Recent economic data suggests a sluggish recovery with slowing job growth, inflation and heightened household financial anxiety. President Joe Biden’s recent budget proposed $2.975 trillion in tax hikes which will only exacerbate these problems. As part of this tax hike, Mr. Biden wants to more than double the tax on capital gains and dividends.
Worse, Mr. Biden’s budget assumes that the capital gains tax hike took effect in late April, making it a retroactive tax.
Capital gains and dividend tax hikes are among the most damaging tax hikes. The Biden proposals will make America globally uncompetitive, reduce new investment and threaten access to capital for startups. It will suppress economic growth and even result in less, not more revenue as investors sit on the sidelines.
Capital gains taxes are imposed when a taxpayer sells an asset, such as stocks, bonds or real estate. The tax is imposed on the difference between the purchase price, or cost basis, and the sale price.
Mr. Biden wants to increase this tax from 23.8 percent to 43.4 percent, which includes a 39.6 percent long-term capital gains rate and the 3.8 percent Obamacare net investment income tax. This would be on top of the capital gains taxes levied at the state level, which averages 5.4 percent.
In many states, taxpayers could face a capital gains tax rate of over 50 percent. For instance, California taxpayers would pay a top capital gains tax of 56.7 percent.
Not only would Mr. Biden’s capital gains tax hike slug taxpayers hard, it would also leave America globally uncompetitive. Mr. Biden’s 48.8 percent rate is radically uncompetitive with China’s 20 percent rate and the Organisation for Economic Co-operation and Development (OECD) weighted average of 23.2 percent. Despite this steep tax increase, it is likely that the proposal will result in less, not more federal revenues as taxpayers will delay realizing their gains or not invest in the first place. This is why the Wall Street Journal has referred to Mr. Biden’s capital gains tax hike as “the dumbest tax increase.”
Capital gains taxes naturally have a “lock in” effect that discourages taxpayers from realizing their gains. Mr. Biden would supercharge this effect by setting the capital gains tax rate to 43.4 percent, significantly higher than what economists call the “revenue maximizing rate.”
For instance, the Congressional Budget Office has argued the revenue maximizing rate for capital gains is about 28 percent, which was the highest capital gains rate proposed by former President Obama. Other economists say the revenue maximizing rate is much lower.
While economists disagree on the exact rate at which capital gains revenue begins to decline, it is clear that Mr. Biden’s proposal is much higher than anything economists would recommend. This will lead to a decline in new investment, productivity and growth.
By suppressing new investment, the capital gains tax hike will harm entrepreneurs and startup businesses across the country that already must fight tooth and nail for access to new capital.
This is not the only damage Mr. Biden’s capital gains tax would have on the economy. By increasing taxes on capital gains, Mr. Biden will also raise taxes on carried interest capital gains, threatening the retirement savings of Americans across the country.
Carried interest is the capital gain for private equity investment, which counts public pension funds including firefighters, teachers, and police officers, as their largest investors.
In fact, according to research, public pension funds representing 20 million public sector workers have invested an average of 9 percent of their portfolios in private equity, totaling an investment of $150 billion.
Mr. Biden also wants to apply capital gains at death by taking away a provision known as “step-up in basis.” This will create a second death tax as the capital gains tax will be imposed on the unrealized gains of every asset owned by a taxpayer when they die and will be imposed in addition to, and separate from, the existing 40 percent Death Tax.
This will impose another tax on family-owned businesses, many of which are asset rich, but cash poor. It will impose crushing complexity as these businesses will have to figure out the cost basis of every asset they purchased years, or even decades ago. As noted by an Ernst and Young study, if the taxpayer fails to provide sufficient evidence, the cost basis could be zero, meaning the capital gains tax is imposed on the entire value of the asset.
Coming out of the pandemic, the economy desperately needs new investment, job growth, and business creation. Mr. Biden’s capital gains tax hike will threaten the recovery, make the U.S more uncompetitive, and deprive small business of capital.
• Isabelle Morales is policy communications specialist at Americans for Tax Reform.