President-elect Joe Biden promised throughout his campaign that, if elected, he would implement a variety of significant new tax increases, including nearly doubling the capital gains tax. He says the tax increases would only be for high earners, but the truth is his proposals would hit all of us by damaging investment, entrepreneurship and job opportunities – plus raising the prices of goods and services across the board.
Many Americans will unfortunately believe Biden’s claims that his tax increases only affect “the rich,” and for that reason, a lot of people may support them (i.e. – sock it to the rich). But nearly doubling the capital gains tax rate will deliver a powerful blow to the economy as I will explain.
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As long-time readers know, I am not a fan of tax increases in general because they negatively affect the economy over time. Yet perhaps Mr. Biden’s worst idea is to hike the top capital gains tax rate from up to 23.8% currently to 43.4%. That is a radical proposal!
I begin this argument by pointing out that Congress has kept long-term capital gains tax rates below rates on ordinary income for most of the past century, and nearly all other advanced economies provide favorable tax rules for capital gains. There are good reasons for this, as I will discuss below, but President-elect Biden (or those who control him) don’t seem to care.
Raising Capital Gains Tax is a Bad Idea
The current highest U.S. capital gains tax rate, including the average state rate on cap gains, is about 28%, but the average rate across Europe is just 19.5%. More importantly, numerous countries do not tax long‐term capital gains at all including Belgium, the Czech Republic, New Zealand, Singapore, Switzerland and others. There are good reasons for that, as I will point out.
So, why do many countries provide low, or no, tax rates for capital gains? For one thing, they know capital is mobile in today’s global economy, and it will flow out of their countries if tax rates are unfavorable compared to other developed nations – and sometimes rapidly.
Another concern is inflation. If you buy a stock and sell it years later for a profit, part of the gain is simply inflation, which is not a real return. But you pay tax on that gain nonetheless. Providing a lower capital gains rate offsets this investment-killing “inflation tax.”
Double taxation is yet another concern. If expected corporate profits rise, share prices increase, thus creating an individual capital gain for those who own them. But those future profits will also be taxed at the corporate level. If the combined rate of those two taxes is high, companies will reduce investment.
A capital gains tax increase would also harm investment in start-up and growth companies. The reward “angel investors” receive for putting their time and money into startups is a long-term capital gain five or more years down the road. Higher capital gains taxes cause angel investors to shift their money to safer investments, thus starving the economy of fuel for dynamic industries, which are always in need of additional capital.
The bottom line is: Higher capital gains taxes reduce entrepreneurship, period. People considering launching new business startups would instead take safer wage-paying jobs because the chance to earn a capital gain from a high-growth startup would not be worth all the extra stress, hard work and much higher risk. Remember, almost half of new businesses fail in the first five years.
Higher Capital Gains Taxes Hurt New Business Formation
If [politicians] follow through on their tax increases, money will flow out of America’s fastest growing business sectors. These high-growth sectors have flourished as the cash generated from public offerings and buy-outs of successful growing firms has been reinvested in new rounds of startups. Higher taxes would rob the economy of this wealth that is recycled into new ventures.
Various tax incentives in recent years have allowed technology investors to escape or defer capital gains taxes when they exit successful investments. We are told that tech industry leaders backed Joe Biden in the recent presidential election. Why? Perhaps they assumed they will retain the current lower cap gains rates even if Biden pushes up individual tax rates.
Yet this is a stupid assumption given that Biden has said repeatedly he will almost double the capital gains tax rate if elected. I don’t believe most leaders in the tech world are stupid. So, why then did they overwhelmingly back Biden? I believe it was because they despise Donald Trump more than they mind paying higher taxes. But that’s a discussion for another day.
State Revenues Will Fall
Another loser if President-elect Biden is successful in nearly doubling the capital gains rate is state governments. The states compete against the federal government when it comes to collecting taxes from Americans. There is only so much money to be collected. If Biden hikes the federal capital gains rate, then state tax bases will shrink. State tax revenues in states such as California, New York and many others which depend on capital gains will fall.
The point should be clear: If state tax revenues fall, then services provided by those states will also fall. Simple as that! States can’t print money and run unlimited budget deficits like the federal government can. Do you think any state wants to see its revenues fall? Of course not.
Corporations Don’t Absorb Price Increases – We Do!
Progressives would like the rest of us to believe corporations – when faced with price increases (whether they are due to rising cost of goods sold or higher taxes) – just absorb those increases and shrink their profit margins. Yet we all know that is not the case.
When corporations see their profit margins shrink, they raise prices on you and me. That’s just how the world works. So, when Joe Biden or any other politician vows to make corporations “pay their fair share,” and then propose higher taxes, we all know who will eventually foot the bill. It’s consumers.
The United States is home to nearly 30 million businesses – about one for every 12 Americans. Some are large enterprises, but the vast majority are small businesses – and many times have just one employee – the owner. Still, political rhetoric frequently leads to a disconnect between the business as an entity, and the person or people behind them.
The truth of the matter is this: When government taxes businesses more, there is nothing those businesses can do but pass the increased tax burden on to individuals, in one form or another. It’s always been that way. Consumers pay the true burden of higher business taxes.
This hidden tax shift happens in three ways. The first to pay are the employees – people who do not get that raise or end of year bonus – or perhaps even lose their jobs. Next are the millions of Americans who have investments in businesses, who often see their value eroded as a result of higher corporate taxes.
Finally, as noted above, American consumers pay more as a result of higher business taxes, since taxes get passed along in the form of higher prices. Hiking business taxes leads to higher prices at the gas pump, a larger bill at the grocery store, etc., etc. and less disposable income. None of this is good for the economy.
Conclusions: It Comes Down to Who Controls the Senate
While a lot of Americans may believe President-elect Biden’s rhetoric claiming his tax increases will only affect the wealthy (those making over $400,000 a year), and his doubling of the capital gains tax will only affect corporations, we all know that is simply not true.
Higher taxes result in higher prices for everyone – over time. Period.
I keep harping on this point, and I will continue to: It all comes down to who controls the Senate. And that boils down to those two Senate runoff races in Georgia on January 5th. The two incumbent Senators are Republicans; the two Democrat challengers are liberal Democrats.
If the two Democrats win their races, then the U.S. Senate will be split 50-50, which means Vice President-elect Kamala Harris will decide which side wins. We all know what that means. If this happens, Joe Biden will be able to push through the most liberal parts of his economic agenda, including doubling the capital gains tax.
So what happens in Georgia on January 5th is incredibly important! I must tell you I am very nervous about this. Democrats are gushing money into Georgia to support their challengers, and this will only intensify in the weeks just ahead. I don’t get the feeling the Republicans are keeping pace, although this could change, hopefully.
We should all keep our eyes focused on this because if the Democrats gain control of the Senate (plus the House and White House), we could see the most liberal swing this country has seen in our lifetimes!
I’m not exaggerating.
AOA’S NOTE: The party’s platform not only includes a big tax increase but also favors more rent control, i.e. tenant welfare!!
Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com.