Why are you singling out capital gains? Your argument works equally well for labor-based income, but capital gains are already taxed much less than labor.
Labor is taxed year-by-year so inflation does not have much influence on it. Capital gains tax taxes the sales of things (capital) that might have been held for decades. Buy a piece of land and hold it for 20 years. If inflation is 3% then the dollar value will go up by a factor of 1.8 without any real increase in value but if you sell it you will get taxed on that inflation created gain. Some see that is not "fair". That is the spin, anyway.
I think the way to mitigate this problem is to index capital gains to the CPI and then tax gains like income. This cleans up the tax code quite a bit, stops favoring capital over labor, and balances out the pressure on the CPI with having a powerful group of people wanting to have it go up. At the moment CPI is probably under-reported and keeping social security and other inflation adjusted things lower than they would be otherwise.
I don’t think CPI needs to be used to mitigate the problem of taxing inflation on assets. It would just increase the politicization of CPI, which is already not realistic.
The market can easily adjust prices for assets to factor in the cost of inflation and taxes.
No. If I pay you $1 and you get taxed $0.5 you are still $0.5 better off than you were before. If inflation raises you salary to $2 and you get taxed $1, you are still one (inflated) dollar better off than you were before you were paid.
But if you buy a stock for $1 and it goes to $2 as a result of inflation, you get taxed $0.5 on the $1 gain, but your resulting $1.5 has less purchasing power than the $1 you invested.
There isn’t enough time between labor being performed and it being paid for inflation to have much effect. Long term capital investments have plenty of time for inflation to pile up and distort the naive calculation of “gain”.
I see your point, but it seems to rest on the rest on the way we determine when capital gains are realized. Capital gains accumulate regularly just like other sources of income; in my mind the tax obligation is incurred at the time of the gain, just like the tax obligation on other income.
For practical reasons the state does not demand the tax until the accumulated gains have been realized by selling the asset. This makes sense for illiquid assets like stock in your private startup, but I don't think it should change the calculation of when the tax was incurred and how much. For liquid assets like shares in public companies, I think it would actually be perfectly reasonable to demand the tax on unrealized gains.
I think the way to mitigate this problem is to index capital gains to the CPI and then tax gains like income. This cleans up the tax code quite a bit, stops favoring capital over labor, and balances out the pressure on the CPI with having a powerful group of people wanting to have it go up. At the moment CPI is probably under-reported and keeping social security and other inflation adjusted things lower than they would be otherwise.