Biden capital gains tax plan for rich expected to pass, but with some changes

Published Thu, Apr 22 20214:02 PM EDTUpdated Thu, Apr 22 20214:49 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Democrats are expected to raise the capital gains taxes for the wealthy, but the plan is not likely to pass as proposed, policy strategists said. President Joe Biden has been expected to introduce a higher capital gains tax rate, totaling 43.4% for the wealthiest taxpayers earning $1 million or more, strategists said. However, they do not expect the plan to pass as proposed, and a compromise could reduce the tax rate or increase the income threshold. Stocks sold off Thursday after an early afternoon news report said Biden would introduce the proposal next week as part of the tax increases to pay for social spending in his "American Families Plan." No matter how the plan is structured, it is expected to result in more stock market selling. "Certainly, there is a sell first, ask questions later mentality to this," said Brian Gardner, Stifel chief Washington policy strategist. "We don't know the date when it's effective yet. I think that's why we're seeing the reaction right now." Gardner said some investors were mistakenly under the perception that Biden was not going to propose a higher capital gains tax since he didn't do it when he introduced a higher corporate tax to pay for his infrastructure plan. The strategist said that was part of the reason for the big stock market reaction Thursday afternoon that sent the Dow more than 300 points. "It's not a purely equities issues. It's any kind of asset," said Gardner. "There's going to be horse trading between now and when a bill gets finalized. It's really tough to predict at this point. I think we're seeing the impact in the markets. If you change the tax rates on capital gains, then the market will react rationally and it's going to go to valuations. The market will adjust to that over time." The 43.4% rate would be reached in a two-step process. Biden has also proposed raising the top ordinary income tax rate to 39.6% for taxpayers earning more than $400,000, and then raising the capital gains rate to the ordinary income rate on capital gains for those earnings more than $1 million. Then there would be an additional 3.8% tax surcharge on capital gains for the Affordable Care Act that would take it to 43.4%. Currently, only short-term capital gains are paid at the ordinary income level, but longer-term gains are taxed at the much lower 20% rate. In high-tax states like New York and California, tax payers could be paying capital gains taxes of more than 50% because of additional state taxes. Targeting hedge funds Private equity and hedge fund partners especially would be especially hit by potential changes. Partners who make profits on personal assets in funds or are paid carried interest can be taxed on those earnings at the long-term capital gains rate, or 20% at most. Biden has proposed closing that loophole by changing the capital gains tax structure for those making over $1 million at the ordinary income rate. Biden has said taxes would not go up for taxpayers making under $400,000 a year. "A hedge fund manager that derives carried interest income would have no advantage for capital gains income anymore," said Gardner. "This is part of a wider populist effort to soak the rich, on this view they are not paying their fair share. It's very good politics in Democratic circles." Peter Boockvar, chief investment officer at Bleakley Global Advisors, said selling could ripple through the hedge fund community and hedge funds could also be sellers. That would in turn hurt hedge fund investors potentially. "I just think the key question of the capital gains tax change is not just where he wants the rate to go, it's the timing of it," said Boockvar. "If it's this year, and it will be retroactive to this year, they're trapping people. If it's next year, you have a recipe for a lot of selling this year as people lock in lower rates." Tom Block, Washington policy analyst at Fundstrat, disagrees that Democrats will even get enough votes to make the change. "If you look at the Democratic senators that are up for re-election," said Block. "There are several that are from states, like New Hampshire and Arizona that have a lot of retirees. They can't vote on increasing taxes ... I don't think they have the votes to increase personal tax rates." Strategists say there are a lot of unknowns about the plan, like whether it is aimed at couples earning $1 million or individuals. If it is aimed at couples, the question is then whether that includes single taxpayers earning $500,000. "I expect some version of this to pass," said Mills. "I do expect this is the high water mark, and I think there is compromise from here. If you are potentially impacted by this you have to realize there is risk that your taxes are going up."

President Joe Biden speaks after a jury reached guilty verdicts in the murder trial of former Minneapolis police officer Derek Chauvin stemming from George Floyd's deadly arrest, in the Cross Hall at the White House in Washington, U.S., April 20, 2021.

Tom Brenner | Reuters

Democrats are expected to raise the capital gains taxes for the wealthy, but the plan is not likely to pass as proposed, policy strategists said.

President Joe Biden has been expected to introduce a higher capital gains tax rate, totaling 43.4% for the wealthiest taxpayers earning $1 million or more, strategists said. However, they do not expect the plan to pass as proposed, and a compromise could reduce the tax rate or increase the income threshold.

Stocks sold off Thursday after an early afternoon news report said Biden would introduce the proposal next week as part of the tax increases to pay for social spending in his "American Families Plan." No matter how the plan is structured, it is expected to result in more stock market selling.

"Certainly, there is a sell first, ask questions later mentality to this," said Brian Gardner, Stifel chief Washington policy strategist. "We don't know the date when it's effective yet. I think that's why we're seeing the reaction right now."