Wealthy Americans will be able to dodge as much as 90% of the estimated $1 trillion increase in investment taxes that President Joe Biden is proposing this week, according to a new analysis from the University of Pennsylvania.
Biden is proposing a capital gains tax hike to 39.6% on people earning $1 million and over with an estimate that it will generate $1 trillion in tax revenues over the next decade. Wealthy individuals could see their federal rates reach as high as 43.4% when the investment tax is included, Bloomberg has noted.
But will the wealthy sell investments and generate nearly double the capital gains tax they currently pay? Not according to John Ricco, co-author of the study and associate director of policy analysis at the Penn Wharton Budget Model, a nonpartisan fiscal policy research group at UPenn’s Wharton School.
“We think it is pretty reasonable to estimate that wealthy investors will be able to avoid 90% of investment taxes” if they continue to realize gains the way they are currently, Ricco told Financial Advisor.
He says that’s because investors realize capital gains less often when the taxes on them increase, and the reverse is also true, something shown by “a large body of empirical research,” Ricco said.
“Compared with other forms of income taxed under the individual income tax, capital gains are relatively responsive, or elastic, with respect to tax rates,” the study says.
In other words, an increase in the capital gains tax will lead wealthy Americans to avoid the sale of appreciated stock and other investments, pair gains with losses for tax harvesting and sell off investments slowly to minimize taxes, the Wharton researchers say.
Biden has proposed the nearly $1 trillion in taxes to offset his $1.5 trillion "American Families Plan,” which includes free prekindergarten education, includes two years of tuition-free community college, extends the child tax credit and creates a national paid leave program.
Step-Up Gone?
Another Biden policy proposal is to eliminate the step-up in basis for assets when an investor dies, a policy that allows the wealthy to pass on highly appreciated assets to heirs tax-free. If the step-up were removed, the proposed tax rate increase would raise $113 billion over 10 years—far less than the $1 trillion the Biden administration is estimating, the Penn-Wharton study found.
Will Congress be able to squeak out legislation containing both policy changes? “The critical piece is how the legislation is designed and how much teeth it actually has,” Ricco said. “If the step-up in basis remains intact, then wealthy taxpayers would have an incentive to defer investment sales indefinitely.