July 25, 2024

The Economic Ripple Effect of Biden’s Proposed Tax Increase

The United States tax system is intricate, with distinct approaches for taxing ordinary income and long-term capital gains. While ordinary income stems from employment or business earnings, long-term capital gains arise from the appreciation of assets held for over a year, such as stocks or business values. With thousands of pages of tax code, many Americans find it challenging to navigate the differences between these tax categories and understand their implications on personal finances and the broader economy.

Key Takeaways:

  1. Proposed Tax Increase Details:
    • The Biden administration’s fiscal year 2025 budget proposes raising the top marginal rate on long-term capital gains and qualified dividends to 44.6%.
    • This is a significant increase from the current 23.8%, marking an 87.4% hike, not the commonly cited 20.8%.
  2. Components of the Tax Hike:
    • The top ordinary income marginal tax rate is set to rise from 37% to 39.6%.
    • Long-term capital gains tax would match this top rate, increasing from 20% to 39.6%.
    • The Affordable Care Act’s net investment income tax (NIIT) would increase from 3.8% to 5%.
  3. Economic Implications:
    • The increased capital gains tax could lead to a significant sell-off in the stock market as investors seek to lock in gains at the lower tax rate before the hike takes effect.
    • Small business owners, who generate substantial entrepreneurial wealth, might rush to sell their businesses to avoid higher taxes, potentially consolidating smaller companies and leading to job losses.
  4. Impact on Entrepreneurship and Real Estate:
    • Entrepreneurs might find the risk-reward balance less appealing, leading to fewer new businesses being started.
    • Higher taxes on investment real estate could result in an influx of properties on the market, exacerbating challenges for potential buyers, including millennials and Gen Zers.

Detailed Analysis:

The proposed tax increases are poised to create profound disruptions in the economy. As outlined in a Treasury Department report led by Secretary Janet Yellen, the top marginal rate on long-term capital gains and qualified dividends could rise to an unprecedented 44.6%. This hike, if implemented, would drastically change the investment landscape.

Breakdown of the Tax Increase:

  1. Ordinary Income Tax Increase: The top marginal rate for ordinary income would move from 37% to 39.6%.
  2. Alignment of Capital Gains with Ordinary Income: The capital gains tax would align with the new top ordinary income rate, jumping from 20% to 39.6%.
  3. Affordable Care Act Surtax: The net investment income tax, instituted under the Affordable Care Act, would rise from 3.8% to 5%.

When these components are combined, the overall tax rate on long-term capital gains would reach 44.6%, nearly doubling the current rate.

Implications for the Stock Market and Economy:

The potential impact on the stock market is significant. Investors, anticipating higher taxes, might sell off their appreciated assets to benefit from the current lower rates, potentially triggering a market downturn. The principle of supply and demand suggests that increased selling pressure could lead to further declines in stock prices.

For small business owners, the tax increase presents a substantial challenge. These entrepreneurs, who contribute to creating over 60% of jobs in the U.S., might rush to sell their businesses to avoid the higher tax burden. This could result in a wave of mergers and acquisitions, leading to job losses as smaller businesses consolidate.

Entrepreneurship and Real Estate Market:

The proposed tax changes could dampen entrepreneurial activity. With the increased tax burden, the financial risks associated with starting a new business might outweigh the potential rewards, stifling innovation and economic growth.

In the real estate market, higher capital gains taxes on investment properties could lead to a glut of properties for sale. This would pose additional challenges for potential buyers, particularly younger generations already struggling to afford homeownership.

Conclusion:

The proposed capital gains tax increase under President Biden’s administration represents a significant shift in the U.S. tax landscape. With potential rates soaring to 44.6%, the implications for investors, business owners, and the broader economy are profound. The anticipated sell-off in the stock market, coupled with the challenges for small businesses and the real estate sector, underscores the need for careful consideration and analysis of these tax changes. Americans must stay informed and engaged with these developments, understanding how they might impact personal finances and the country’s economic future.

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