Even more Biden Tax Hikes are coming!
Many Americans remain unaware that the U.S. operates under a bifurcated tax system. This system divides taxation into two distinct categories: ordinary income and long-term capital gains. Ordinary income includes earnings from wages, salaries, and business profits, while long-term capital gains pertain to profits from assets like stocks or business equity held for over a year. With the tax code stretching over thousands of pages, understanding its intricacies can be daunting for most people. The distinctions between ordinary income tax, capital gains tax, and their broader economic implications are particularly complex.
A recent report from the Treasury Department, led by Secretary Janet Yellen, sheds light on President Biden’s proposed fiscal year 2025 budget. This budget suggests raising the top marginal rate on long-term capital gains and qualified dividends to a striking 44.6%. Currently, the top marginal rate for long-term capital gains stands at 23.8%. It’s misleading to frame this increase as a mere 20.8% hike; in reality, it represents an 87.4% increase.
Here’s a detailed look at how this substantial tax hike would come about:
- Ordinary Income Tax Rate Increase: The top marginal tax rate for ordinary income would rise from 37% to 39.6%.
- Capital Gains Rate Adjustment: The top rate for long-term capital gains would align with the new top ordinary income rate, jumping from 20% to 39.6%.
- Net Investment Income Tax (NIIT): Introduced under the Affordable Care Act in 2010, the NIIT adds a surtax on certain investment incomes. Initially set at 3.8%, Biden’s plan proposes increasing this to 5%.
Combining the proposed 39.6% capital gains tax with the 5% NIIT yields an overall rate of 44.6%.
Impact on the Economy
If these policies are enacted, particularly as the Tax Cuts and Jobs Act (TCJA) of 2017 sunsets at the end of 2025, there could be significant economic repercussions. Investors, anticipating higher future taxes, might rush to sell off appreciated stocks at current rates, leading to a massive sell-off. This surge in selling could trigger further declines in stock prices due to the basic principles of supply and demand.
The potential for widespread divestment is heightened by political uncertainty. Should Congress, the Senate, and the White House all be controlled by the Democratic Party, the likelihood of these tax changes becoming law increases, which could further unsettle the markets.
Impact on Small Business Owners
Entrepreneurial wealth is often tied up in business equity and real estate. Small business owners, who create a significant portion of U.S. jobs, would face a daunting challenge. To net the same amount of money post-tax change as they would today, business owners would need to increase their business value by 50%. Consequently, many might decide to sell their businesses preemptively, leading to a surge in business sales.
This wave of sales could result in job losses as smaller businesses are absorbed by larger ones. Furthermore, the potential deterrent effect on new business formation could be severe. The increased financial, legal, and personal risks without adequate upside might dissuade entrepreneurs from launching new ventures.
State-Level Impacts
Under the proposed tax plan, some states would see their capital gains taxes exceed 50%. California would be the hardest hit, with a combined rate of 57.9%. Owners of investment real estate might also rush to sell properties, exacerbating issues in the housing market. High-interest rates, coupled with a glut of properties, could make it even harder for millennials and Gen Zers to enter the housing market.
Conclusion
These proposed tax changes warrant careful consideration from all Americans. The economic landscape could be dramatically altered by a 44.6% top capital gains rate. The potential for increased stock market volatility, reduced entrepreneurial activity, and significant shifts in the real estate market are real and concerning. It’s essential for the public to understand these proposals and their far-reaching implications. If implemented, these tax changes could fundamentally reshape the U.S. economy, potentially stifling growth and innovation at a critical time.
