The Tax Policy Center–which is not a conservative outfit–notes that Senator Sanders’s proposal that the top tax rate on capital gains be 64.2 percent “would be well beyond current estimates of the rate that maximizes revenues, and without other changes it might even lead to lost revenues as taxpayers aggressively try to avoid the tax.” But the proposed rate understates how high the tax would be, because the tax applies to nominal gains: They’re not indexed for inflation.
Let’s say an investment returns a 6 percent nominal return over a year, while inflation runs at 2 percent. Then the effective tax rate on the real capital gain is 96 percent. (The math is simple. You invest $100, get a $6 nominal return but a $4 real one. The tax is 64.2 percent of 6, which equals $3.85; that’s 96 percent of your $4 real gain.)
And that effective tax rate rises the longer the investment is held. If you assume that return and that inflation rate persist over five years, the effective tax rate is 100 percent. Go longer than five years, and you’re over 100 percent.
The risk of high inflation is also worth mentioning. Let’s say inflation runs at 3 percent and our nominal return is 7 percent (leaving the real return unchanged compared to our first example). Then the effective tax rate on one year of investment is 112 percent rather than 96 percent.