Fears that a Democratic Congress coupled with a Biden White House will mean higher taxes for investors in U.S.-based ETFs are overblown.
The next administration will surely be looking to raise some taxes, but that doesn’t mean that ETFs are in their crosshairs or that the next Congress will aggressively hike taxes. Democrats will have only a slight majority in the House and may not even control the Senate in the next Congress. That will be decided in two Georgia runoff races in early January.
Even if the Democrats win both seats, the vice president would be needed to break a 50/50 tie, and it’s likely that some Democrats in the Senate and the House will oppose aggressive tax hikes or even a change in the law that alters the taxation of ETFs.
Under current law, ETFs, unlike mutual funds, do not have to sell their underlying securities, which could be subject to capital gains taxes, when making changes to portfolios. They can instead hand over in-kind baskets of stock to their authorized participants who redeem and create shares in ETFs, which is not considered a taxable event.
Asked about a Financial Times story that raised concerns about eliminating the in-kind redemption and creation advantage of ETFs under the next presidential administration, Dan Clifton, head of policy research for Strategas Securities, told ThinkAdvisor he doesn’t think that such a move would reflect “the intention of policymakers” in the incoming Biden administration.
“The focus is going to be on getting broad-based tax increases and trying to solve for income inequality,” said Clifton. “Raising taxes on ETFs doesn’t solve for the problem, but raising the capital gains tax rate is possible.” Moreover, noted Clifton, several executives at BlackRock, the world’s largest asset manager and largest issuer of ETFs, are reportedly under consideration for top roles in the Biden White House.
Tom Donilon, chairman of the BlackRock Investment Institute who served as deputy national security advisor to President Barack Obama, is reportedly under consideration as CIA director or secretary of state, according to news reports, and his brother Mike has been named a senior advisor.
Also being talked about for posts in the Biden White House are Mike Pyle, chief investment strategist at the BlackRock Investment Institute, who was a senior advisor to Lael Brainard, under secretary of the Treasury for International Affairs in the Obama administration and a leading candidate for Treasury in the Biden White House; and Brian Deese, global head of sustainable investing at BlackRock who served in the Obama administration as a senior advisor for climate and energy policy and deputy director of the Office of Management and Budget.
Clifton and others doubt big tax changes in the Biden administration because Democrats won’t have big majorities in Congress even if they win the two Senate runoff races in Georgia, which is a big if. They will also have the smallest majority in the House in decades.
Todd Rosenbluth, head of ETF and mutual fund research at CFRA, also doubts that ETFs will lose their tax advantage. “ETFs are highly popular among investors and have gained traction in the last few years, reaching $5 trillion in assets by making it cheaper to participate in the market and avoid trying to time the market,” he said. “Investors in ETFs pay taxes when they sell their own shares, just not when other shareholders do.”
His latter comment refers to the tax liability of mutual fund investors. When a fund sells shares to meet redemptions or for other reasons, those sales are subject to capital gains taxes that are distributed to all shareholders, not just the ones that redeemed their shares.
Ben Slavin, global head of ETFs, Asset Servicing, at BNY Mellon, says there is a perception that ETFs are avoiding taxes but that’s not the case. “The Treasury is not losing anything. Taxes are paid by the shareholder when they sell shares.”
Slavin said the next Congress could increase taxes of capital gains and dividends, which might affect some changes in asset flows, but “the chance of sweeping tax changes seems to be slim.”
He added that an increase in the top marginal tax rate would raise in interest in muni bond ETFs and Democratic control of the Senate could increase in green energy-themed ETFs.
Biden’s election platform includes increases in taxes on capital gains and dividends for those with incomes above $1 million; raises the top marginal income tax for those earning more than $400,000, from 37% to 39.6%; and imposes a 12.4% FICA tax rate on income above $400,000 (Incomes below $137,000 would also be subject to the same 12.4% tax, creating a “donut hole” for incomes between $137,000 and $400,000.)
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