Saturday, January 13, 2007

Capital Gains on Renewable Energy - Time to Index

Have you noticed that in almost all of the leading finance portals, starting with Yahoo Finance and Google Finance (which is still in Beta) the industry classification doesn't list renewable energy companies seperately. They are still listed under Energy segment.

In a capitalist economy like that of US one of the easiest ways to get a technology out on the road and get attention is to get the Wall Street to rally behind it. And one of the easiest ways to do that is to first of give the renewable energy sector its due respect, exposure and platform it deserves.

Another way to drive investors and promote renewable energy companies in the investment communities is to lower the capital gains tax by, let's say, half a percentage point. Not only will this divert money to, often, cash strapped communities, the financial interests of institutional investors will drive a market generation/conversion. Also, all the capital gains for this industry segment should be indexed and inflation-adjusted, unlike the norm which is the nominal capital gains. This will induce an affectionate inventment in the renewable energy market where investors will make decisions purely for economic reasons and will not be swayed by tax considerations.

The figure on the top-right is from Tax Foundation, which it released in its special report in November 2006. It tells you that if you bought a stock worth $45.35 in 1956, it'd be worth $1228.81 in 2005. With a capital gains tax of 15% on $1183.46 (1228.81 - 45.35), an investor would owe $177.52 . However, taking inflation into account the current value of the asset would have been $263.64 the actual capital gain would have been $965.17 (1228.81 - 263.64) and the tax owed would have been $144.78. That means an investor lost $32.74 (177.52 - 144.78), which is roughly 3.4% of indexed capital gain of $965.17. Hence, instead of 15% capital gain that investor actually paid 18.4% capital gain. This would have been so accetuated in 1984 when the same investor would have actually paid 306% capital gains tax instead of the statuatory (nomial) of 20%.

It is an unprecedented opportunity for Congress to act. With inflation being tamed for past two decades and an industry needing support, which can break the clasp of mid-East oil on USA, the Congress not only bootstrap the energy-future of this country but can also improve the fairness of capital gains tax system with minimal risk.