A President Biden would double the tax rate on capital gains. The highest marginal rate on capital gains would rise from 20% to 39.6%. Add on the Obamacare surtax of 3.8% and you are looking at a 43.4% tax rate on capital gains.
Why does Biden want to increase the capital gains tax rate? Do higher capital gains rates lead to more tax revenue?
It’s not even close. Lower, not higher, capital gains rates generate more capital gains tax revenue.
So why the focus on capital gains tax rate? For Biden and the progressive Left it’s about closing the wealth gap.
Will higher capital gains tax rates close the wealth gap? Sounds like a non-starter if a higher rate will generate less capital gains tax revenue. The most likely outcome of a higher capital gains tax rate is distortive incentives to avoid the taxes and a windfall for tax accountants, tax lawyers, and insurance companies.
If Biden really wanted to do something about the wealth gap, he would turn his attention to the Federal Reserve. The Fed’s focus on propping up financial asset prices owned by a small portion of the population exacerbated the wealth gap coming out of the financial crisis and it is doing the same today. Unemployment is high and private sector income is deeply depressed. Low- and moderate-income Americans have been hit especially hard in this recession, but stock and bond prices are only a whisper away from record highs. The Fed has played a leading role in the rally.
The political class rarely connects Fed policy to negative economic outcomes, but they should start. The end-result of years of the Fed encouraging misallocation, mispricing, and malinvestment with manipulated interest rates is an unbalanced economy. An economy where a candidate like Joe Biden decides he can solve the yawning wealth gap with yet another big-government solution.
The Wall Street Journal has more on Biden’s capital gains tax proposal.
Focus on the capital-gains proposal. No one has defined what is at stake here better than President John F. Kennedy, who wrote in 1963: “The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced by new ventures in obtaining capital and thereby the strength and potential for growth of the economy.”
In addition to the federal tax of up to 43.4% under Mr. Biden’s proposal, there are state and local taxes on capital gains, which are no longer deductible for federal income tax purposes. Unless the deduction is reinstated, the total top long-term capital-gains tax bite under Mr. Biden’s plan would rise to well over 50% for residents of New York and California. (The Biden proposal doesn’t say how capital losses would be treated, but under current law they can be offset against ordinary income up to $3,000 a year.)
What are some of the economic implications of the proposals if enacted? First, there is the effect on individual realizations of long-term capital gains. At the American Council for Capital Formation we have monitored this effect closely for 42 years. Realizations of long-term capital gains—particularly those of high-income investors—are very sensitive to changes in capital-gains tax rates. Such investors respond to increases in these taxes by holding on to their gains for longer—sometimes indefinitely. There is no doubt that an approximate doubling of the top capital-gains tax rate would lead to a substantial reduction in the realization of long-term gains. The Congressional Budget Office estimates this elasticity is 1.2 in the short-run. This means that for each 1% increase in the capital-gains tax rate. there would be a 1.2% decline in capital gains realizations. But there hasn’t been a capital-gains tax increase of the magnitude proposed by Mr. Biden in recent history. The reduction in realizations it would cause could be even more severe than 1.2%.
In any case, a doubling of the top capital-gains tax rate would greatly restrict the mobility of individual capital, which Kennedy warned affects the flow of capital to new and smaller business ventures. Also, it would never raise anywhere near the tax revenues that its proponents claim. These claims are based on government tax-expenditure tables that use “static” analysis, ignoring the rather obvious “dynamic” effects of changes in realizations and economic growth. Interestingly, the negative effect on some state tax receipts could be substantial. States like New York and California (and some municipalities, notably New York City) rely heavily on realizations of capital gains, which would drop significantly.
If lawmakers want to increase tax receipts from wealthy individuals, they should lower the top capital-gains rate. Such a step would jump start realizations that even now are somewhat depressed. That’s what happened in 2003, when the rate was reduced to 15%.
