By Timothy L. O’Brien / Bloomberg Opinion
Wealthy Americans are greeting the possibility of a big capital gains tax increase on their investments with “anger, denial and grief,” according to a recent article from Bloomberg News colleagues. “Over-taxing success is un-American,” Charlie Myers, chairman of Signum Global Advisors and a fundraiser for President Biden, told the reporters.
Others are also angry and grieving about Biden’s plan to raise the rate to 39.6 percent from 20 percent. “It felt like I was in some sort of weird daydream,” Jim Iuorio, an options trader, told Larry Kudlow on the Fox Business Network. “It’s just asinine. They know full well that not only will it not gain anymore tax receipts from it … it is such an economic negative.”
All of this echoes long-standing whining that an increase in taxes paid when somebody sells appreciated securities or real estate will trigger financial and economic catastrophes. It is inevitable, the argument goes, that such hikes force a downturn in the prices of assets such as stocks, causes business investment to lag and actually reduces the government’s tax revenue.
But these outcomes have greater traction in the imaginations of those predicting them than they do in the data. If critics of Biden’s proposed tax increase want to make an argument for holding on to an already outsized piece of the prosperity pie, they’ll need to do better than rely on voodoo.
Let’s look at stock prices first, since it’s the least consequential item on the menu. As my Bloomberg Opinion colleague John Authers noted last week, there have been three recent, real-world opportunities to observe the impact of a capital gains tax hike: in 1987, 1988 and 2013. In each case, equities (with the exception of momentum stocks) stumbled before the hikes were enacted but outperformed afterward.
The stock market overall has been on a mammoth upward swing since 1987 despite seismic upheavals such as the 2008 financial crisis and the arrival of the covid-19 pandemic last year. It continued soaring despite capital gains hikes as well. And the fruits of the market’s boom have been narrowly enjoyed. The wealthiest 1 precent of Americans reported about 75 percent of all long-term capital gains in 2019, according to the Tax Policy Center, with the wealthiest 0.1 percent — the cohort with annual incomes above $3.8 million — hauling in more than half of all capital gains.
After Bloomberg News broke the news last Thursday that Biden was planning to unveil the tax hike this week to help fund new government initiatives, stock prices swooned. See, critics said, that’s what happens! Stocks surged the next day, rising on a tide of good economic data that landed on Friday.
This makes sense. The market is grounded, over the long haul at least, on the prospect of better corporate earnings and not on the more slender financial needs of affluent investors peeved about losing extra icing on the big slice of cake they’ve been served.
Government tax revenue also depends on a robust economy, and the idea that boosting the capital gains tax rate will depress revenue doesn’t appear to be grounded in the data either. The argument here is that investors, stymied by a higher rate, will wait to sell or won’t invest at all and the government won’t receive tax funds it might otherwise have pulled in. But the Committee for Economic Development, a nonpartisan think tank backed by corporate executives, examined the impact of hikes during the 1990s and 2000s and found that increasing capital gains tax rates didn’t undercut tax revenue.
There’s also a lot that still isn’t fully understood about the dynamics informing hikes in the capital gains tax rate.
Economists monitoring how well tax legislation “scores” in terms of meeting the government’s revenue goals have called for more sophisticated and updated analyses of what constitutes an optimal capital gains rate. A group of economists recently argued in the Chicago Booth Review that the prevailing wisdom among scorekeepers that the revenue-maximizing rate is about 30 percent may be misplaced; and could allow for an even higher rate. A pair of Princeton University economists published research in December showing that hikes may raise “substantially more tax revenue” than scorekeepers currently believe and that the revenue-maximizing rate may be about 40 percent; almost exactly where Biden’s proposal falls.
Economists and analysts have also made the case that cuts in capital gains rates have a negligible impact on investment decisions and economic growth. (Though, like much around capital gains, that debate isn’t entirely settled.) Still, some economists don’t think capital gains rates drive sentiment when entrepreneurs hitch their dreams and talent to a startup that may, someday, reinvigorate the economy and create bounteous jobs. “It is hard to imagine entrepreneurs making decisions about investment and risk on the basis of the capital gains tax regime: Mark Zuckerberg was not focusing on the capital gains tax when he was in his dorm room coding up Facebook,” the Chicago Booth Review writers observed.
That perspective is bound to fill Silicon Valley venture capitalists with anger, denial and grief, and indeed those folks were among the most vociferous opponents when Biden’s plan was reported.
Lurking behind this outrage is the fact that a lucrative loophole will close if Biden’s proposal is enacted. Private equity investors, hedge fund managers and other financiers currently treat the income they earn each year as so-called carried interest; essentially allowing them to pay a lowly 20 percent capital gains tax rate on their income rather than the higher income tax rate everyone else has to pay. Increasing the capital gains rate would end that game.
So for all of the wealthy but mournful investors who have seen their portfolios balloon over the last few decades but bemoan the possibility that a more rational and equitable tax structure may be in the works, I offer them a consolation prize: the world’s tiniest violin.
Timothy L. O’Brien is a senior columnist for Bloomberg Opinion.