What a terrible time to be rich in America. The stock market rally has flatlined, there’s talk of regulating bitcoin, and worst of all, the president wants to raise taxes on the wealthy.
The stock market shuddered this week when a detail of President Biden’s forthcoming “American Family Plan” leaked to the press: Biden wants to nearly double the capital gains tax rate for Americans earning more than $1 million. Biden said he would do this while campaigning for president last year, but investors must have thought he didn’t really mean it. He meant it. The tax hike will be one of several Biden pushes Congress to pass as part of his infrastructure and social-welfare spending plans.
Bloomberg reported that investors are suffering “anger, denial and grief” at the prospect of higher taxes on investment gains, because bad things would happen: There would be a stock-market selloff. Investments in new business would dry up. Jobs would disappear. American capital would move overseas. Republican Rep. Kevin Brady of Texas said it would “sabotage” the economy and Republican Sen. Charles Grassley of Iowa claimed the tax hike was a fix for a problem that doesn’t exist.
Maybe everybody should try to calm down.
Biden’s legislative priorities include several proposed tax hikes he’s been talking about for two years. He wants to raise the corporate tax rate from 21% to 28%. He’d boost the top individual income tax rate from 37% to 39.6% and raise the estate tax on holdings above $3.5 million. As for the capital gains tax, he’d raise it to the regular income-tax rate for people earning more than $1 million per year. If the top rate went to 39.6%, then the rate on long-term capital gains for the wealthy would rise from the current 20% to 39.6%. Biden insists he won't raise taxes on households earning less than $400,000, and his capital gains hike would directly affect just 0.3% of taxpayers.
The fulminators point out that there’s also a 3.8% investment tax surcharge for high earners, along with state and local taxes on capital gains. Overall, that could push the combined capital gains tax rate above 50% in places like New York and California.
That’s on paper. We also know there’s a massive “tax gap” each year, with people who legally owe federal taxes hiding as much as $1 trillion from the IRS. Those tax evaders aren’t ordinary people who earn most or all of their income from labor. They’re wealthy Americans with multiple income streams and sophisticated strategies for concealing wealth and exploiting tax loopholes. If anybody ever paid a combined capital gains tax rate above 50%, it would probably be due to incompetent tax advisors.
There’s also an alarming degree of wealth inequality in the United States, which is forcing political action. The growing gap between the rich and the rest animated Donald Trump’s populist campaign in 2016 and helped him win the White House. Biden offered a more persuasive populist narrative in 2020, promising to restore prosperity and dignity to working-class Americans. Voters knew he planned to raise taxes on businesses and the wealthy, and basically said go ahead, do it.
So Biden is doing it. He’s not pushing tax hikes to punish the wealthy. He’s doing it to raise revenue for new programs meant to improve growth, address climate change, narrow the inequality gaps and improve living standards for those who have stagnated. Upper-echelon households, and especially the top 1%, have captured an increasing portion of national wealth for the last 30 years, while the bottom 50% has done worse. That’s what Biden wants to fix.
The risk isn’t that Americans will revolt if Biden raises taxes on the wealthy. It’s that he’ll raise taxes but won’t deliver the promised result, with working-class Americans noticing no improvement in their fortunes. That will come down to how effectively the government targets new spending, and also to a messaging campaign that makes sure voters notice the gains, if there are any.
Financial markets will be fine, and the hyperventilating will look silly in retrospect. First, Congress probably won’t raise taxes as much as Biden wants, which Biden knows. Congress might be able to raise the capital-gains rate to 30%, max, for wealthy investors. Other tax hikes will fall short of Biden’s ask, as well.
There probably would be a modest stock-market selloff prior to a capital gains tax hike going into effect, since investors looking to lock in gains would rather do so at a lower tax rate than a higher one. But markets would then return to fundamentals, including a friendly Federal Reserve, strong earnings, the ongoing boost from stimulus spending and a consumer savings glut. Investing firm UBS examined prior periods when capital gains rates went up, and found that “history shows no relationship between capital gains tax rate changes and stock market performance.”
Simple logic explains why. If higher taxes cut the return on a stock investment from 20% to 10%, that alone is no reason to stop investing in stocks. You’d only pull your money from stocks if something else yielded more than 10%. And other assets would be subject to the higher tax rate, too. The same goes for investing in a startup or any other venture. You could try moving your money overseas, but you’d forfeit the benefits of the dynamic U.S. economy and the accommodative Federal Reserve. Lower returns aren’t the same as no returns, and America will still have an ample supply of rich people if Biden gets his way.
Rick Newman is the author of four books, including "Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. You can also send confidential tips, and click here to get Rick’s stories by email.
Read more:
Get the latest financial and business news from Yahoo Finance