The stimulus package was passed by Congress and incorporated into law, adding another large sum to the federal budget and accumulated debt.
The aim is to help individuals and the economy through these troubled times and then return to prosperity. Closely behind this discussion is the question of paying for such programs.
President Joe Biden has not mentioned any possible tax changes so far, possibly because his focus has been on the novel coronavirus pandemic and promoting economic recovery. But Biden really made a commitment to keep his election promises. Changing parts of the tax law is one of those commitments.
Changes in tax law could have a major impact on financial markets. One proposal is to raise capital gains tax from the current 23% for high earners to the normal income rate of 39.6%.
A review of capital gains tax increases over the past four decades shows little significant impact on financial markets.
President Ronald Reagan raised the tax rate on capital gains from 20.9% to 28% in 1986 because it was unfair that a millionaire who traded stocks could pay a lower rate than regular employees. President Barack Obama phased out George W. Bush’s tax cuts for those who earned more than $ 400,000 in 2013. The result was an increase in tax rates on capital gains and dividends from 15% to 20% or 23% for certain levels set under the Affordable Care Act.
Note that these tax changes affected high net worth investors and had little or no effect on the majority of stockholders. The financial markets also seemed unaware, with substantial increases despite the additional taxes for wealthy investors.
In context, you should be aware that the magnitude of the capital gains and dividend tax increases currently under consideration would be a multiple of Reagan and Obama’s tax increases. Part of the proposal is the “promise” that no one who earns less than $ 400,000 a year will see a tax hike. That promise can be hard to keep.
Some details are not clear, e.g. B. whether this only applies to ordinary income or also to investment income. No formal proposal has appeared. If capital gains below $ 400,000 are not exempted, it will almost certainly have an impact, especially for retirees who rely on dividends for a substantial portion of their income.
Neither markets nor investors will react well to tax increases just because nobody wants to take money out of their personal pot. Some commentators suggest that the reality of a large capital gains tax hike would trigger a sell-off. In fact, the results would have more nuances.
A subset of investors might be selling, but remember that someone has to buy these stocks. Other investors could just hold their time and wait. As more investors hold their positions in a given year to avoid taxes, the level of trading could decrease.
When trade declines due to taxes, it has some undesirable consequences.
New and improved companies may have a harder time raising money when investors are stuck and reluctant to pay the taxes. Certainly, the amount of taxes levied may be less than hoped. Taxes would potentially be with some questions about when the actual tax revenue would arrive. In other words, an increase in the level of taxes does not mean that taxes will come in immediately. You don’t pay tax on any profit until you sell the stock. Suddenly, tax decisions could have an unduly large impact on sound financial decisions.
The discussion of social justice, ie the convergence of tax rates on ordinary income and capital gains, deals with the argument of preferential treatment for one group over another. Be aware, however, that slowing the collection rate can create problems of its own. For example, tax revenues from investment income from Silicon Valley have supported the California budget on many occasions, including the pandemic.
Higher taxes could also create financial problems for California with its own tax rules. People can move, as evidenced by the decision to leave the state by a growing number of companies, not to mention many people moving out of the state. When you can work virtually anywhere, you have more choices. The risk to California is that higher tax rates don’t guarantee higher revenues.
My final point is that for each of you as an individual, taxes are part of your decision, but only part. You should make financial decisions with due consideration to all factors. Don’t let the control tail wag the dog.
Mark Sievers, President of Epsilon Financial Group, is a certified financial planner with a Masters in Business Administration from the University of California at Berkeley. Contact him by email at [email protected].