In his first congressional speech on April 28th, President Joe Biden declared his plan to raise the capital gains tax on some of the nation’s highest earners.
As stated by the Institute on Taxation and Economic Policy, just 0.7 percent of households would face a tax hike, with almost the entire burden being felt by the richest 1 percent.
Raising taxes on the top 1 percent earners is part of Biden’s ambitious plan to reduce income inequality by spending more money to help less affluent Americans.
Breaking Down Biden’s New Capital Gains Tax Increase
As stipulated under the $1.8 trillion American Families Plan, Biden plans to raise taxes on the richest Americans in the following ways:
- 39.6 percent would be the new top marginal income tax bracket – up from 37 percent.
This would apply to 2022 income above $509,300 for a married couple and $452,700 for individuals.
- Americans earning over $1 million would have their long-term capital gains taxed at 39.6 percent as well – up from 20 percent.
Under the current law, capital gains from the sales of stocks, bonds and other assets are taxed at 0 percent, 15 percent or 20 percent rate. The highest rate (20 percent) is saved for well-off taxpayers, i.e., couples filing a joint return with $501,600+ taxable income, head-of-household filers with $473,750+ taxable income and single filers with $445,850+ taxable income.
Under Biden’s American Families Plan, anyone making more than $1 million per year would have to pay nearly twice as much as the current rate. Doubling the tax rate would impact about 0.3 percent of US households.
- Surtax on Net Investment Income
That rate could soar to 43.4 percent when you include the 3.8 percent net investment income tax (NIIT).
Net investment income includes taxable interest, passive rents, dividends, gains, royalties and annuities.
This extra tax hits joint filers with a modified adjusted gross income of over $250k and single taxpayers with a modified AGI of over $200k.
The Biden Administration hasn’t suggested modifying or doing away with this extra tax.
- Inherited assets that have appreciated by over a million dollars since they were purchased would be taxed when the owner dies.
Why Now?
We’ve just started to recover from the current recession; why propose to raise capital gains taxes now?
Well, there are 2 major reasons for this: the need to increase revenue and a desire to battle income inequality.
The full plan entails priorities like:
- Greater subsidies for those buying health insurance
- Tax breaks for lower-income families with kids
- Free pre-school and community college
- Scholarships for future teachers
- Limits on child-care costs and much more
The Biden Administration sees the tax hike as a means to end what it believes to be one of the most unfair dynamics of the current tax system.
Basically, the idea is for the wealthy to pay the same tax on long-term capital gains that they’d pay on normal income, such as wages.
The Impact of The New Capital Gains Tax Increase
According to a recent study from the University of Pennsylvania’s Wharton Business School, increasing the top rate to 39.6 percent will reduce tax revenue between 2022 and 2031 by $33 billion.
If you earn less than $1 million annually, you’re unlikely to feel the direct impact of these proposed changes.
Doubling capital gains taxes for investors earning over $1 million could compel some to sell off assets and max out retirement contributions before the tax hike takes effect.
Wealthy investors living off investments will look into other tactics to lower their taxes.
What About The Stock Market?
After Biden’s proposal sent a jolt through markets shortly after his address, there has been rising concern about the effects on the stock market.
According to most financial experts, it’s unlikely that an increase in the capital gains tax rate would affect the stock market.
If history is anything to go by, the effects of changes in capital gains rates will not endure.
There may be a short-lived downside effect on the market but no real, lasting influence.
In a briefing addressing the tax’s influence, Brian Deese, director of the National Economic Council, said that the market had little to fear.
A research note by UBS Global Wealth Management reiterated that history shows no correlation between changes in capital gains tax rate and stock market performance.
The note also said that only about 25 percent of the United States stock market would fall under the capital gains tax.
1 in 4 investors holds stock in taxable brokerage accounts that would be subject to this tax.
The other 75 percent is owned in accounts not subject to capital gains taxes, such as endowments held by tax-exempt organizations like colleges, retirement accounts like IRA and 401 (k), and foreign investors.
Does It Have a Chance Politically?
There’s no guarantee that the recommended capital gains tax hike will ever materialize. Proposals like these provide a framework that policymakers can use to design future legislation.
Let’s look at some facts.
Before he can sign it into law, the president’s plan must be passed by Congress.
The Democrats have a narrow control of both House and Senate. Despite this giving them the power to approve tax raises without the Republican support, to pass this bill will require nearly unanimous support in the party.
Unfortunately, there’s already some skepticism from a section of Democratic Senators. Those not thrilled with the idea claim the bill could hurt stock prices, won’t actually raise that much revenue and may cause economic growth to slow.
The opponents believe that increasing rates on capital gains would incentivize or encourage investors to hold onto assets.
Bob Menendez, the New Jersey Democratic senator who’s a member of the Senate Finance Committee, aired his concerns on how the capital gains hike could hurt “the ability of growth to continue to take place.”
As expected, Republicans are united in opposition to the capital gains changes due to their potential impact on the economy. They have maintained their support for the 2017 tax cuts implemented by former President Donald Trump.
When commenting on Biden’s capital-gains plan, Chuck Grassley, a top Iowa Republican on the Senate Finance Committee, said, “It’s going to cut down on investment and cause unemployment.”
Since Biden’s American Families Plan contains other “tax the rich” provisions, there will probably be lots of back-and-forth in Congress to find the right balance of tax hikes on the rich to pay for the recommended tax breaks and benefits for the lower- and middle-income Americans.
Whether a capital gains rate change can eventually make it into the final bill remains to be seen.
If the plan passes through Congress, it remains uncertain when the suggested tax hikes would go into effect.