Inflation of 5.4% in June highlights one of President Biden’s most damaging and pipe-dreaming economic proposals: to raise the highest tax rate on capital gains. Nominally, it would increase it to match the ordinary income tax rate. But the real rate, including inflation, would be so high that investors could drastically change their behavior, seriously damaging the economy and the job market.

While dipping the rich may sound appealing, the president’s proposal is more like drowning them. On paper, the president’s proposal would increase the nominal capital gains rate from 20% to 39.6%, plus the ObamaCare surcharge of 3.8% for Medicare. Many of the investors who would be subject to the proposal live in places like California and New York City, where combined federal, state and local tax rates would reach 56% and 58%, respectively. Capital gains taxes of corporate shareholders are already double taxation, as income is taxed at the corporate level before it goes to shareholders. Total federal, state and local income taxes paid by corporations and shareholders on corporate income would rise to 75% under the Biden proposals.

That’s everything before inflation. Capital gains taxes apply to nominal returns. If you bought a stock decades ago for $ 100 and sell it today for $ 1,000, you’ll pay income taxes of $ 900, no matter how much of it reflects dilution. of the dollar. As inflation accumulates, savers’ assets are pushed up. But inflation-induced appreciation does not increase real wealth, which erodes as these phantom gains are taxed. This problem, which exists in the current tax code, could be solved by indexing the basis on which the gain is calculated, in our example, reevaluating the purchase price from $ 100 to 2021 dollars before calculating the profit.

Over the past 20 years, the nominal average annual total return of the S&P 500 Index has been approximately 8.6%. If this continues in the future and the Federal Reserve manages to hit its 2% inflation target – an optimistic outlook given the grossly excessive fiscal policies this year – total real returns, after inflation, will be around 6.6%. A tax rate of 58% on a nominal return of 8.6% is equivalent to a tax of 76% on returns after inflation of 6.6%. An investor would keep less than a quarter of the gain after inflation.

This risk calculation seems even more difficult given the way the Fed has defined inflation. The central bank’s definition – the personal consumption expenditure price index – includes services the government pays, like Medicare reimbursements to doctors, that have nothing to do with what Americans pay out of their pocket. poached. The Consumer Price Index, which relates more directly to what consumers pay for themselves and what Americans think of as the cost of living, tends to be 0.4 percentage points above the measure of inflation from the Fed. Using this more realistic understanding of the cost of living, the effective marginal tax rate would be around 80.5%.

What if the Biden administration’s delusional fiscal policies led to several years of disappointing stock returns? Excessive fiscal spending, combined with the Fed’s explicit policy of targeting above-target inflation, make it likely that the United States will experience some inflation overrun. With, say, a nominal stock return of 7% and a 0.5 percentage point overshoot of the Fed’s inflation target, that real marginal tax rate becomes an astounding 99%. Lower those stock returns to 6%, and the real rate becomes 112%, which eats away at capital.

If inflation continues at a rate close to 5% (without raising nominal equity returns above their long-term average of 8.6%, as high inflation tends to lead to poor performance), the marginal real tax rate climbs to an overwhelming level on% investments. Young Americans are fortunate to have never been impacted by high inflation, but they will suffer if policymakers ignore its potential dangers.

The Biden proposal will affect middle-income families as well as the wealthy. A household could invest and hold an asset for decades, the face value of which appreciates due to inflation. Even if the real value of the asset remained the same, the gain on the sticker price value would be taxed and the one-time sale could push them into a high capital gains range.

Such high effective tax rates would encourage savers to withdraw money from productive investments, making it more difficult for entrepreneurs and businesses to take risks and operate. Less dollars to fund business operations means less job creation, innovation and growth. And while the highest tax rate would affect relatively few taxpayers, these taxpayers provide a disproportionate amount of savings and capital that businesses use to operate and pay their employees. The rich can resist this economic brutalization; the hardest impact will be on the poor and disenfranchised, the people the Biden administration claims to want to help.

The real way to give these Americans a boost is to create a strong and lasting demand for American workers, as the previous administration demonstrated, with its tax reform, trade renegotiation, and cuts in government regulation. Increases in labor demand resulting from stimulating government spending will eventually run out of steam, while accompanying tax rate hikes permanently hamper job creation.

Mr. Miran is a former senior economic policy adviser to the US Treasury. Mr. Friedman is a director and senior tax advisor at the Federal Policy Group and a former senior tax policy advisor to the Treasury.

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