Toward Adding Further Complexity to the Internal Revenue Code: A New Paradigm for the Deductibility of Capital Losses
Posted: 19 Jul 2000
Congress long ago recognized that if it wanted to induce taxpayers to invest in risky undertakings, it would have to permit the deductibility of capital losses resulting from those investments. However, with one short-lived exception, there have always been limitations imposed on the deductibility of capital losses. These limitations have been justified on three policy grounds: parallelism, cherrypicking, and bunching.
This article examines problems inherent in the current loss limitation system, arguing that it is ill-equipped to meet parallelism concerns and that cherrypicking is not a problem that a loss limitation scheme should address. The article also argues that the current system is both fundamentally unfair to taxpayers and promotes economic inefficiency in the marketplace. It proposes an alternative system for the tax treatment of capital losses that would allow such losses to offset all types of income, but only up to the tax rate that would have been imposed had the losses instead been capital gains. The article concludes that adopting this new paradigm for the deductibility of capital losses would provide a fairer and more economically efficient solution to the problems giving rise to the need for loss limitations that have plagued legislators since the inception of the income tax.
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