Market Reaction to Biden's Capital Gains Tax Plan Surprises Political Pundits

Political watchers voiced surprise Friday at the markets’ reaction to the news Thursday that President Joe Biden plans to release next week a proposal to increase the capital gains tax rate on the highest earners.

The Dow Jones Industrial Average, S&P 500 and Nasdaq slipped about 1% Thursday but rebounded Friday.

Biden’s capital gains proposal has been public “since last fall, so it shouldn’t have been a surprise for the markets, which were rocked yesterday by a leak that capital gains taxes will rise,” Greg Valliere, chief U.S. policy strategist for AGF Investments, said Friday in his Capitol Notes email briefing.

The important point, said Valliere: “A new tax as high as 43.8% is very unlikely because it would be opposed by all 50 Republican senators and a handful of Democrats.”

On Thursday, Bloomberg reported that Biden plans to propose “almost doubling the capital gains tax rate for wealthy individuals to 39.6% to help pay for a raft of social spending that addresses long-standing inequality.”

For those earning $1 million or more, Bloomberg reported that “the new top rate, coupled with an existing surtax on investment income, means that federal tax rates for wealthy investors could be as high as 43.4%.”

The new marginal 39.6% rate would be an increase from the current top marginal rate of 20%, which kicks in when taxable income exceeds $441,450 for an individual or $496,600 for a couple.

Andy Friedman, principal and founder of The Washington Update and a former tax attorney, told ThinkAdvisor Friday in an email that he’s “surprised that the leak of Biden’s plan to increase the capital gains tax rate is causing such a fuss.”

Biden, Friedman said, “has made clear since the campaign that he wants to raise the capital gains rate to the ordinary income tax rate (39.6% under his tax proposals). I have always assumed that Biden will propose this change publicly when he announces his individual tax plan.”

It is possible, Friedman opined, “that the administration leaked the proposed rate to test the market reaction. They then conceivably could mollify the markets by backing off to a lesser rate increase. More likely, though, Biden will maintain his position as a starting point for congressional negotiations.”

A capital gains tax rate increase “is in the offing,” Friedman said. “But I doubt it will go nearly so high. When the dust settles, we’ll likely see a rate in the 25% to 28% range.”

Both Valliere and Raymond James analysts agreed that Biden’s tax proposals are an opening salvo in the negotiation process.

“It’s entirely possible that the top capital gains rate for millionaires will rise from 23.8% now to something like 30%,” Valliere said. “Most of the administration’s proposals will get watered down later this year.”

Raymond James analysts noted in their Friday email briefing that the administration’s proposed hike in the capital gains rate “to the envisioned ordinary income rate of 39.6% on incomes above $1 million” as part of Biden’s American Families Plan “is likely to see adjustment on the rate or the income threshold.”

A higher capital gains rate “is a staple of Biden’s ‘economic fairness’ agenda and has been well communicated over the course of his candidacy/presidency, but we expect the market reaction seen Thursday to raise hesitancy among moderate Democrats and serve as a potential moderating force,” Raymond James analysts said.

“In an aggressive scenario of a 39.6% rate being effective in 2022,” the analysts continued, “we would expect to see continued market volatility as the Biden infrastructure/tax agenda makes its way through Congress.”

The markets, Valliere warned, will also have to be on guard for other tax trial balloons: “raising the estate tax, possibly combined with killing the ‘step up’ basis; hiking the top individual rate; almost certainly increasing the corporate rate; imposing a minimum corporate tax; and cracking down on business loopholes, including the sheltering of profits abroad.”