How Taxing Capital Gains Will Support Biden’s Infrastructure Bill

Biden needs $2.7 trillion for the so-called infrastructure plan. This will be funded, partially, by raising the corporate tax rate from 21% to 28%. The Biden Administration cannot raise enough money for its lofty plans by merely taxing wages. Hence, they are coming for the rich, big business, and Wall Street. Biden also plans to double government spending on childcare and support for parents. To pay for this, he will double the top rate of federal tax on capital gains and dividends. Biden will increase the top tax rate on wage income from 37& to 39.6%. For Americans that earn more than $1,000,000 per year, levies on income will be raised to equal the top rate on wage income.

In real terms, the levies will double for the tiny group of wealthy investors who form a large proportion of shareholders.

Investors are not happy. They do not doubt that Biden’s plans will crush economic growth. Economist Magazine disagrees. America can bear higher rates of capital taxation, it says. However, the magazine offers no basis for this platitudinal observation. Despite the same, Economist Magazine does warn about the unintended consequences of these increased levies on capital. According to Economist, the solution would be for Biden to improve the design of his plans merely.

In 2010, out of the four regular taxes, the OECD ranked corporate taxes as the most harmful to economic growth. Economic models predict that Biden’s tax plans would cut the size of the US economy by 1% by 2050. Discouraging savings and investment will hurt the economy over the long term. The taxation of savings and investment income is double taxation, which is unfair and inefficient.

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The Rationale

When capital is taxed lightly, taxpayers tend to disguise wages as capital income.

  • Taxpayers will utilize the ‘carried interest loophole, allowing private equity and hedge-fund managers to class their fees as capital gains instead of income.
  • Pass-through firms like partnerships allow law firms, consultancies, and medical enterprises to classify more than 50% of the earning that partnership investors receive as dividends and capital gains.

Bringing taxes on wages and capital into line could make avoidance harder. When all capital levies reach rates that resemble income taxes, the government will take a more significant bite out of investment income.

Californian shareholders must pay Biden’s 28% corporate tax, 39.6% federal capital gains tax, and a 13.3% state tax on capital gains plus a 3.8% levy on investment income. The shareholders retain less than a third of their returns under Biden. However, corporate taxes are driven by loopholes, like under the current system: government waives capital gains taxes when the assets are inherited.

However, parity between capital and labor taxation compensated by investment incentives will not raise enough money for Mr. Biden’s plans, but it will reduce tax avoidance.

Will joe Biden’s Proposed Taxes on Capital Make America An Outlier?

The Biden Administration plans to raise America’s top rate of federal capital gains and dividend tax to 39.6%, twice the average maximum rate in Europe. Biden’s top rate would apply to the highest-earning 0.3% of taxpayers earning more than $1 million per year.

It is hard to compare the taxes on capital for different countries with differing tax systems and rules. Groups like the OECD do not publically track capital gains tax rates. Carve-outs and exemptions make the task nearly impossible. What can be done is to compare the money raised by different countries.

Taxes on capital for America brought in revenues close to 5% of GDP in 2018. A panel of sixteen OECD countries brought in a total of 5.8% of GSP for the same.

America’s mix of capital taxes is unusual:

  1. US corporate taxes bring in meager revenue.
  2. Property tax revenues are high.
  3. Capital taxes make up 20% of total revenue, fifth among the 16 countries in the sample.

Biden’s Impact

Would Biden’s plans change the status quo? Corporate taxes are said to increase from 21% to 28%, while the rate on capital gains and dividends for top earners would almost double from 20%. However, it is impossible to predict how savings and investment will respond to these capital taxes.

Financial experts reckon that a revenue-maximizing rate of capital gains of 28%. Keep in mind. This figure falls under current rules, which waives tax on estates when heirs inherit it. Biden wants to stop this, so it follows that the postponement of capital gains almost indefinitely might lose some of its appeal, which will pull more investors into the tax net.

When the Penn-Wharton budget model analyzes these changes, it finds that the capital gains proposal would raise an extra $113 billion over ten years. On the other hand, Biden’s increase in the corporate tax is supposed to raise an additional $1 trillion in revenue. These revenues equal only 0.4% of the US projected GDP for the next decade.

According to Larry Summers of Harvard University, planners underestimate the revenue from changing capital gains taxes. Some find rates of between 38-47% would be more than adequate to maximize revenue. Uncertainty about the veracity of these analyses remains high.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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