Analyst(s) predict that Democratic lawmakers would boost the capital gains taxes on the rich, but the proposal is not likely to succeed since it lacks support in Congress.
Brian Gardner, a Stifel top Washington policy strategist, agreed, saying, “Certainly, there is a sell first, ask questions later approach to this.” We don’t know the date by which the effects will be apparent yet.” This may explain why we are experiencing the response that we are now witnessing.
Gardner stated that some investors were mistakenly under the impression that Biden would not propose a higher capital gains tax because he did not do so when he proposed a higher corporate tax to fund his infrastructure plan. According to the strategist, this was part of the reason for the large stock market reaction Thursday afternoon, which sent the Dow up more than 300 points.
“This isn’t just an equity issue. Gardner defined it as “any kind of asset.” “There will be horse trading between now and the time when a bill is finalized. At this point, forecasting is extremely difficult. Markets, I believe, are feeling the effects. If you change the capital gains tax rates, the market will react rationally, and it will go to valuations. Over time, the market will adjust to this.”
The 43.4 percent rate would be achieved in two steps.
Biden has also proposed raising the top ordinary income tax rate for taxpayers earning more than $400,000 to 39.6 percent, and then raising the capital gains rate to the ordinary income rate for those earning more than $1 million.
Then, for the Affordable Care Act, there would be an additional 3.8 percent tax surcharge on capital gains, bringing the total to 43.4 percent.
Currently, only short-term capital gains are taxed at the ordinary income level, whereas longer-term gains are taxed at a much lower 20% rate. Taxpayers in high-tax states such as New York and California may face capital gains taxes of more than 50% due to additional state taxes.
Hedge funds are being targeted.
Potential changes would disproportionately affect private equity and hedge fund partners. Partners who profit from personal assets in funds or are paid carried interest can be taxed at the long-term capital gains rate, which is currently 20%.
Biden has proposed closing that loophole by changing the capital gains tax structure for individuals earning more than $1 million at the ordinary income rate. Biden has stated that taxes for taxpayers earning less than $400,000 per year will not be raised.
“A hedge fund manager who derives carried interest income would no longer have an advantage for capital gains income,” Gardner explained. “This is part of a larger populist effort to soak the rich, who, according to this logic, are not paying their fair share. In Democratic circles, it’s very good politics.”
According to Peter Boockvar, chief investment officer at Bleakley Global Advisors, selling could spread throughout the hedge fund community, and hedge funds themselves could be sellers. This, in turn, could harm hedge fund investors.
“I just think the key question about the capital gains tax change is not just where he wants the rate to go, but when he wants it to go,” said Boockvar. “If it is this year, and it is retroactive to this year, they are trapping people. If it’s next year, you’re looking at a lot of sales this year as people lock in lower rates.”
Tom Block, a Fundstrat Washington policy analyst, believes Democrats will not even get enough votes to make the change.
“Look at the Democratic senators up for re-election,” Block said. “Several are from states with a high number of retirees, such as New Hampshire and Arizona. They are unable to vote on tax increases… I don’t believe they have enough votes to raise personal tax rates.”
According to strategists, there are many unknowns about the plan, such as whether it is aimed at couples earning $1 million or individuals. If it is aimed at couples, the question is whether it also applies to single taxpayers earning less than $500,000.
“I expect some version of this to pass,” Mills predicted. “I believe this is the high water mark, and I believe there is room for compromise from here. If you are potentially affected by this, you must be aware that your taxes may increase.”