Last week news broke that U.S. President Joe Biden is expected to propose a raise of the federal capital gains tax from its current base rate of 20%. Combined with the Obamacare levy, Americans earning over $1 Million per year will pay as high as 43.4% on capital gains federally. Total capital gains tax rates will vary by state. While the news of the rising capital gains tax rate came as little surprise to the markets, the magnitude of the proposed change did, albeit briefly. Markets were able to brush off the sticker shock of the new expected policy in short order, making back their Thursday losses by mid-day Friday and edging even higher into market close. Based on historical data, this seems like a rational response to the announcement.
Many critics of the tax argue that it may have a negative effect on the markets; however, this argument holds very little merit historically. As seen in the figure below, there is no statistically significant correlation between rising capital gains tax rates and lower market returns in the subsequent year. After the most recent hike in federal capital gains taxes in 2013, a 9% rate increase, stocks rose 30% for the calendar year.
The magnitude of the tax increase remains uncertain until finalized by Congress as does its impact on the market; however, if the past is any indicator – strong economic growth and improving fundamentals coming out of the pandemic should sow the seeds for a strong market moving forward. Capital gains tax increases or not.
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 Versprille & Davidson – Bloomberg Tax: https://news.bloombergtax.com/daily-tax-report-state/biden-to-propose-capital-gains-tax-as-high-as-43-4-for-wealthy