and Presidential Power
By CHARLES J. COOPER
THE WALL STREET JOURNAL
MONDAY, AUGUST 31, 1992
President Bush may not be able to get Congress to go along with his proposal to
cut the capital gains tax, but there is a simple action he could take on his own authority to make the tax treatment of capital
equitable. He could instruct the Treasury to index capital gains to inflation.
Until quite recently Congress has implicitly recognized and compensated for the effects
of inflation by giving
preferential tax treatment to capital gains, either by taxing them at a lower rate or by partially excluding them from
taxable income. It recognized that otherwise investors would often be taxed unfairly on income that was attributable
in some significant part to inflation, rather than real income, as the example in the
nearby box demonstrates.
While this kind of preferential tax status was at best a blunt tool to counter the effects of inflation, it was nonetheless
recognized as such a tool.. It thus largely obviated, until 1986, the need to establish
a more accurate counter for
inflation, such as indexation, and tile president had no pressing need to lake up this issue.
In 1986, however, the Tax Reform Act ended preferential treatment for capital gains, taxing there at the same rate
as ordinary income. Although bills providing for indexing have passed at different times ever the past decade to both
houses of Congress, none has been enacted.
It is not surprising, then, that the question of the president's regulatory authority to index capital gains has only
recently come into sharp focus. Earlier this summer I was asked by the National Chamber Foundation and the National
Taxpayers Union Foundation to examine the issue. Despite initial skepticism. I have
concluded that the president has
the legal authority to adopt a regulation indexing capital gains.
The inquiry begins with the Sixteenth Amendment, which in 1913 authorized Congress to "lay and collect taxes on
incomes." In 1919, the Supreme Court defined income as including "profit gained through a sale or conversion of
The "profit or "gain" as defined by the Tax Code is the "excess of the amount realized
[from the sale or other
disposition of property] over the adjusted basis." The "basis" of the property is defined simply as its "cost." The
meaning of the word cost is the heart of the matter.
How Indexing Would Work
Consider the example of a taxpayer who bought a house for $100,000 in 1982 and sells it for $200,000 in 1992. Under
the current tax regime, he is taxed on a "gain" of $100,000. If, however, inflation has caused the general price level to
double between 1982 and 1992, the taxpayer has not realized any increase in wealth at all; that is, there has been no increase in the value of his house.
The $200,000 he has in 1992 represents the same
purchasing power as the $100,000 he
had in 1982. The value of his asset has not increased; it has merely kept pace with inflation. In fact, the taxpayer is
worse off than if he had not bought the house, since the tax on its sale will eat into his nominal gain.
If the capital gains tax were indexed to inflation, the taxpayer would be taxed just on that portion of the gain above
inflation. To use the same example, if he sold his home for $220,000, he would pay
tax on only $20,000, the portion of
the sale price above inflation.
Congress has never defined cost, and until 1957 neither did Treasury regulations. In
practice, however, Treasury has always interpreted cost to mean the amount, in nominal dollars, paid at the time
of purchase. Regulations issued in 1957 formalized this interpretation. Treasury's
interpretation of cost as
purchase puce is no doubt a reasonable one. The critical question, however, is whether it is the only reasonable
Under our system of separated powers, the executive branch has the initial
responsibility of interpreting the laws
that Congress makes. Unless clearly forbidden by Congress, Treasury can interpret the Tax
Code to define cost as adjusted fur inflation; that is, it can index capital gains.
It is important to stress that the question at hand is not whether a court would conclude that indexation is
under the Tax Code. Rather, the question is whether a
court would conclude that a Treasury regulation indexing capital gain was based on a permissible reading of that
statute. While Treasury has consistently interpreted the cost of a capital asset to mean the asset's original purchase
price, this definition as not required by law. Nothing in the legislative history of the past 75 years suggests that
Congress intended to deny Treasury this sort of interpretive discretion.
The right of executive branch agencies to "fill any gap left, implicitly,
or explicitly by Congress" in a statute was articulated in 1984 in Chevron U.S.A.
v . National Resources Defense Council. Under Chevron, in order to reject an executive branch interpretation the courts
must decide "whether Congress has directly spoken to the precise question at issue."
There is no doubt that, in the matter of the cost of a capital asset, Congress
has never spoken.
Next, says the Chevron decision, "if the statute is silent or ambiguous with respect to the specific issue, the question
for the court is whether the agency's answer is based on a permissible construction of the statute." It is permissible,
the court said last year in Rust v. Sullivan, as long as "it reflects a plausible construction of the plain language of the
statute and does not otherwise conflict with Congress' expressed intent."
Construing cost to
include the effect of
inflation is at least as
plausible as Treasury's purchase-price interpretation.
The only difference
between the two interpretations is that
the former measures cost at the time the capital asset is sold, while the latter measures
cost at the time the asset was purchased. Ask any homeowner how much his
house cost, and he will tell you what he
paid for it -- and when he bought it.
Even so, a new Treasury regulation changing the definition of cost from nominal dollars to inflation-adjusted dollars
would certainly be a sharp departure from past practice, and some have argued that Congress's failure to enact
indexing legislation amounts to a de facto ban. Quite
apart from the general point -- reiterated by the Supreme Court in Patterson
v. McClean Credit Union (1989) -- that
"congressional inaction cannot amend a duly enacted statute," the argument is particularly weak here.
Nowhere in the legislative history of these proposals did Congress address the precise issue of the meaning of cost,
let alone endorse Treasury's purchase-price interpretation. To be sure, by failing to enact the proposed
amendments, Congress elected not to require Treasury to index capital gains. But Congress in no way indicated that
Treasury was not permitted to do so.
In other words, if Congress left any
gaps in the statutory meaning of cost prior to its consideration of indexation amendments, those gaps were not closed
when it failed to exercise its own discretion to amend the statute. By failing to fill in
the gap in the meaning of cost, Congress did not extinguish Treasury's discretion to do so. Again, the Supreme
Court has made it abundantly clear
that executive-branch agencies are entitled to considerable deference in interpreting
statutes they administer.
In Rust v. Sullivan the Supreme Court upheld the new Health and Human Services regulations forbidding clinics that
received federal money from offering abortion counseling. That such regulations
" 'reverse a longstanding agency policy...' and thus represent a sharp break from the secretary's
prior construction of the
statute" was deemed insufficient grounds for forbidding them. Under Chevron, it said. HHS was entitled to modify
regulations so long as the change was supported by a "reasoned basis."
A Reasonable Interpretation
In short, Congress has for more than seven decades left undefined the term "cost" in the capital gains section of the Tax
Code. The traditional definition of cost as the nominal dollars spent at the
time of purchase can he changed by the Treasury to reflect a more realistic method of computing the
gain that an
investor reaps from the sale of his property. This is at least as reasonable an interpretation of cost as the
traditionally used, and thus entitled to deference by the courts.
The president can correct this serious deficiency in the way our tax laws are applied today,
if he wishes. And if Congress objects, it can pass a law outlawing indexing.
Mr. Cooper, a Washington attorney, was an assistant attorney general in the
This page was updated:
Sunday, January 29, 2012