Biden's Capital Gains Tax Increase- Highest in the World
Biden's Capital Gains Tax Increase- Highest in the World
Capital gains taxes are the target of Democrats as the go-to tax to increase government revenue.
Most income taxes are divided in two: Earned Income, those gained from wages, commissions, and bonuses and taxed on a progressive tiered structure up to 37% for the highest earners; and the second is Investment Income, which consists mainly of dividends and the capital gains from the sale of appreciated securities.
Currently, long term capital gains taxes have three tiers: 0% for lower income taxpayers; 15% for middle income, and 20% for high earners.
Short term capital gains (held less than one year) are taxed as ordinary income- so that income is lumped together with your wages and taxed according to the progressive tiered structure mentioned early.
The reason capital gains are the target here is that for so many of the millionaires and billionaires out there, many live off the investment income of their portfolios. For instance, Jeff Bezos has 99% of his net worth creation from AMZN stock. He therefore sells the stock periodically to produce the funds he uses to live off of. He would be taxed at the 20%, not the highest federal earned income tax tier of 37% (plus state and local taxes).
Biden’s proposal would be to raise the pure rate to 39.6%, with another 3.8% Medicare surtax on top of that, for a total of 43.4% top rate- to bring that capital gains tax rate more in line with high earners wage income tax. It would apply to taxpayers whose income exceeds $1 million (or $500,000 for couples filing separate tax returns).
This would put the United States at the top of all OECD countries in terms of highest capital gains taxes. Many countries seek to incentivize long-term saving by providing a lower tax rate or a partial exemption on long-term gains.
The capital gains rate would be retroactive to the “date of announcement,” according to the Treasury document. It’s unclear whether that means Friday’s announcement or perhaps Biden’s outline of the American Families Plan in April.
The plan will need to pass both houses of Congress- so nothing is set in stone as of yet.
Biden also proposed eliminating an existing tax break at death (the “step-up” in basis) that allows appreciated assets to pass to heirs tax-free. Investors therefore can’t necessarily avoid capital gains tax outright by holding until death.
These reforms to the capital gains tax are expected to raise about $322 billion over a decade, according to the White House.
Many economists are pushing back on the proposal.
For one, capital gains and dividends are largely or entirely double-taxed. When an individual receives a dividend, that money has already been taxed at the corporate level. Same with sale of a security- the corporation had years of growth, paying tax along the way. So the capital gains tax on the sale of the stock would be the second time that growth is taxed.
Also, theoretically when we significantly lower the rate of taxation on capital, the U.S. Treasury generates more (not less) revenue. This is exactly what happened in the late 1990s and early 2000s when the capital gain rate went from 28% to 20% to 15%. This phenomenon contributed heavily to the annual surpluses in the last few years of the Clinton administration.
It also happened further back during the Carter/Reagan presidencies when the rate was lowered multiple times, increasing tax revenue substantially (see below chart).
According to the Tax Foundation, higher tax rates on individual shareholders reduce the return to saving and higher taxes on corporations raise the cost of investment, reducing saving and investment. Lower investment levels and reductions in capital stock translate to lower work productivity, reduced wages, and lower economic output.
It is still early, but most likely in our opinion, Biden is using the same tactic he used with the infrastructure bill, start the negotiation with an absurdly high number, and work down to a more reasonable (and passable) number. It remains to be seen where it will land…
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