The prospect of higher taxes is likely to permeate discussions around US equities in the near-term.
News of the Biden administration’s proposed capital gains tax hike was a wakeup call of sorts for a market which, over the course of the post-election rally, largely ignored the risk of higher taxes, both corporate and individual.
It’s far from obvious that there are long-term ramifications from higher levies on capital gains for a tiny sliver of US investors. As Bloomberg wrote Friday, “only about 0.32% of American taxpayers reported adjusted gross income of more than $1 million and capital gains or losses on their returns” in 2018.
It’s also worth noting that at least some of the folks who comprise that 0.32% of filers likely didn’t pay their share under existing tax laws, at least if you extrapolate from recent research on tax enforcement.
Read more: Richest Americans Hide 20% Of Income, Costing You $175 Billion Annually
The GOP is already keen to suggest that this admits of summary treatment and should be dismissed out of hand.
Chuck Grassley (not exactly an archvillain, by the way) offered a laughably simplistic assessment. “It’s going to cut down on investment and cause unemployment,” he said, of the prospective capital gains move, as though the calculus for the rich is that simple and admits of no nuance at all.
Something like this: “I brought you all here today to say that it looks like my portfolio gains, not to mention the windfall I was expecting from my yacht, will be taxed at twice the previous rate, so I’m shutting down the company. Unfortunately, all of you will need to find new jobs next week.”
To let Republicans tell it, the 0.3% of filers to whom this applies are just going to fire everybody, cut the lights off, take what they can carry and stroll off down the street like Steve Martin in The Jerk.
(“Well I’m gonna go then! And I don’t need any of this. I don’t need this stuff, and I don’t need you. I don’t need anything. Except this ashtray… And this paddle game. – The ashtray and the paddle game and that’s all I need… And this remote control. The ashtray, the paddle game, and the remote control, and that’s all I need.”)
Invariably, the wealthy and the GOP will attempt to undermine Biden’s “Families Plan” by disseminating misinformation about the ramifications of any capital gains tax hike. Unfortunately, many voters will believe the propaganda, despite the appeal to common sense embedded in the plan. As Ron Wyden, Senate Finance Committee Chairman, remarked, “There ought to be equal treatment for wages and wealth.”
Right. Unless, of course, you’re wealthy. In which case that’s a bitter pill to swallow. So, you’ll argue along the lines that investment gains are part of what motivates you to deploy your capital in a socially useful way, either through capex or hiring or something else you’re not really doing.
Sarcasm aside, how plausible is that narrative? I’ve been over this countless times previous. It tacitly assumes an almost direct connection between people who live off investment income and a capacity to facilitate economic growth in an expeditious way. While that assumption may well hold for some folks, it makes no sense at all for others.
Academics generally describe America’s elite as a class of “super-managers,” but the country still has a rentier class. Perhaps more importantly, it’s not a stretch to suggest that the children of today’s super-managers could form a new rentier generation straight out of some Belle Epoque novel.
In the same linked article (above), Bloomberg quoted a partner at a law firm which advises high-net worth individuals on tax planning. “It’s a high-anxiety time,” he said.
Right. But not as “high-anxiety” as that “time” around the 25th of each month, when lower- and middle-income households check and re-check their own math to make sure that once all the bills are debited, their account won’t be overdrawn, in which case their zero balance would be “taxed” into negative territory.
Taxes should be public information. There are countries where the people survive such an affront.
Back in the 90’s, theTurkish government used to publish a list of top taxpayers by province ( they may still do). For a number of years running, the leader in Istanbul was the madame of a house of ill repute. But she was proud to be a taxpayer and support the Republic.
I lived in Iowa for 35 years and taught in a public university. That fact qualified me to be on of the money grubbing souls who should be marked for public humiliation by having my salary published in the pages of the Des Moines Register every year when the state budget was published. Don’t know if they still do that but I do know everybody made sure they checked those numbers every year.
Excellent post. Should be shared with every Republican member of Congress. (Not that any of them would care.)
Income inequality in the US is the highest of any G-7 country. Middle income families share of U.S. aggregate wealth has fallen from 32% in 1983 to 15% today. The statistics go on and on. Republicans look fondly to the past, but fail to realize that the middle class life that they miss is due to growing income inequality, and not abortion on demand, or the lack of prayer in schools.
The US does seem destined to become a Potemkin Village of prosperity.
On my walk this morning, I was able to pass a person, who, having slept in his car all night, was waking up and letting out the usual morning piss. It’s so nice a refreshing to know that we are a rich and prosperous nation. I wanted to tell the guy that he is lucky to be an American, that if he worked harder, and had more “merit,” he wouldn’t be in the position he is. I decided against it, not wanting to interrupt his stream of thought.
It will be ever thus. The problem for the GOP is the younger folks in their teens, twenties and early 30s have experienced or seen too much stress. Eventually this new generation becomes voters and if polling is accurate expect more of the government to expand opportunity and provide a better safety net. Same for the majority (but not all of course) of newer Americans, and folks of color who are now voting in greater numbers. It is a slow process, but as I have been saying in the comment section on this blog, Biden has been vastly underated as an agent of change. He won’t succeed all the time, but enough to get the ball rolling.
And McConnell will be quick to remind the wealthy and the corporations their job is to shut up and send money.
I don’t spend any emotional energy on the 0.3% of earners. However, is anyone troubled by the fact that if passed, the top capital gains rate in NY, NY will be 58.176% and in California it will be 56.7%? I do not care how much someone earns, that is outrageous. Too much government taking too much of the economic rents is very bad public policy.
I’d love to have the problem of those 0.32% of filers with $1M AGI and capital gains or losses on my tax return.
There are about 12,000 “unhoused” people in the county I live in. I suspect there are some of them who like the freedom of not having to pay taxes. Some are too high on drugs, escaping despair, to even ponder such a fate. For the rest, I suspect they would willingly trade balance sheets with a $1M AGI tax payer. There are about 120M households in America who would be happy to trade balance sheets.
“There are about 120M households in America who would be happy to trade balance sheets.” Yes, but are they willing to trade the work and effort that it took to get to the $1M/year?
The cases of Gates, Bezos, Zuck, etc. are easy. Sure, what the hell, tax them at some rate over 50%. But the brain or heart surgeon who is $500,000 in debt and suffered twelve years of opportunity cost to earn the $1M/year? Or the corporate lawyer who lives in Manhattan, has an unemployed spouse three kids in private school at $40k/year, trying to save for private college. Below I gave an example of an entrepreneur who works for thirty years, doesn’t take a salary, build up a small business, and then sells for $5M. That person would have a very high tax burden for just one year.
Yes, H gave the example of the VC person in the Valley crying the crocodile tears about higher rates. Really, my only point is that there are people in the middle, the “Rich” as H called them yesterday in another piece, who do get really hurt with these high rates.
H: I have looked at the charts extensively. And I am also very familiar with the effective tax rates charts that have been recently published the factor in all taxes (federal, FICA, Medicare, Medicaid, state, local, property, sales, etc) that show that very high-earners have total effective tax rates equal to or sometimes lower than folks who are lower middle class.
I note that the when marginal rates were approaching 90% several decades ago, there were significantly more deductions. I am sure that you know this. Thereby making the effective tax rates significantly lower than the purported marginal rates.
My only point here on this post is that there is a capital gains rate that, when crossed, is bad public policy. Take for example the person who starts a business, takes very little salary, builds it up over decades, and sells it for $5M. This person will get crushed in the ONE YEAR where they happen to earn over $1M. This is patently unfair to this entrepreneur. Especially considering the investment is not indexed to inflation.
As Lenin said, “the way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.”
“Bad” is a normative term, not an objective reality.
Also, I think it’s important to acknowledge that most (and probably all) of the fine folks commenting here in these pages are either paying their taxes in accordance with what they understand to be the law or else have accountants who, as far as they know, are following the same laws.
The problem, as I’ve gently pointed out previously, is that past a certain threshold for wealth, people have a tendency to “lose track” (to employ a euphemism) of those laws and so do their accountants.
So, there’s a sense in which, when well-meaning Republican voters proclaim “I followed the law, I paid everything I was supposed to pay, and the rest of society should thank me!” Democrats are thinking “Right. We weren’t worried about you in the first place. You just thought we were because you listened to too many people on CNBC and Fox mischaracterize our position.”
“Take for example the person who starts a business, takes very little salary, builds it up over decades, and sells it for $5M.”
That person in your example has been neglecting paying himself a reasonable salary why? To avoid paying taxes. Good then if capital gains bites him in the ass.
I had a profitable S-corp until 2008 dried up my business. Every year I had pass-through earnings that I paid taxes on whether or not I paid myself, so there’s no point in not paying one’s self.
I was honest, paid my fair share, and everything worked out fine. And I can promise you that paying taxes on profits was, still is, and ever will be the least of my worries
I have been reading your recent posts avidly (as i always do)..
A cgt hike will as you rightly point out not force me to close up shop, take away my remote control and close my main business..
but.. two points
i am a serial angel investor.. i am right now in negotiations with (literally) the kid next door who reckons he has an fpga that can beat the street.. i dont know if he is right (im a luddite) but im prepared to give him a chance..
Lets say there is a 50 pct chance he makes money.. at 20 pct cgt i can almost take that risk, at 40 pct its actually stupid..
Fixed income is poor right now.. but leveraged property rental is actually quite good given low interest costs.. if you tax income (rental) at the same as cap ganes.. you push me towards the certain contractual reward (borrowing 75 pct at 200 bps to yield 500 bps which grosses up at a decent double digit return on capital employed).. you push me to a rentier portfolio than i otherwise would have, and take capital out of the creative/disruptive/productive space.. (and allow/force me to bid up homes out of the reach of regular folks)
Earnings on risk should be taxed at a significantly lower rate than on near certain income.. we came to that settlement after many centuries of trial and error, and we will end up back there, because it is right.. otherwise you discourage risk taking..
I truly feel for the uber-eats drivers of the world, but the worst they can do tomorrow is earn zero, they don’t have to deal with frequent realised losses that justify the current tax differential between income and speculative gains..
Sorry.. i didn’t finish.. there is clearly a need for money (re)distribution in our society… but don’t tax me, inflate me.. it forces me to act and circulate my cash, which is what the economy needs.. we seem to now to have disentangled gdp growth, inequality and velocity… greater money velocity by definition brings gdp growth and reduces inequality..
The “rich” should not be punished for investing in the future and harvesting gains.. they should be punished for hoarding cash..
Okay. Then what policy do you advocate to reduce inequalities? Or maybe you don’t consider the current levels of inequality problematic?
Very interesting comment. I personally prefer taxes to inflation. I used the expression “inflation was the silent thief, trying to make it the silent robinhood doesn’t sell it to me”.
but I do take your point about risk and taxes. I agree that taxing risk taking is a bad idea overall.
So, to echo Nicolas H below, what would you do? Note we’ve been trying to create inflation for 20 years at least and, so far, without much success…
I am mot arguing for inflation as an ideal.. i guess I am advocating MMT.. the govt should print the money and run the risk of inflation.. as H has made very clear, this is what is happening anyway.. and I am not against all taxes.. there is just a strong justification for taxing income and gains at different rates..
The CGT adjustment will not make a huge impact on the deficit.. i think it probably lands more in the camp of identity politics than economic policy..
So, I happen to trade markets professionally and I have the same problems with taxing trading gains. The societal good of speculation is clearly more limited than that of angel/VC financing but Keynes himself recognized liquidity providing as important (though, one good that could be pushed to excess).
I understand that trading losses can offset gains but, overall, if I beat the random walk, 50/50 odds, of speculation, am I not exhibiting talent? And, since the state won’t offset my losses if I lose with regularity, why is the state taking some of my gains? What I am doing is essentially gambling. The casinos can take a cut, to provide the infrastructure, overall security and rule-making. But the casino doesn’t take a cut directly out of a gambler’s gains.
OTOH, markets do go up over time so it seems to me that long term investing, being ‘surer’ than short term speculation ought to be taxed at a higher rate, closer to income. Which is, obviously, the reverse of what’s happening in reality.
Basically, this shit is hard. But I agree with a general principle of taxing growth-generating, risky endeavours less than passive, more certain activities. Providing debt should be taxed more than providing equity.
So, yeah. I haven’t figured out what I’d do if I was made tyrant of the polity. I’d like to learn more about land taxes as well…
Artillery, you write “…they don’t have to deal with frequent realised losses that justify the current tax differential between income and speculative gains..” I understand the point you are making but it singles out one form of economic activity for special treatment on the presumption that the long-term good warrants such.
There’s an analogous situation that more Americans than just VCs and financiers can relate to. In the run-up to the GFC many people bought houses (or bigger houses) than they could afford, often using ARMs that reset with negatove implications. If such a buyer walks away from the loan (jingle mail), short sells or is foreclosed the value of the trade goes to zero, There is no tax benefit or loss carry-forward. In fact, many short sellers wind up with a tax bill!.
The carping of financial types aside, the doom forecast to arise from higher taxes or a tumultuous economy are, perhaps, overstated. Consider: Fairchild Semicondcutor (now INTC) was founded in 1969. Amphenol was founded in 1932. History, rather than anecdote and received wisdom, suggests innovation and entrepreneurial activity are not as constrained by the tax or economic environment as some might like us to believe.