As the name suggests, the “capital gains tax” is a tax assessed on capital gains for investments that are held for at least one year. Capital gains held for less than one year are considered “short-term capital gains” and are taxed at the ordinary income tax rate. The capital gains tax rate is far lower than the ordinary income tax rate, topping out at 20%. Importantly, the capital gains tax rate is only assessed gains at sale. So if one holds an investment asset that appreciates 50% in value, one only pays the tax once one sells the asset. Moreover, the tax is assessed on nominal gains, not just real gains. Suppose someone holds an asset worth $100 and economy-wide inflation is 5% annually. The next year, the asset is worth $103. Despite actually losing money on the year in real terms, that $3 is still taxed on gains.
The capital gains tax rate is a frequent source of controversy. Many progressives argue that since the wealthiest Americans derive most of their income from investment income, the lower capital gains tax rate exacerbates inequality. Others argue the opposite: that the capital gains tax rate itself constitutes an inefficient form of double taxation. First, one is taxed when one earns their ordinary income. Whatever that person saves becomes investment, and the tax on the return on those investments is thus double taxation. They also argue that this double taxation inefficiently discourages savings and investment in favor of consumption.