Speculation, informed and otherwise, is that in his address to Congress tonight, President Joe Biden will propose raising the top income tax rate to 39.6% from the current 37%. And (this is the one that sticks in Wall Street’s craw) raising the tax on long-term capital gains to 39.6% for tax payers with an income above $1 million. The current rate on long-term capital gains is 20%. (There’s a tax surcharge from the Affordable Care Act that raises the effect capital gains tax rate to 23.8% currently. With that surcharge the proposed new rate would be 43.4%)
What does this mean for your portfolio–assuming that you’re not one of those making more than $1 million a year?
The White House logic for this move and these rates is very clear. This tax rate would equalize the rate that taxpayers pay on investment gains and on employment income. And the money from this increase would go some of the way to pay for the Biden Administration’s infrastructure spending and its plans–to be announced tonight–to expand spending on social programs such as early childhood education.
The objections to these rates from Wall Street is equally clear. First, it’s Wall Street’s ox that will get gored. And second, the argument goes, investors need incentives to risk their capital to start new businesses or to expand existing ones. Raising taxes on capital gains would, this argument goes, slow investment and growth in the economy in the long run.
It’s pretty clear from a dry run a few days ago when the Biden agenda was first floated what the market reaction would be.
Lots of folks sitting on large long-term capital gains would look to sell newish to beat the deadline for the tax increase. (One crucial detail is when the higher rates would go into effect. On January 1, 2022? Sometime in the fall of 2021? Retroactively on January 1, 2021?)
So stocks that have shown big gains in this market rally might be expected to sell off.
But I doubt that the selling would be permanent. Sure you might sell your shares of Tesla (TSLA) in order to escape the higher tax rates on your huge gains. But once you’ve sold and sheltered those gains, wouldn’t you just rebuy in 30-days?
By selling you’ve reset your basis price so that those past gains are now irrelevant to your future tax bill.
My opinion is that those who sold to protect gains from taxes will look around in vain to find any place else to put their cash. (After you’ve bought your first house in New Zealand, a very popular move by the Masters of the Universe these days, you’re going to buy another one?)
Look to the schedule for when the tax increases are proposed to take effect to see when the selling might set in–and when you might look for a buy-on-the-tax-selling-dip. And, of course, do remember that whatever the President proposes still has to win passage in the House and the Senate.