Hi, can someone help me understand why inflation has a greater eroding impact on after-tax gains than on annual income?
This is what Schweser is saying…
Capital gains usually have a lower tax rate; with annual income, you get “bracket creep” and for fixed income, inflation erodes purchasing power the further in time one goes.
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Look at an example.
Suppose cap gains tax is 20% and you make a real gain (after inflation) of 10%
If inflation is 0% then you make a gain of 10% and after tax you have 8% which is a real gain of 8%
If inflation is 10% then you make a gain of 20% and after tax you have 16% which is a real gain of 6%
You have to pay tax on both (the real return) and (the return to keep up with inflation)
Edit: added:
from memory, at some point (1980s? 1990s?) the Thatcher administration in the UK tried to address this using indexation, so that you only paid cap gains tax on gains over and above the official rate of inflation.
That didn’t last vey long and has long since been done away with