What Biden’s Tax Changes Might Mean for Investors
This past Wednesday, President Biden laid out the tax changes he is proposing to fund his most recent spending package, which he has named “The American Family Plan”. The $1.8 trillion dollar plan, which comes less than a month after the President announced his $2 trillion “Made in America” plan, calls for about $1 trillion in new entitlement spending and approximately $800 billion in middle income tax cuts over the next decade.
To pay for these expenditures, the plan proposes to raise tax on wealthy Americans in two ways.
The first is less controversial. It would restore the top income tax rate to 39.6% for those with an income greater than $400,000.
The second is more punitive. It would nearly double the tax rate on capital gains and dividends to 43.4% (after factoring a 3.8% ObamaCare surcharge) for households making more than $1 million.
The proposed tax increases on individuals comes on the heels of last month’s corporate tax rate boost included in the “Made in America” plan. That proposal would raise the corporate tax rate by approximately 35%, from the current 21% to 28%.
The White House asserts the proposed tax hikes will be limited to the very wealthy and corporations. However, when all is said and done, the sting of the President’s revenue raising proposals may not be just limited to high income earners and corporations. The reason is that everyone who participates in the economy is inter-connected.
Zion Research Group estimates the corporate rate hike proposed by President Biden could reduce the earnings of companies in the S&P 500 by at least 10%. All else being equal, lower corporate earnings can be expected to lead to lower stock prices.
Businesses may elect to raise prices in an effort to preserve their after-tax profit margins, pushing the inflation rate higher.
As home prices soar, people who sell their homes could be pushed into the higher tax bracket for capital gains.
Investors who know that they are facing greater capital gain taxes in the future will have a strong incentive to harvest those gains before the new rate takes effect, by selling stocks that have built in gains. The resulting surge in selling could end up causing a major distorting in the stock market.
The tax hikes could have other unintended tax consequences as well. For one, the Congressional Budget Office says the revenue-maximizing rate for capital gains is about 28%. When rates go higher than that, people hold on to their capital assets longer, thereby avoiding capital gain taxes altogether. The CBO has found that for each 1% increase in the capital-gains rate, there is a 1.2% reduction in capital gain recognition.
Furthermore, some economists are concerned that raising the capital tax rate would hurt U.S. companies’ ability to compete globally. That’s because the rate increase, when combined with state income taxes, would mean the U.S. would reclaim its spot on the list of developed nations with the highest corporate tax rates.
That said, improving the nation’s infrastructure could lead to greater productivity and stronger GDP growth, which would be good for stocks. And raising capital gain taxes could address concerns about growing wealth disparity amongst the haves and have nots.
It’s also important to keep in mind that the proposal requires approval by Congress, where it will be subject to negotiations and possible changes. But claiming the proposed tax hikes will impact a very small number of ultra-wealthy Americans seems like a bit of a reach.
Thank you for reading.