It looks like inflation is here

[Loren Pechtel]

That is ignores the advantage of unrealized capital gains. Unrealized capital gains basically defer taxes until they are realized. That allows for the a larger gain than if they were taxed annually.

So, depending on the length of the deferment, it is possible that inflation ends up helping an investor.

Please explain your reasoning. What does unrealized capital gains have to do with it?

All capital gains are unrealized until the asset is sold. The point is that defering realization may negate your argument.

The question is how the deferred capital gains have anything to do with the effect of inflation.

 

[laughing dog]

All capital gains are unrealized until the asset is sold. The point is that defering realization may negate your argument.

The question is how the deferred capital gains have anything to do with the effect of inflation.

Duh. The point is that sufficient deferral of capital gains along with the favorable tax treatment outweigh the effect of taxing inflationary gains. Your analysis ignores that capital gains include the effects of inflation (i.e. the rate of growth of capital should include a component for expected inflation - see post 114 for an explanation about expected inflation and its effects).

 

[Swammerdami]

All capital gains are unrealized until the asset is sold. The point is that defering realization may negate your argument.

The question is how the deferred capital gains have anything to do with the effect of inflation.

It has to do with the benefits of compounding. (Are you aware that even without the benefit of lower tax rate on long-term gains — and even ignoring the tax advantage of passing to heirs at death, and ignoring inflation — waiting years to sell reduces taxes?)

Let's look at specific arithmetic. To keep the numbers simple, assume 10% annual stock appreciation, 5% annual inflation, and a 50% tax rate.

1 year (1990 - 1991)
200 --> 220 --> 210 --> 200

7 years (1990 - 1997)
200 --> 390 --> 295 --> 209.65

The first number ($200) is starting investment; the 2nd number ($220 or $390) is what you sell it for after 1 (or 7) years assuming 10% annual gain; the 3rd number what's left after you pay the tax man; the 4th number is the inflation-adjusted version of the 3rd number.

So, if you switch stocks every year, the profit after inflation is equal to the tax. Reinvest the (inflation-adjusted) $200 in 1991 and get the same net value when you sell it in 1992; and so on. In 1997 you finish with $200 in "1990 dollars." All the real gain has been taxed away.

But hold that stock for 7 years, sell it, pay the tax, and finish with almost $210 in "1990 dollars."

ETA:
Do the same calculation with 0% inflation, and your $200 grows to $281 after 7 years if you trade once a year, and to $295 (after taxes) if you wait 7 years to sell.

 

[Loren Pechtel]

All capital gains are unrealized until the asset is sold. The point is that defering realization may negate your argument.

The question is how the deferred capital gains have anything to do with the effect of inflation.

Duh. The point is that sufficient deferral of capital gains along with the favorable tax treatment outweigh the effect of taxing inflationary gains. Your analysis ignores that capital gains include the effects of inflation (i.e. the rate of growth of capital should include a component for expected inflation - see post 114 for an explanation about expected inflation and its effects).

This is evasion, not an answer.

Whether the capital gains deferral exceeds the effects of inflation or not is completely irrelevant to the question.

The question is simple: Identify a scenario in which the investor ends up with more real (inflation adjusted) dollars due to higher inflation.

How it actually works:

Scenario A: Real return of 6% annual, inflation rate of zero, hold for 10 years.

Invest $1000. Sell for $1790.85, capital gains of $790.85 @ 20% = $158.17 for a net of $1,632.68. No inflation, real value = $1,632.68

Scenario B: Inflation rate of 5%, all other parameters unchanged.

Sell for $2839.42, capital gains = $1,839.42, tax = $367.88, net = $2471.54. Prices have gone up 63% in the meantime. Real value = $1,516.28

Inflation cost them money, it didn't make them money.

 

[Loren Pechtel]

All capital gains are unrealized until the asset is sold. The point is that defering realization may negate your argument.

The question is how the deferred capital gains have anything to do with the effect of inflation.

It has to do with the benefits of compounding. (Are you aware that even without the benefit of lower tax rate on long-term gains — and even ignoring the tax advantage of passing to heirs at death, and ignoring inflation — waiting years to sell reduces taxes?)

Let's look at specific arithmetic. To keep the numbers simple, assume 10% annual stock appreciation, 5% annual inflation, and a 50% tax rate.

1 year (1990 - 1991)
200 --> 220 --> 210 --> 200

7 years (1990 - 1997)
200 --> 390 --> 295 --> 209.65

The first number ($200) is starting investment; the 2nd number ($220 or $390) is what you sell it for after 1 (or 7) years assuming 10% annual gain; the 3rd number what's left after you pay the tax man; the 4th number is the inflation-adjusted version of the 3rd number.

So, if you switch stocks every year, the profit after inflation is equal to the tax. Reinvest the (inflation-adjusted) $200 in 1991 and get the same net value when you sell it in 1992; and so on. In 1997 you finish with $200 in "1990 dollars." All the real gain has been taxed away.

But hold that stock for 7 years, sell it, pay the tax, and finish with almost $210 in "1990 dollars."

ETA:
Do the same calculation with 0% inflation, and your $200 grows to $281 after 7 years if you trade once a year, and to $295 (after taxes) if you wait 7 years to sell.

You're showing the power of tax deferral, you are not addressing my point that inflation doesn't help them.

You are also missing the fact that stock prices will be subject to inflation--if you have 10% stock appreciation in 5% inflation you actually have only 5% growth and the comparison should be to 5% appreciation, 0% inflation.

 

[Jason Harvestdancer]

Prove it.

I for one am shocked to find a libertarian who has economics completely backwards.

Shocked, I tell you.

This is my shocked face.

I wouldn't say deflation is bad per se. The causes of deflation are bad. It means large sections of society don't have the money to purchase goods and services, because of unemployment or other reasons.

Or it could mean that there has been an increase in the amount of goods or services with regards to the amount of currency.

 

[ZiprHead]

I wouldn't say deflation is bad per se. The causes of deflation are bad. It means large sections of society don't have the money to purchase goods and services, because of unemployment or other reasons.

Or it could mean that there has been an increase in the amount of goods or services with regards to the amount of currency.

Accepted. Which do you believe to be the most common cause?