It turns out that Joe Biden was not, in fact, joking during his presidential run when he told everyone that he planned to tax the bejesus out of wealthy investors. Bloomberg reports Thursday that the White House is considering a plan that would nearly double the top tax rate on long-term capital gains to 39.6 percent for Americans who earn more than $1 million, up from about 20 percent.
Stocks swooned a bit in response to the news, unsurprisingly. But the development shouldn’t have come as a total surprise, since Biden clearly stated in his campaign platform that he planned to tax investment returns at the same rate as ordinary income. He now appears ready to follow through on that promise. The money would be used to fund the trillion-dollar package of family policies, such as child-care funding and paid leave, that Biden intends to unveil next week.
Under the the proposal, those raking in seven figures would ultimately face a 43.4 percent levy on capital gains. That would be the grand total between the new 39.6 percent long-term rate, and the 3.8 percent Medicare surtax on investment income that was created as part of the Affordable Care Act. Currently, the tax rate on ordinary labor income maxes out at 37 percent, but during the campaign Biden promised he would nudge it back to 39.6 percent. High earners also face a 3.8 payroll tax for Medicare. (For what it’s worth, Press Secretary Jen Psaki told reporters on Thursday afternoon that nothing had been finalized yet.)
So, other than the fact that private equity guys are probably about to start making Uncle Joe Stalin jokes, what can we take from this? Here are a few points that I think are worth keeping in mind:
• First, this is a dramatic break with tax history, and wealthy investors are going to be ticked. With some brief exceptions, such as the very early 20th century and the period from 1988 to 1990, capital gains have traditionally been taxed at a lower rate than ordinary income, partly in order to encourage more savings and investment. I would expect that much of the pushback against this will ultimately come from Silicon Valley, since venture capital returns are taxed at capital gains rates. See, for instance, the reaction from Billionaire VC Tim Draper.
•Second, for his plan to work, Biden can’t just raise the capital gains rate—he has to reform how taxes on investment are collected, too. Today, Americans only have to pony up capital gains taxes when they sell an asset like a stock or bond and net a profit. If the government raises the rate too high, the mainstream view is that many investors will simply choose to sit on their portfolio and let it rise in value, rather than sell, in order to avoid paying the tax. Economists call this a “lock-in effect.” And because of it, the conventional wisdom has been that government can raise the most revenue from capital gains taxes at a rate of 28 percent. Go any further and the government will end up on the wrong side of the Laffer Curve and raise less money.
However, there are ways that Biden can raise the revenue-maximizing rate. One reason that lock-in is currently such a problem is that wealthy heirs are exempted from paying capital gains taxes when they sell assets that they’ve inherited under a rule known as stepped-up basis. As a result, wealthy Americans can avoid a massive IRS bill by just holding their assets until death, and passing them on to their kids or donating them to a foundation. During his campaign, Biden said he would end stepped-up basis, making it harder to skirt the tax man forever. Another idea that Democrats are considering would be to essentially make wealthy investors pay taxes each year on the paper profits from their assets if they increase in value, even if they aren’t sold. Senate Finance Chair Ron Wyden has said he plans to push for such a “mark-to-market system.”
• Third, between this potential capital gains hike, the proposed increase to the corporate tax rate, and Biden’s plan to crack down on global tax havens and impose a minimum worldwide corporate tax, it’s pretty clear that the president isn’t just trying to raise revenues from the rich. Rather, he’s aiming to tax capital. Instead of going after highly paid lawyers, doctors, and entertainers who draw a big salary or partnership profits that are essentially labor income, he’s really sticking it to shareholders. Which is just kind of funny coming from the former senator from Delaware of all places, which as we all know is a glorified corporate P.O. box with an Amtrak stop.