That the Biden administration has enormous confidence in the government’s ability to invest wisely is no secret, however ill-founded that confidence may turn out to be. So there is a certain perverse logic to its proposal to fund, at least in part, the newest proposed spending spree with a dramatic increase in the capital-gains tax rates paid by — a bit of class warfare always helps — “the rich.” To believe that this will not discourage investment is to believe that those investors who are subject to the tax disregard post-tax returns. That’s not likely. They will either demand a higher price for their capital, or put an increased premium on safety, or search for investments that offer less in the way of growth, but more in the way of tax shelter. Others may choose to consume more and invest less. Some would-be entrepreneurs, meanwhile, will decide not to give up their day jobs. None of these developments would be good for the economy and those who would benefit from its flourishing.
Turning to the grim details, if this proposal is approved, those earning more than $1 million a year will face a top tax rate on long-term capital gains of 43.4 percent (once the Obamacare surtax on net investment income is thrown in), compared with 23.8 percent today. That would be a top rate higher — generally much higher — than anywhere in Europe, and that’s before considering what state and local taxes can do to the math. Those living in high-tax states such as California and New York will be looking at a top rate in excess of 54 percent, and for those lucky enough to be resident in de Blasio’s New York City, over 58 percent. Those who have been making plans to leave will get moving, and others are likely to join them, something that would come as a major blow to their governments’ already-shaky finances.
Some defenders of this increase argue that it will lead to a “fairer” tax system. Leaving aside the fact that the U.S. income-tax system is already sharply progressive, as well as the unequal treatment of capital losses and gains under current rules, this also ignores the way that the tax is levied on nominal capital gains. No adjustment is made for inflation, which even at the relatively low rates of recent years can matter, particularly if the asset is held over a longer period (which is what those who rail against “speculation” claim to want). This will be of even more relevance if relief provided by the “step up” in the cost basis on death is pared back. And if inflation picks up . . .
The assumption that this increase will affect only the rich does not hold up, and not just because the real value of that $1 million will almost certainly be allowed to erode. Beyond that, there is the case of the small entrepreneur who has spent a lifetime building up his or her business, perhaps forgoing income to do so. When the time comes to sell that business, to the extent that the gain (plus any other income) tops $1 million in nominal terms, he or she will be subject to the top rate payable by the rich, a Croesus just for a year. Thereafter it may well be a different matter, but the money will have gone for good.
On the question of equity, there is also the claim that capital-gains tax is a form of double taxation. This is not necessarily the strongest of arguments, but it has the most force when it comes to the sale of a stock by a holder who has already paid tax on the dividends received (something that is itself a form of double taxation, given that dividends are paid out of post-tax income).
Taxes are sometimes used to deliver a message as well as to raise money. If the effect of raising the top rate on capital gains to a level so high that any increase in revenue starts to go into reverse, as it is likely to do (people respond to disincentives), then the motivation for such a move will be interpreted as an attempt at crude and vindictive leveling down: We can think of more enticing investment environments.