May 04th, 2021
Why a capital gains tax increase hurts us all
BY JULIA ANDERSON
Those of us who are retired should pay attention to the proposed tax increases on capital gains income being promoted both by states (Washington state) and by the Biden Administration.
Even though President Biden says his capital gains tax increase will only affect the wealthy, not you, don’t believe it. Any change in tax law affects markets top to bottom, changes investment strategies and could generally dampen enthusiasm for capital investment at all levels.
Retirees are living on investment savings --- CDS, stocks and bonds -- and income generated by U.S. stock markets and underlaying resilient economy. For the past ten years, it has been a good ride, up 13.6 percent a year. Our portfolios are looking healthy.
Here’s the deal. Even though only those with $400,000 of capital gains “profit” or more annually would pay higher capital gains taxes up to 43.4 percent (double the current rate), the higher tax rate will hurt markets…our markets.
Capital gains tax (15 percent for middle income investors, 20 percent for the wealthy) have been used by government for decades to deliberately create incentives for investors who put money into new business ventures and into corporate stock. This tax strategy supports new enterprise, grows overall employment, and strengthens the general economy. Middle-income retirees benefit from this economic momentum. When these stocks are sold, up to now, we pay a lower income tax on the gain (or profit). Here’s a chart:
2021 capital gains tax rates:
15 percent for those with taxable income of $40,451 to $441,450.
20 percent for those with taxable income $441,451 and more
2021 ordinary federal income tax rates - married, filing jointly.
12 percent for those with taxable income from $19,751 to $80,250
22 percent for those with taxable income of $80,251 to $171,050
Raising capital gains taxes punishes businesses seeking capital investment to support expansion. At the same time, higher capital gains tax punishes investors by reducing income. That means fewer of their discretionary dollars are spent on housing, cars, consumer goods, dining out -- all the sectors that need support as we recover from the pandemic. The higher tax puts a damper on the entire U.S. economy.
Meanwhile, wealthy Americans are already strategizing for how to avoid higher capital gains taxes. Wharton School of Business researchers conclude that tax avoidance could cut $900 billion from the estimated $1 trillion the Biden Administration says it will collect in new capital gains tax money to pay for infrastructure and more. Do they think the wealthy are stupid? An easy alternative for them? Tax-exempt municipal bonds.
By the way, money coming out of your tax deferred retirement (401(k) and IRAs) accounts is taxed as ordinary income at a rate commensurate with your federal income tax bracket. An increased capital gains tax applies only to income from shares invested outside of a retirement plan.
Expert analysis in numerous studies on capital gains taxes, however, says that a rise in the capital gains tax rate reduces wage growth by dampening investment in corporations looking for new capital to expand. At the same time, the tax reduces revenue growth for governments simply because people will be more reluctant to sell stock and thus pay the higher tax. According to the Congressional Budget Office for each 1 percent increase in the capital gains rate, there is a 1.2 percent reduction in tax realizations (collections). That’s because rich investors will hold on to investments longer and look for other ways to avoid taxes.
There are other aspects in the Biden tax proposal that have estate planners and their clients worried. Those include changes in inheritance tax regulations that will make it harder to pass on farms and businesses to a new generation. But that deserves a separate column.
Many states also have capital gains taxes or are implementing them. California leads the pack with a rate of 13.3 percent. Among other top five capital gains tax states are Hawaii, (11 percent), New jersey, (10.75 percent), Oregon, (9.9 percent) and Minnesota, (9.8 percent).
Washington state’s Legislature has approved a bill (2021) that creates a new capital gains flat tax of 7 percent on the long-term gain from the sale of stocks, bonds, and other high-end assets more than $250,000 for both individuals and couples. For details, click here.
The tax exempts real estate, retirement accounts, agricultural land, and family-owned small businesses. It still is a new tax on income in a state that up to now has not had an income tax.
Meanwhile, the Biden administration is proposing a top tax rate on capital gains of 43.4 percent, up from the current 23.8 percent. That means on every $10,000 of stock sold, the tax would total $4,340, up from $2,380 with the lower rates. The editorial board of the Wall Street Journal calls the idea, “the dumbest way” to raise taxes.
The bandwagon to raise capital gains taxes is pitched as a tax on “rich people” who should “pay their fair share.” This ignores that fact that the top 50 percent of all taxpayers already pay 97 percent of all federal individual income tax. The top 1 percent pay 40.1 percent. The bottom 90 percent of taxpayers combined pay 28.6 percent of all federal income tax. In 2019, 46.6 percent of U.S. households with an annual income of between $40,000 and $50,000 paid NO income taxes at all. Click here.
The Biden Administration says only 500,000 taxpayers would be affected by the proposed tax. The issue is not about who pays but the longer-term impact on markets in terms of slower investment and slower economic growth that will affect us all.
It’s politics, not common-sense economics that is driving the capital-gains campaign. Tax incentives related to capital gains have been on the books for more than 50 years. They work.
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