Warren Buffett was wrong to suggest that capital gains taxes are too low (“Calling Buffett’s bluff,” Comment & Analysis, Monday). They are actually much too high, since they force people to pay taxes when they sell a stock based on inflation that occurred after they bought it.
Impoverished investors can be forced to pay capital gains taxes even during huge slumps in the stock market, when inflation masks the slump. Capital “gains” are not indexed for inflation; the seller pays tax not only on the real gain in purchasing power, but also on the illusory gain due to inflation. The liberal economist Alan Blinder, a former Federal Reserve Board member, conceded in 1980 that “most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of principal in an inflationary world.”
Between 1970 and 1980, U.S. stock prices fell by half after being adjusted for inflation. But if you sold stock in 1980, after a decade of getting poorer and poorer you would have had to pay capital gains tax, since inflation made stock prices rise in nominal terms. That inflation penalty – not favoritism toward the rich – is why capital gains have historically been taxed at lower rates than other kinds of income, like Warren Buffett’s salary.